<PAGE> 1
As filed with the Securities and Registration No. 2-96219
Exchange Commission on August 1, 2000. 811-4182
===========================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [ ]
Pre-Effective Amendment No. [ ]
Post-Effective Amendment No. 30 [x]
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940 [ ]
Amendment No. 32 [x]
(Check appropriate box or boxes)
------------------------
HOTCHKIS AND WILEY FUNDS
(Exact name of registrant as specified in charter)
725 S. Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code (213) 430-1000
Turner Swan
725 S. Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(Name and address of Agent for Service)
with a copy to:
Paul H. Dykstra, Esq.
Gardner, Carton & Douglas
321 North Clark Street
Chicago, IL 60610-4795
Approximate date of proposed public offering: As soon as practicable
after the effective date of the registration statement.
It is proposed that this filing will become effective (check
appropriate box)
[ ] immediately upon filing pursuant to paragraph (b)
[ ] on (date) pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[X] on October 5, 2000 pursuant to paragraph (a)(1)
[ ] 75 days after filing pursuant to paragraph (a)(2)
[ ] on (date) pursuant to paragraph (a)(2) of Rule 485
If appropriate, check the following box:
[ ] this post-effective amendment designates a new effective date
for a previously filed post-effective amendment.
================================================================================
Title of Securities Being Registered..............Shares of Beneficial Interest,
no par value
<PAGE> 2
MERCURY HW LARGE CAP VALUE FUND
OF MERCURY HW FUNDS
[ARTWORK]
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING INFORMATION
ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST
AND KEEP IT FOR FUTURE REFERENCE.
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.
PROSPECTUS - October , 2000
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
[GLOBE ICON]
FUND FACTS
-----------------------------------------------------------------
About the Mercury HW Large Cap Value Fund................... 2
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[MAGNIFYING GLASS ICON]
ABOUT THE DETAILS
-----------------------------------------------------------------
How the Fund Invests........................................ 7
Investment Risks............................................ 7
Statement of Additional Information......................... 11
[CHECKMARK ICON]
ACCOUNT CHOICES
-----------------------------------------------------------------
Pricing of Shares........................................... 12
How to Buy, Sell, Transfer and Exchange Shares.............. 14
How Shares are Priced....................................... 18
Fee-Based Programs.......................................... 18
Dividends and Taxes......................................... 19
[MANAGEMENT TEAM ICON]
THE MANAGEMENT TEAM
-----------------------------------------------------------------
Management of the Fund...................................... 21
Financial Highlights........................................ 22
[TELEPHONE ICON]
TO LEARN MORE
-----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERCURY HW LARGE CAP VALUE FUND
<PAGE> 4
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
COMMON STOCK -- units of ownership of a corporation.
PRICE-TO-EARNINGS RATIO -- price of a stock divided by its earnings per share.
YIELD -- percentage rate of return paid on a stock in dividends and share
repurchases.
PRICE-TO-BOOK VALUE RATIO -- price of a stock divided by its book value per
share.
[GLOBE ICON] Fund Facts
ABOUT THE MERCURY HW LARGE CAP VALUE FUND
--------------------------------------------------------------------------------
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to seek current income and long-term growth
of income, accompanied by growth of capital.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests primarily in COMMON STOCKS of U.S. companies.
In investing the Fund's assets, Mercury Advisors (the "Investment Adviser")
follows a value style. This means that the Investment Adviser buys stocks that
it believes are currently undervalued by the market and thus have a lower price
than their true worth. Typical value characteristics include:
- low PRICE-TO-EARNINGS RATIO relative to the market
- high YIELD relative to the market
- low PRICE-TO-BOOK VALUE RATIO relative to the market
- financial strength
Stocks may be "undervalued" because they are part of an industry that is out of
favor with investors generally. Even in those industries, though, individual
companies may have high rates of growth of earnings and be financially sound. At
the same time, the price of their common stock may be depressed because
investors associate the companies with their industries.
This value discipline sometimes prevents or limits investments in stocks that
are in well-known indexes, like the S&P 500 Index. Also, the return of the Fund
will not necessarily be similar to the return of the S&P 500 Index.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of Fund shares, may go up or down. These changes may occur because the
stock market is rising or falling. At other times, there are specific factors
that may affect the value of a particular investment. If the value of the Fund's
investments goes down, you may lose money.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
2
MERCURY HW LARGE CAP VALUE FUND
<PAGE> 5
[GLOBE ICON] Fund Facts
See "Investment Risks" for more information about the risks associated with the
Fund.
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are seeking long-term growth of capital and can withstand the
share price volatility of equity investing.
- Are seeking a diversified portfolio of equity securities.
- Want a professionally managed and diversified portfolio.
- Are willing to accept the risk that the value of your investment
may decline in order to seek long-term capital appreciation.
- Are prepared to receive taxable distributions.
MERCURY HW LARGE CAP VALUE FUND 3
<PAGE> 6
[GLOBE ICON] Fund Facts
RISK/RETURN BAR CHART
--------------------------------------------------------------------------------
The bar chart and table below provide some indication of the risks of investing
in the Fund by showing changes in the year to year performance of the Fund and
by showing how the Fund's average annual total returns for 1, 5 and 10 years and
for its life compare with those of a broad measure of market performance. How
the Fund has performed in the past is not necessarily an indication of how the
Fund will perform in the future.
<TABLE>
<S> <C>
1990 -18.06%
1991 34.62%
1992 13.95%
1993 15.78%
1994 -3.49%
1995 34.43%
1996 17.39%
1997 31.16%
1998 4.34%
1999 -2.35%
</TABLE>
Total return for the six months ended June 30, 2000: -9.52%.
During the period shown in the bar chart, the highest return for a quarter was
17.70% (quarter ended March 31, 1991) and the lowest return for a quarter was
-19.94% (quarter ended September 30, 1990).
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
(FOR THE PERIODS ENDED DECEMBER 31, PAST PAST PAST SINCE
1999) ONE YEAR FIVE YEARS TEN YEARS INCEPTION
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CLASS I*+ -2.35% 16.09% 11.47% 11.01%(1)
S&P 500 INDEX 21.14% 28.66% 18.25% 16.32%
-------------------------------------------------------------------------------------------
</TABLE>
The S&P 500 Index is a capital weighted, unmanaged index representing the
aggregate market value of the common equity of 500 stocks primarily traded on
the New York Stock Exchange.
* Includes the effect of sales charges, which were not imposed until October
, 2000.
+ As of October , 2000, Investor Class shares were redesignated Class I
shares.
(1) Inception date is June 24, 1987.
4
MERCURY HW LARGE CAP VALUE FUND
<PAGE> 7
[GLOBE ICON] Fund Facts
UNDERSTANDING EXPENSES
Fund investors pay various expenses, either directly or indirectly. Listed below
are some of the main types of expenses, which all mutual funds may charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
INVESTMENT ADVISORY FEE -- a fee paid to the Investment Adviser for managing the
Fund.
FEES AND EXPENSES
--------------------------------------------------------------------------------
The Fund offers a single class of shares.
THIS TABLE SHOWS THE DIFFERENT FEES AND EXPENSES THAT YOU MAY PAY IF YOU BUY AND
HOLD SHARES OF THE FUND. FUTURE EXPENSES MAY BE GREATER OR LESS THAN THOSE
INDICATED BELOW.
<TABLE>
<CAPTION>
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)(A): CLASS I*
------------------------------------------------------------------------
<S> <C>
Maximum Sales Charge (Load) imposed on purchases (as a
percentage of offering price) 5.25%(b)
------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a percentage of
original purchase price or redemption proceeds, whichever is
lower) None(c)
------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend Reinvestments None
------------------------------------------------------------------------
Redemption Fee None
------------------------------------------------------------------------
Exchange Fee None
------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED
FROM THE FUND'S TOTAL ASSETS):
------------------------------------------------------------------------
INVESTMENT ADVISORY FEE(d) 0.75%
------------------------------------------------------------------------
DISTRIBUTION AND/OR SERVICE (12b-1) FEES None
------------------------------------------------------------------------
Other Expenses (including transfer agency fees) 0.27%
------------------------------------------------------------------------
TOTAL ANNUAL OPERATING EXPENSES 1.02%
------------------------------------------------------------------------
Expense Reimbursement(d) 0.07%
------------------------------------------------------------------------
NET ANNUAL FUND OPERATING EXPENSES 0.95%
------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C>
( *) As of October , 2000, Investor Class shares were
redesignated Class I shares.
(a) Certain securities dealers or other financial intermediaries
may charge a fee to process a purchase or sale of shares.
See "How to Buy, Sell, Transfer and Exchange Shares."
(b) Some investors may qualify for reductions in the sales
charge (load).
(c) You may pay a deferred sales charge if you purchase $1
million or more and you redeem within one year.
(d) The Investment Adviser has contractually agreed to waive
management fees and/or reimburse expenses through June 30,
2001, as shown in the table.
</TABLE>
MERCURY HW LARGE CAP VALUE FUND 5
<PAGE> 8
[GLOBE ICON] Fund Facts
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, and that the Fund's operating expenses remain the same except for
the expense reimbursement in effect for the first year. This assumption is not
meant to indicate you will receive a 5% annual rate of return. Your annual
return may be more or less than the 5% used in these examples. Although your
actual costs may be higher or lower, based on these assumptions, your costs
would be:
<TABLE>
<CAPTION>
CLASS I
-------------------------------------------------------------------------------
<S> <C>
ONE YEAR $ 617
-------------------------------------------------------------------------------
THREE YEARS $ 826
-------------------------------------------------------------------------------
FIVE YEARS $1,052
-------------------------------------------------------------------------------
TEN YEARS $1,705
-------------------------------------------------------------------------------
</TABLE>
6
MERCURY HW LARGE CAP VALUE FUND
<PAGE> 9
ABOUT THE PORTFOLIO MANAGERS -- Gail Bardin is a managing director of the
Investment Adviser and began co-managing the Fund in April 1994. She has been a
portfolio manager of the Investment Adviser since 1988.
Sheldon Lieberman joined the Investment Adviser in 1994 and began co-managing
the Fund in August 1997. Before joining the Investment Adviser, Mr. Lieberman
was the Chief Investment Officer for the Los Angeles County Employees Retirement
Association.
ABOUT THE INVESTMENT ADVISER -- Mercury Advisors manages the Fund.
[MAGNIFYING GLASS ICON] About the Details
HOW THE FUND INVESTS
--------------------------------------------------------------------------------
The Fund's investment objective is to provide current income and long-term
growth of income, accompanied by growth of capital.
The Fund invests mostly in common stocks of large U.S. companies. Normally, the
Fund invests at least 80% of its total assets in stocks that pay dividends. It
also may invest in stocks that don't pay dividends, but have growth potential
unrecognized by the market or changes in business or management that indicate
growth potential.
The Fund can invest up to 10% of its total assets in foreign securities.
MONEY MARKET INVESTMENTS
To meet redemptions and when waiting to invest cash receipts, the Fund may
invest in short-term, investment grade bonds, money market mutual funds and
other money market instruments. Also, the Fund temporarily can invest up to 100%
of its assets in short-term, investment grade bonds and other money market
instruments in response to adverse market, economic or political conditions. The
Fund may not achieve its objectives using this type of investing.
INVESTMENT RISKS
--------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK
Market risk is the risk that the market will go down in value, including the
possibility that the market will go down sharply and unpredictably. Selection
risk is the risk that the investments that Fund management selects will
underperform the market or other funds with similar investment objectives and
investment strategies.
FOREIGN MARKET RISK
The Fund may invest up to 10% of its total assets in foreign securities. Such
investments involve special risks not present in U.S. investments that can
increase the chances that the Fund will lose money. In particular, investments
in foreign
MERCURY HW LARGE CAP VALUE FUND 7
<PAGE> 10
[MAGNIFYING GLASS ICON] About the Details
securities involve the following risks, which are generally greater for
investments in emerging markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair the Fund's
ability to purchase or sell foreign securities or transfer its
assets or income back into the U.S., or otherwise adversely affect
the Fund's operations.
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal
remedies available to investors in some foreign countries may be
less extensive than those available to investors in the U.S.
- Because there are generally fewer investors on foreign exchanges
and a smaller number of shares traded each day, it may be
difficult for the Fund to buy and sell securities on those
exchanges. In addition, prices of foreign securities may go up and
down more than prices of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and the Fund's assets may be
8
MERCURY HW LARGE CAP VALUE FUND
<PAGE> 11
[MAGNIFYING GLASS ICON] About the Details
uninvested and not earning returns. The Fund also may miss
investment opportunities or be unable to sell an investment
because of these delays.
- The value of the Fund's foreign holdings (and hedging transactions
in foreign currencies) will be affected by changes in currency
exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- International trade barriers or economic sanctions against certain
foreign countries may adversely affect the Fund's holdings.
EUROPEAN ECONOMIC AND MONETARY UNION (EMU)
A number of European countries have entered into EMU in an effort to reduce
trade barriers between themselves and eliminate fluctuations in their
currencies. EMU establishes a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These securities trade and make dividend and other payments only in euros. Like
other investment companies and business organizations, including the companies
in which the Fund invests, the Fund could be adversely affected if the
transition to euro, or EMU as a whole, does not take effect as planned, or if a
participating country withdraws from EMU.
RISKS OF CONVERTIBLE SECURITIES
Convertibles are generally bonds or preferred stocks that may be converted into
common stock. Convertibles typically pay current income, as either interest
(bond convertibles) or dividends (preferred stocks). A convertible's value
usually reflects both the stream of current income payments and the value of the
underlying common stock. The market value of a convertible performs like regular
bonds; that is, if market interest rates rise, the value of a convertible
MERCURY HW LARGE CAP VALUE FUND 9
<PAGE> 12
[MAGNIFYING GLASS ICON] About the Details
usually falls. Since it is convertible into common stock, the convertible also
has the same types of market and issuer risk as the underlying common stock.
DEBT SECURITIES
Debt securities, such as bonds, involve credit risk, which is the risk that the
borrower will not make timely payments of principal and interest. These
securities are also subject to interest rate risk, which is the risk that the
value of the security may fall when interest rates rise. In general, the market
price of debt securities with longer maturities will go up or down more in
response to changes in interest rates than shorter-term securities.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD COMMITMENTS
When-issued securities, delayed-delivery securities and forward commitments
involve the risk that the security the Fund buys will lose value prior to its
delivery to the Fund. There also is the risk that the security will not be
issued or that the other party will not meet its obligation, in which case the
Fund loses the investment opportunity of the assets it has set aside to pay for
the security and any gain in the security's price.
DERIVATIVES
Derivatives involve the following risks:
- CREDIT RISK -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Fund.
- CURRENCY RISK -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
- LEVERAGE RISK -- Leverage risk is the risk associated with certain
types of investments or trading strategies that relatively small
market movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- LIQUIDITY RISK -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time that
the seller would like or at the price that the seller believes the
security is currently worth.
- INDEX RISK -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
10
MERCURY HW LARGE CAP VALUE FUND
<PAGE> 13
[MAGNIFYING GLASS ICON] About the Details
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
STATEMENT OF ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERCURY HW LARGE CAP VALUE FUND 11
<PAGE> 14
[CHECKMARK ICON] Account Choices
PRICING OF SHARES
--------------------------------------------------------------------------------
The Fund offers a single class of shares.
The Fund's shares are distributed by FAM Distributors, Inc. (the "Distributor").
Certain financial institutions may charge you additional fees in connection with
transactions in fund shares. The Investment Adviser, the Distributor or their
affiliates may make payments out of their own resources to securities dealers
and other financial intermediaries for providing services intended to result in
the sale of Fund shares or for shareholder servicing activities.
To better understand the pricing of the Fund's shares, we have summarized the
information below:
<TABLE>
<CAPTION>
CLASS I*
--------------------------------------------------------------------------------------
<S> <C>
Availability LIMITED TO CERTAIN INVESTORS INCLUDING:
- Investor Class and current Class I shareholders.
- Certain retirement plans.
- Participants in certain sponsored programs.
- Certain affiliates or customers of selected
securities dealers or other financial intermediaries.
[- Certain institutional investors.]
--------------------------------------------------------------------------------------
Initial Sales Charge? YES. PAYABLE AT TIME OF PURCHASE. LOWER SALES CHARGES
AVAILABLE FOR LARGER INVESTMENTS.
--------------------------------------------------------------------------------------
Deferred Sales Charge? NO. (MAY BE CHARGED FOR PURCHASES OVER $1 MILLION THAT
ARE REDEEMED WITHIN ONE YEAR.)
--------------------------------------------------------------------------------------
Account Maintenance and NO.
Distribution Fees?
--------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares.
12
MERCURY HW LARGE CAP VALUE FUND
<PAGE> 15
[CHECKMARK ICON] Account Choices
RIGHT OF ACCUMULATION -- permits you to pay the sales charge applicable to the
cost or value (whichever is higher) of all shares you own in the Mercury mutual
funds.
LETTER OF INTENT -- permits you to pay the sales charge that would be applicable
if you add up all shares of Mercury mutual funds that you agree to buy within a
13 month period. Certain restrictions apply.
CLASS I SHARES* -- INITIAL SALES CHARGE OPTION
If you buy shares of the Fund, you will pay a sales charge at the time of
purchase as shown in the following table. Securities dealers' compensation will
be as shown in the last column.
<TABLE>
<CAPTION>
DEALER
AS A % OF COMPENSATION
AS A % OF YOUR AS A % OF
YOUR INVESTMENT OFFERING PRICE INVESTMENT** OFFERING PRICE
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
LESS THAN $25,000 5.25% 5.54% 5.00%
---------------------------------------------------------------------------------------
$25,000 BUT LESS THAN
$50,000 4.75% 4.99% 4.50%
---------------------------------------------------------------------------------------
$50,000 BUT LESS THAN
$100,000 4.00% 4.17% 3.75%
---------------------------------------------------------------------------------------
$100,000 BUT LESS THAN
$250,000 3.00% 3.09% 2.75%
---------------------------------------------------------------------------------------
$250,000 BUT LESS THAN
$1,000,000 2.00% 2.04% 1.80%
---------------------------------------------------------------------------------------
$1,000,000 AND OVER*** 0.00% 0.00% 0.00%
---------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares.
** Rounded to the nearest one-hundredth percent.
*** If you invest $1,000,000 or more in Class I shares, you may not pay an
initial sales charge. In that case, the Investment Adviser compensates the
selling dealer or other financial intermediary from its own resources. If
you redeem your shares within one year after purchase, you may be charged a
deferred sales charge. This charge is 1% of the lesser of the original cost
of the shares being redeemed or your redemption proceeds. A sales charge of
0.75% will be charged on purchases of $1,000,000 or more of Class I shares
by certain employer sponsored retirement or savings plans.
No initial sales charge applies to shares that you buy through reinvestment of
dividends.
A reduced or waived sales charge on a purchase of Class I shares may apply for:
- Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT
- Certain trusts managed by banks, thrifts or trust companies
including those affiliated with the Investment Adviser or its
affiliates
- Certain employer-sponsored retirement or savings plans
- Certain investors, including directors or trustees of mutual funds
sponsored by the Investment Adviser or its affiliates, employees
of the Investment Adviser and its affiliates and employees or
customers of selected dealers
MERCURY HW LARGE CAP VALUE FUND 13
<PAGE> 16
[CHECKMARK ICON] Account Choices
- Certain fee-based programs managed by the Investment Adviser or
its affiliates
- Certain fee-based programs managed by selected securities dealers
that have an agreement with the Distributor
- Purchases through certain financial advisers, selected securities
dealers, brokers, investment advisers, service providers and other
financial intermediaries
- Purchases through certain accounts over which the Investment
Adviser or an affiliate exercises investment discretion
[- Certain institutional investors.]
If you redeem Class I shares and within 30 days buy new shares of the same
class, you will not pay a sales charge on the new purchase amount. The amount
eligible for this "Reinstatement Privilege" may not exceed the amount of your
redemption proceeds. To exercise the privilege, contact your financial
consultant, selected securities dealer or other financial intermediary or the
Fund's Transfer Agent at 1-800-236-4479.
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
--------------------------------------------------------------------------------
The chart below summarizes how to buy, sell, transfer and exchange shares
through your financial consultant, selected securities dealer, broker,
investment adviser, service provider or other financial intermediary. You may
also buy shares through the Transfer Agent. To learn more about buying shares
through the Transfer Agent, call 1-800-236-4479. Because the selection of a
mutual fund involves many considerations, your financial consultant, selected
securities dealer or other financial intermediary may help you with this
decision. The Fund does not issue share certificates.
Because of the high cost of maintaining smaller shareholder accounts, the Fund
may redeem the shares in your account (without charging any deferred sales
charge) if the net asset value of your account falls below $500 due to
redemptions you have made. You will be notified that the value of your account
is less than $500 before the Fund makes an involuntary redemption. You will then
have 60 days to make an additional investment to bring the value of your account
to at least $500 before the Fund takes any action. This involuntary redemption
does not apply to retirement plans or Uniform Gifts or Transfers to Minors Act
accounts.
14
MERCURY HW LARGE CAP VALUE FUND
<PAGE> 17
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BUY SHARES
Determine the amount of your The minimum initial investment for the Fund is $1,000 for
investment all accounts except:
- $500 for certain fee-based programs
- $100 for retirement plans (The minimums for initial
investments may be waived under certain circumstances.)
-------------------------------------------------------------------------------------------------
Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. Purchase orders
other financial intermediary placed prior to the close of regular trading on the New York
submit your purchase order Stock Exchange (generally, 4:00 p.m. Eastern time) are
priced at the net asset value determined that day. Certain
financial intermediaries, however, may require submission of
orders prior to that time.
Purchase orders placed after that time are priced at the net
asset value determined on the next business day. The Fund
may reject any order to buy shares and may suspend the sale
of shares at any time. Certain financial intermediaries may
charge a fee to process a purchase. For example, Merrill
Lynch, Pierce, Fenner & Smith Incorporated currently charges
a $5.35 processing fee. The fees charged by other financial
intermediaries may be higher or lower.
-------------------------------------------------------------------------------------------------
Or contact the Transfer Agent To purchase shares directly, call the Transfer Agent at
1-800-236-4479 and request a purchase application. Mail the
completed purchase application to the Transfer Agent at the
address on the back cover of this prospectus.
------------------------------------------------------------------------------------------------------------------------
ADD TO YOUR Purchase additional shares The minimum investment for additional purchases is generally
INVESTMENT $100 for all accounts except:
- $50 for certain fee-based programs
- $1 for retirement plans (The minimums for additional
purchases may be waived under certain circumstances.)
-------------------------------------------------------------------------------------------------
Acquire additional shares All dividends are automatically reinvested without a sales
through the automatic dividend charge.
reinvestment plan
-------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan your selected securities dealer or other financial
intermediary. The current minimum for such automatic
reinvestments is $100. The minimum may be waived or revised
under certain circumstances.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY HW LARGE CAP VALUE FUND 15
<PAGE> 18
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
TRANSFER SHARES TO Transfer to a participating You may transfer your Fund shares to another selected
ANOTHER SELECTED securities dealer or other securities dealer or other financial intermediary if
SECURITIES DEALER financial intermediary authorized dealer agreements are in place between the
OR OTHER FINANCIAL Distributor and the transferring intermediary and the
INTERMEDIARY Distributor and the receiving intermediary. Certain
shareholder services may not be available for all
transferred shares. You may only purchase additional shares
of funds previously owned before the transfer. All future
trading of these shares must be coordinated by the receiving
intermediary.
-------------------------------------------------------------------------------------------------
Transfer to a non-participating You must either: - Transfer your shares to an account with
securities dealer or other the Transfer Agent; or - Sell your shares, paying any
financial intermediary applicable deferred sales charge.
------------------------------------------------------------------------------------------------------------------------
SELL YOUR SHARES Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. For your
other financial intermediary redemption request to be priced at the net asset value on
submit your sales order the day of your request, you must submit your request to
your selected securities dealer or other financial
intermediary prior to that day's close of regular trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern
time). Certain financial intermediaries, however, may
require submission of orders prior to that time. Redemption
requests placed after that time are priced at the net asset
value at the close of regular trading on the next business
day.
Certain financial intermediaries may charge a fee to process
a sale of shares. For example, Merrill Lynch, Pierce, Fenner
& Smith Incorporated currently charges a $5.35 processing
fee. No processing fee is charged if you redeem the shares
directly through the Transfer Agent. The fees charged by
other intermediaries may be higher or lower.
The Fund may reject an order to sell shares under certain
circumstances.
-------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by writing to
the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter. A signature guarantee will generally be
required but may be waived in certain limited circumstances.
You can obtain a signature guarantee from a bank, securities
dealer, securities broker, credit union, savings
association, national securities exchange and registered
securities association. A notary public seal will not be
acceptable. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
16 MERCURY HW LARGE CAP VALUE FUND
<PAGE> 19
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SELL SHARES Participate in the Fund's You can choose to receive systematic payments from your Fund
SYSTEMATICALLY Systematic Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. You can
generally arrange through your selected securities dealer or
other financial intermediary for systematic sales of shares
of a fixed dollar amount on a monthly, bi-monthly,
quarterly, semi-annual or annual basis, subject to certain
conditions. Under either method, you must have dividends
automatically reinvested. Ask your financial intermediary
for details.
------------------------------------------------------------------------------------------------------------------------
EXCHANGE YOUR Select the fund into which you You can exchange your shares of the Fund for shares of other
SHARES want to exchange. Be sure to Mercury mutual funds or for shares of the Summit Cash
read that fund's prospectus Reserves Fund. You must have held the shares used in the
exchange for at least 15 calendar days before you can
exchange to another fund.
If you wish to exchange into a fund in which you have no
Class I shares (and are not eligible to buy Class I shares),
you will exchange into Class A shares. If you wish to
exchange into Summit, you will exchange into Class A shares
of Summit.
Some of the Mercury mutual funds may impose a different
initial or deferred sales charge schedule. If you exchange
Class I shares for shares of a fund with a higher initial
sales charge than you originally paid, you may be charged
the difference at the time of exchange.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY HW LARGE CAP VALUE FUND 17
<PAGE> 20
[CHECKMARK ICON] Account Choices
NET ASSET VALUE -- the market value in U.S. dollars of the Fund's total assets
after deducting liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
--------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open as of the close of regular trading on the Exchange based on
prices at the time of closing. Regular trading on the Exchange generally closes
at 4:00 p.m. Eastern time. The net asset value used in determining your price is
the next one calculated after your purchase or redemption order is placed.
Foreign securities owned by the Fund may trade on weekends or other days when
the Fund does not price its shares. As a result, the Fund's net asset value may
change on days when you will not be able to purchase or redeem the Fund's
shares.
The Fund may accept orders from certain authorized financial intermediaries or
their designees. The Fund will be deemed to receive an order when accepted by
the intermediary or designee and the order will receive the net asset value next
computed by the Fund after such acceptance. If the payment for a purchase order
is not made by a designated later time, the order will be canceled and the
financial intermediary could be held liable for any losses.
FEE-BASED PROGRAMS
--------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by the Investment
Adviser or an affiliate of the Investment Adviser, or by selected securities
dealers or other financial intermediaries that have an agreement with the
Distributor, you may be able to buy Class I shares at net asset value, including
by exchanges from other share classes. Sales charges on the shares being
exchanged may be reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program [and purchase shares of another class, which may be subject to
distribution and account maintenance fees.] This may be a taxable event and you
will pay any applicable sales charges.
18
MERCURY HW LARGE CAP VALUE FUND
<PAGE> 21
[CHECKMARK ICON] Account Choices
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed ordinary income or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
[If you leave one of these programs, your shares may be redeemed or
automatically exchanged into another class of the Fund's shares or into the
Summit fund. The class you receive may be the class you originally owned when
you entered the program, or in certain cases, a different class.] Any redemption
or exchange will be at net asset value. However, if you participate in the
program for less than a specified period, you may be charged a fee in accordance
with the terms of the program.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your financial
consultant, selected securities dealer or other financial intermediary.
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
The Fund will distribute any net investment income quarterly and any net
realized long-term or short-term capital gains at least annually. The Fund may
also pay a special distribution at the end of the calendar year to comply with
Federal tax requirements. DIVIDENDS may be reinvested automatically in shares of
the Fund at net asset value without a sales charge or may be taken in cash. If
your account is with a selected securities dealer or other financial
intermediary that has an agreement with the Fund, contact your dealer or
intermediary about which option you would like. If your account is with the
Transfer Agent and you would like to receive dividends in cash, contact the
Transfer Agent. The Fund anticipates that the majority of its dividends, if any,
will consist of ordinary income. Capital gains, if any, may be taxable to you at
different rates, depending, in part, on how long the Fund has held the assets
sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your shares and any
gain on the transaction may be subject to tax. Capital gain dividends are
generally taxed at different rates than ordinary income dividends.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax treaties between certain countries
and the U.S. may reduce or eliminate such taxes.
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
MERCURY HW LARGE CAP VALUE FUND 19
<PAGE> 22
[CHECKMARK ICON] Account Choices
By law, the Fund must withhold 31% of your dividends and redemption proceeds if
you have not provided a taxpayer identification number or social security number
or if the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
20
MERCURY HW LARGE CAP VALUE FUND
<PAGE> 23
[MANAGEMENT TEAM ICON] The Management Team
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
Mercury Advisors, the Fund's Investment Adviser, manages the Fund's investments
under the overall supervision of the Board of Trustees. The Investment Adviser
has the responsibility for making all investment decisions for the Fund. For the
fiscal year ended June 30, 2000, the Fund paid the Investment Adviser a fee at
the annual rate of 0.75% of the average daily net assets of the Fund.
The Investment Adviser was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
The Investment Adviser and its affiliates had approximately $555 billion in
investment company and other portfolio assets under management as of June 30,
2000.
Although not required to do so, the Investment Adviser has agreed to make
reimbursements so that the regular annual operating expenses of the Fund will be
limited as shown in the table on page 5. The Investment Adviser has agreed to
these expense limits through June 2001, and will thereafter give shareholders at
least 30 days' notice if this reimbursement policy will change.
The Investment Adviser is allowed to allocate brokerage based on sales of shares
of funds managed by the Investment Adviser.
MERCURY HW LARGE CAP VALUE FUND 21
<PAGE> 24
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned (or lost) on an investment
in the Fund (assuming reinvestment of all dividends and distributions). These
financial highlights were audited by PricewaterhouseCoopers LLP. The
accountants' report and the Fund's financial statements are included in the
Fund's annual report, which is available upon request. Further performance
information is contained in the annual report.
<TABLE>
<CAPTION>
CLASS I(1)
----------------------------------------------------------------
FOR THE YEAR ENDED JUNE 30,
INCREASE (DECREASE) IN ----------------------------------------------------------------
NET ASSET VALUE: 2000 1999 1998 1997 1996
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
-------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $ 22.02 $ 21.25 $ 18.91 $ 17.24
-------------------------------------------------------------------------------------------------------------------------
Investment income -- net 0.41 0.46 0.49 0.45(2)
-------------------------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss) on investments -- net 0.82 4.02 4.15 2.89
-------------------------------------------------------------------------------------------------------------------------
Total from investment operations 1.23 4.48 4.64 3.34
-------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions
Investment income -- net (0.41) (0.46) (0.48) (0.57)
Realized gain on investments -- net (2.88) (3.25) (1.82) (1.10)
-------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions (3.29) (3.71) (2.30) (1.67)
-------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $ 19.96 $ 22.02 $ 21.25 $ 18.91
-------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
-------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share 7.32% 22.60% 26.15% 20.04%
-------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
-------------------------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement 0.91% 0.87% 0.88% 0.98%
-------------------------------------------------------------------------------------------------------------------------
Expenses 0.91% 0.87% 0.88% 0.98%
-------------------------------------------------------------------------------------------------------------------------
Investment income -- net 2.09% 1.99% 2.49% 2.56%
-------------------------------------------------------------------------------------------------------------------------
Supplemental Data:
-------------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in millions) $148.70 $175.30 $185.90 $182.50
-------------------------------------------------------------------------------------------------------------------------
Portfolio turnover 18% 23% 44% 24%
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) As of October , 2000, Investor Class shares were redesignated Class I
shares.
No sales loads were charged prior to this time.
(2) Net investment income per share is calculated using ending balances prior
to consideration of adjustments for permanent book and tax differences.
* Total investment return excludes the effects of sales charges.
22 MERCURY HW LARGE CAP VALUE FUND
<PAGE> 25
<TABLE>
<S> <C>
FUND
Mercury HW Large Cap Value Fund
of Mercury HW Funds
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(800-236-4479)
INVESTMENT ADVISER
Administrative Offices:
Mercury Advisors
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
725 South Figueroa Street,
Suite 4000
Los Angeles, California 90017-5400
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 41621
Jacksonville, Florida 32232-1621
(800-236-4479)
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
100 E. Wisconsin Ave., Suite 1500
Milwaukee, Wisconsin 53202
DISTRIBUTOR
FAM Distributors, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109-3661
COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610-4795
</TABLE>
<PAGE> 26
SHAREHOLDER REPORTS
Additional information about the Fund's investments will be available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report you will find a discussion of the relevant market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling
1-800-236-4479.
The Fund will send you one copy of each shareholder report and certain other
mailings regardless of the number of Fund accounts you have. To receive separate
shareholder reports for each account, call your financial consultant or other
financial intermediary or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and brokerage or mutual
fund account number. If you have any questions, please call your financial
consultant or other financial intermediary or the Transfer Agent at
1-800-236-4479.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at Financial Data Services, Inc., P.O. Box 41621, Jacksonville, Florida
32232-1621 or by calling 1-800-236-4479.
Contact your financial consultant or other financial intermediary or the Fund at
the telephone number or address indicated on the inside back cover of this
prospectus if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet Site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION IN THIS PROSPECTUS.
Investment Company Act File #811-4182.
CODE #MHW-1040-1000
(C) Mercury Advisors
[TELEPHONE ICON] To Learn More
Mercury HW
Large Cap Value Fund
OF MERCURY HW FUNDS
[ARTWORK]
PROSPECTUS - October , 2000
<PAGE> 27
Mercury HW Mid-Cap Value Fund
OF MERCURY HW FUNDS
[ARTWORK]
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING INFORMATION
ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST
AND KEEP IT FOR FUTURE REFERENCE.
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.
PROSPECTUS - October , 2000
<PAGE> 28
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
[GLOBE ICON]
FUND FACTS
-----------------------------------------------------------------
About the Mercury HW Mid-Cap Value Fund..................... 2
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[MAGNIFYING GLASS ICON]
ABOUT THE DETAILS
-----------------------------------------------------------------
How the Fund Invests........................................ 7
Investment Risks............................................ 7
Statement of Additional Information......................... 11
[CHECKMARK ICON]
ACCOUNT CHOICES
-----------------------------------------------------------------
Pricing of Shares........................................... 12
How to Buy, Sell, Transfer and Exchange Shares.............. 15
How Shares are Priced....................................... 19
Fee-Based Programs.......................................... 19
Dividends and Taxes......................................... 20
[MANAGEMENT TEAM ICON]
THE MANAGEMENT TEAM
-----------------------------------------------------------------
Management of the Fund...................................... 22
Financial Highlights.................... ................... 23
[TELEPHONE ICON]
TO LEARN MORE
-----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERCURY HW MID-CAP VALUE FUND
<PAGE> 29
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
COMMON STOCK -- units of ownership of a corporation.
PRICE-TO-EARNINGS RATIO -- price of a stock divided by its earnings per share.
YIELD -- percentage rate of return paid on a stock in dividends and share
repurchases.
PRICE-TO-BOOK VALUE RATIO -- price of a stock divided by its book value per
share.
[GLOBE ICON] Fund Facts
ABOUT THE MERCURY HW MID-CAP VALUE FUND
--------------------------------------------------------------------------------
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to seek current income and long-term growth
of income, accompanied by growth of capital.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests primarily in COMMON STOCKS of U.S. companies with market
capitalizations of less than $10 billion. The Fund can invest up to 20% of its
total assets in foreign securities.
In investing the Fund's assets, Mercury Advisors (the "Investment Adviser")
follows a value style. This means that the Investment Adviser buys stocks that
it believes are currently undervalued by the market and thus have a lower price
than their true worth. Typical value characteristics include:
- low PRICE-TO-EARNINGS RATIO relative to the market
- high YIELD relative to the market
- low PRICE-TO-BOOK VALUE RATIO relative to the market
- financial strength
Stocks may be "undervalued" because they are part of an industry that is out of
favor with investors generally. Even in those industries, though, individual
companies may have high rates of growth of earnings and be financially sound. At
the same time, the price of their common stock may be depressed because
investors associate the companies with their industries.
This value discipline sometimes prevents or limits investments in stocks that
are in well-known indexes, like the Russell Midcap Index. Also, the return of
the Fund will not necessarily be similar to the return of the Russell Midcap
Index.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of Fund shares, may go up or down. These changes may occur because the
stock market is rising or falling. At other times, there are specific factors
that may affect the value of a particular investment. If the value of the Fund's
investments goes down, you may lose money.
2
MERCURY HW MID-CAP VALUE FUND
<PAGE> 30
[GLOBE ICON] Fund Facts
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
See "Investment Risks" for more information about the risks associated with the
Fund.
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are seeking long-term growth of capital and can withstand the
share price volatility of equity investing.
- Are seeking to diversify a portfolio of equity securities to
include stocks with market capitalizations under $10 billion.
- Want a professionally managed and diversified portfolio.
- Are willing to accept the risk that the value of your investment
may decline in order to seek long-term capital appreciation.
- Are prepared to receive taxable distributions.
MERCURY HW MID-CAP VALUE FUND 3
<PAGE> 31
[GLOBE ICON] Fund Facts
RISK/RETURN BAR CHART
--------------------------------------------------------------------------------
The bar charts and tables below provide some indication of the risks of
investing in the Fund by showing changes in the year to year performance of the
Fund and by showing how the Fund's average annual total returns for 1 year and
for its life compare with those of a broad measure of market performance. How
the Fund has performed in the past is not necessarily an indication of how the
Fund will perform in the future.
<TABLE>
<CAPTION>
---- -----
<S> <C>
1997 32.44%
1998 -10.26%
1999 16.87%
</TABLE>
Total return for the six months ended June 30, 2000: 15.28%.
During the period shown in the bar chart, the highest return for a quarter was
26.36% (quarter ended June 30, 1999) and the lowest return for a quarter was
-17.56% (quarter ended September 30, 1998).
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS PAST SINCE
(FOR THE PERIODS ENDED DECEMBER 31, 1999) ONE YEAR INCEPTION
------------------------------------------------------------------------------------
<S> <C> <C>
CLASS I*+ 16.87% 11.57%(1)
RUSSELL MIDCAP INDEX 18.23% 18.86%(2)
------------------------------------------------------------------------------------
</TABLE>
The Russell Midcap Index is an unmanaged index that measures the performance of
the 800 smallest companies in the Russell 1000 Index, which represents
approximately 26% of the total market capitalization of the Russell 1000 Index.
* Includes the effect of sales charges, which were not imposed until October
, 2000.
+ As of October , 2000, Investor Class shares were redesignated Class I
shares.
(1) Inception date is January 2, 1997.
(2) Since January 1, 1997.
4
MERCURY HW MID-CAP VALUE FUND
<PAGE> 32
[GLOBE ICON] Fund Facts
UNDERSTANDING EXPENSES
Fund investors pay various expenses, either directly or indirectly. Listed below
are some of the main types of expenses, which all mutual funds may charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
INVESTMENT ADVISORY FEE -- a fee paid to the Investment Adviser for managing the
Fund.
FEES AND EXPENSES
--------------------------------------------------------------------------------
The Fund offers a single class of shares.
THIS TABLE SHOWS THE DIFFERENT FEES AND EXPENSES THAT YOU MAY PAY IF YOU BUY AND
HOLD SHARES OF THE FUND. FUTURE EXPENSES MAY BE GREATER OR LESS THAN THOSE
INDICATED BELOW.
<TABLE>
<CAPTION>
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)(A): CLASS I*
------------------------------------------------------------------------
<S> <C>
Maximum Sales Charge (Load) imposed on purchases (as a
percentage of offering price) 5.25%(b)
------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a percentage of
original purchase price or redemption proceeds, whichever is
lower) None(c)
------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend Reinvestments
------------------------------------------------------------------------
Redemption Fee None
------------------------------------------------------------------------
Exchange Fee None
------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED
FROM THE FUND'S TOTAL ASSETS):
------------------------------------------------------------------------
INVESTMENT ADVISORY FEE(d) 0.75%
------------------------------------------------------------------------
DISTRIBUTION AND/OR SERVICE (12b-1) FEES None
------------------------------------------------------------------------
Other Expenses (including transfer agency fees) 1.37%
------------------------------------------------------------------------
TOTAL ANNUAL OPERATING EXPENSES 2.12%
------------------------------------------------------------------------
Expense Reimbursement(d) 0.97%
------------------------------------------------------------------------
NET ANNUAL FUND OPERATING EXPENSES 1.15%
------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C>
( *) As of October , 2000, Investor Class shares were
redesignated Class I shares.
(a) Certain securities dealers or other financial intermediaries
may charge a fee to process a purchase or sale of shares.
See "How to Buy, Sell, Transfer and Exchange Shares."
(b) Some investors may qualify for reductions in the sales
charge (load).
(c) You may pay a deferred sales charge if you purchase $1
million or more and you redeem within one year.
(d) The Investment Adviser has contractually agreed to waive
management fees and/or reimburse expenses through June 30,
2001, as shown in the table.
</TABLE>
MERCURY HW MID-CAP VALUE FUND 5
<PAGE> 33
[GLOBE ICON] Fund Facts
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, and that the Fund's operating expenses remain the same except for
the expense reimbursement in effect for the first year. This assumption is not
meant to indicate you will receive a 5% annual rate of return. Your annual
return may be more or less than the 5% used in these examples. Although your
actual costs may be higher or lower, based on these assumptions, your costs
would be:
<TABLE>
<CAPTION>
CLASS I
-------------------------------------------------------------------------------
<S> <C>
ONE YEAR $ 636
-------------------------------------------------------------------------------
THREE YEARS $1,026
-------------------------------------------------------------------------------
FIVE YEARS $1,440
-------------------------------------------------------------------------------
TEN YEARS $2,591
-------------------------------------------------------------------------------
</TABLE>
6
MERCURY HW MID-CAP VALUE FUND
<PAGE> 34
ABOUT THE PORTFOLIO MANAGERS -- Jim Miles began co-managing the Fund in May 1995
when he joined the Investment Adviser. Before joining the Investment Adviser,
Mr. Miles was with BT Securities Corporation (an affiliate of Bankers Trust New
York Corporation) as vice president in the BT Securities Finance Group from 1988
to 1995.
Stan Majcher has been a portfolio manager of the Fund since January 1999. Mr.
Majcher joined the Investment Adviser in August 1996 as a domestic equity
analyst. From 1994 to 1996, he was an investment banking analyst at Merrill
Lynch & Co. Inc.
ABOUT THE INVESTMENT ADVISER -- Mercury Advisors manages the Fund.
[MAGNIFYING GLASS ICON] About the Details
HOW THE FUND INVESTS
--------------------------------------------------------------------------------
The Fund's investment objective is to provide current income and long-term
growth of income, accompanied by growth of capital.
The Fund invests at least 65% of its total assets in stocks of mid-size U.S.
companies. A "mid-size company" is one with a market capitalization of less than
$10 billion at the time of investment.
The Fund can invest up to 20% of its total assets in foreign securities.
MONEY MARKET INVESTMENTS
To meet redemptions and when waiting to invest cash receipts, the Fund may
invest in short-term, investment grade bonds, money market mutual funds and
other money market instruments. Also, the Fund temporarily can invest up to 100%
of its assets in short-term, investment grade bonds and other money market
instruments in response to adverse market, economic or political conditions. The
Fund may not achieve its objective using this type of investing.
INVESTMENT RISKS
--------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK
Market risk is the risk that the market will go down in value, including the
possibility that the market will go down sharply and unpredictably. Selection
risk is the risk that the investments that Fund management selects will
underperform the market or other funds with similar investment objectives and
investment strategies.
RISKS OF INVESTING IN SMALL AND MID-SIZE COMPANIES
The Fund invests in the securities of small and mid-size companies. Investment
in small and mid-size companies involves more risk than investing in larger,
more established companies. Small and mid-size companies may have limited
product lines or markets. They may be less financially secure than larger, more
established companies. They may depend on a small number of key personnel. If a
product fails, or if management changes, or there are other adverse
developments, the Fund's investment in a small or mid-size company may lose
substantial value.
MERCURY HW MID-CAP VALUE FUND 7
<PAGE> 35
[MAGNIFYING GLASS ICON] About the Details
Securities of small and mid-size companies generally trade in lower volumes and
are subject to greater and more unpredictable price changes than larger cap
securities or the stock market as a whole. Investing in securities of small and
mid-size companies requires a long-term view.
FOREIGN MARKET RISK
The Fund may invest up to 20% of its total assets in foreign securities. Such
investments involve special risks not present in U.S. investments that can
increase the chances that the Fund will lose money. In particular, investments
in foreign securities involve the following risks, which are generally greater
for investments in emerging markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair the Fund's
ability to purchase or sell foreign securities or transfer its
assets or income back into the U.S., or otherwise adversely affect
the Fund's operations.
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal
remedies available to investors in some foreign countries may be
less extensive than those available to investors in the U.S.
8
MERCURY HW MID-CAP VALUE FUND
<PAGE> 36
[MAGNIFYING GLASS ICON] About the Details
- Because there are generally fewer investors on foreign exchanges
and a smaller number of shares traded each day, it may be
difficult for the Fund to buy and sell securities on those
exchanges. In addition, prices of foreign securities may go up and
down more than prices of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and the Fund's assets may be uninvested
and not earning returns. The Fund also may miss investment
opportunities or be unable to sell an investment because of these
delays.
- The value of the Fund's foreign holdings (and hedging transactions
in foreign currencies) will be affected by changes in currency
exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- International trade barriers or economic sanctions against certain
foreign countries may adversely affect the Fund's foreign
holdings.
EUROPEAN ECONOMIC AND MONETARY UNION (EMU)
A number of European countries have entered into EMU in an effort to reduce
trade barriers between themselves and eliminate fluctuations in their
currencies. EMU establishes a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These securities trade and make dividend and other payments only in euros. Like
other investment companies and business organizations, including the companies
in which the Fund invests, the Fund could be adversely affected if the
transition to euro, or EMU as a whole, does not take effect as planned or a
participating country withdraws from EMU.
MERCURY HW MID-CAP VALUE FUND 9
<PAGE> 37
[MAGNIFYING GLASS ICON] About the Details
RISKS OF CONVERTIBLE SECURITIES
Convertibles are generally bonds or preferred stocks that may be converted into
common stock. Convertibles typically pay current income, as either interest
(bond convertibles) or dividends (preferred stocks). A convertible's value
usually reflects both the stream of current income payments and the value of the
underlying common stock. The market value of a convertible performs like regular
bonds; that is, if market interest rates rise, the value of a convertible
usually falls. Since it is convertible into common stock, the convertible also
has the same types of market and issuer risk as the underlying common stock.
DEBT SECURITIES
Debt securities, such as bonds, involve credit risk, which is the risk that the
borrower will not make timely payments of principal and interest. These
securities are also subject to interest rate risk, which is the risk that the
value of the security may fall when interest rates rise. In general, the market
price of debt securities with longer maturities will go up or down more in
response to changes in interest rates than shorter term securities.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD COMMITMENTS
When-issued securities, delayed-delivery securities and forward commitments
involve the risk that the security the Fund buys will lose value prior to its
delivery to the Fund. There also is the risk that the security will not be
issued or that the other party will not meet its obligation, in which case the
Fund loses the investment opportunity of the assets it has set aside to pay for
the security and any gain in the security's price.
DERIVATIVES
Derivatives involve the following risks:
- CREDIT RISK -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Fund.
10
MERCURY HW MID-CAP VALUE FUND
<PAGE> 38
[MAGNIFYING GLASS ICON] About the Details
- CURRENCY RISK -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
- LEVERAGE RISK -- Leverage risk is the risk associated with certain
types of investments or trading strategies that relatively small
market movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- LIQUIDITY RISK -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time that
the seller would like or at the price that the seller believes the
security is currently worth.
- INDEX RISK -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
STATEMENT OF ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERCURY HW MID-CAP VALUE FUND 11
<PAGE> 39
[CHECKMARK ICON] Account Choices
PRICING OF SHARES
--------------------------------------------------------------------------------
The Fund offers a single class of shares.
The Fund's shares are distributed by FAM Distributors, Inc. (the "Distributor").
Certain financial institutions may charge you additional fees in connection with
transactions in fund shares. The Investment Adviser, the Distributor or their
affiliates may make payments out of their own resources to selected securities
dealers and other financial intermediaries for providing services intended to
result in the sale of Fund shares or for shareholder servicing activities.
To better understand the pricing of the Fund's shares, we have summarized the
information below:
<TABLE>
<CAPTION>
CLASS I*
------------------------------------------------------------------------------------
<S> <C>
Availability LIMITED TO CERTAIN INVESTORS INCLUDING: - Investor Class
shareholders.
- Certain retirement plans.
- Participants in certain sponsored programs.
- Certain affiliates or customers of selected securities
dealers and other financial intermediaries.
[- Certain institutional investors.]
------------------------------------------------------------------------------------
Initial Sales Charge? YES. PAYABLE AT TIME OF PURCHASE. LOWER SALES CHARGES
AVAILABLE FOR LARGER INVESTMENTS.
------------------------------------------------------------------------------------
Deferred Sales NO. (MAY BE CHARGED FOR PURCHASES OVER $1 MILLION THAT
Charge? ARE REDEEMED WITHIN ONE YEAR.)
------------------------------------------------------------------------------------
Account Maintenance NO.
and Distribution
Fees?
------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares.
12
MERCURY HW MID-CAP VALUE FUND
<PAGE> 40
[CHECKMARK ICON] Account Choices
RIGHT OF ACCUMULATION -- permits you to pay the sales charge applicable to the
cost or value (whichever is higher) of all shares you own in the Mercury mutual
funds.
LETTER OF INTENT -- permits you to pay the sales charge that would be applicable
if you add up all shares of Mercury mutual funds that you agree to buy within a
13 month period. Certain restrictions apply.
CLASS I SHARES* -- INITIAL SALES CHARGE OPTION
If you buy shares of the Fund, you will pay a sales charge at the time of
purchase as shown in the following table. Securities dealers' compensation will
be as shown in the last column.
<TABLE>
<CAPTION>
DEALER
AS A % OF COMPENSATION
AS A % OF YOUR AS A % OF
YOUR INVESTMENT OFFERING PRICE INVESTMENT** OFFERING PRICE
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
LESS THAN $25,000 5.25% 5.54% 5.00%
---------------------------------------------------------------------------------------
$25,000 BUT LESS THAN
$50,000 4.75% 4.99% 4.50%
---------------------------------------------------------------------------------------
$50,000 BUT LESS THAN
$100,000 4.00% 4.17% 3.75%
---------------------------------------------------------------------------------------
$100,000 BUT LESS THAN
$250,000 3.00% 3.09% 2.75%
---------------------------------------------------------------------------------------
$250,000 BUT LESS THAN
$1,000,000 2.00% 2.04% 1.80%
---------------------------------------------------------------------------------------
$1,000,000 AND OVER*** 0.00% 0.00% 0.00%
---------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares.
** Rounded to the nearest one-hundredth percent.
*** If you invest $1,000,000 or more in Class I shares, you may not pay an
initial sales charge. In that case, the Investment Adviser compensates the
selling dealer or other financial intermediary from its own resources. If
you redeem your shares within one year after purchase, you may be charged a
deferred sales charge. This charge is 1% of the lesser of the original cost
of the shares being redeemed or your redemption proceeds. A sales charge of
0.75% will be charged on purchases of $1,000,000 or more of Class I shares
by certain employer sponsored retirement or savings plans.
No initial sales charge applies to Class I shares that you buy through
reinvestment of dividends.
A reduced or waived sales charge on a purchase of Class I shares may apply for:
- Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT
- Certain trusts managed by banks, thrifts or trust companies
including those affiliated with the Investment Adviser or its
affiliates
- Certain employer-sponsored retirement or savings plans
- Certain investors, including directors or trustees of mutual funds
sponsored by the Investment Adviser or its affiliates, employees
of the Investment Adviser and its affiliates and employees or
customers of selected dealers
MERCURY HW MID-CAP VALUE FUND 13
<PAGE> 41
[CHECKMARK ICON] Account Choices
- Certain fee-based programs managed by the Investment Adviser or
its affiliates
- Certain fee-based programs managed by selected securities dealers
that have an agreement with the Distributor
- Purchases through certain financial advisers, selected securities
dealers, brokers, investment advisers, service providers and other
financial intermediaries
- Purchases through certain accounts over which the Investment
Adviser or an affiliate exercises investment discretion
[- Certain institutional investors]
If you redeem Class I shares and within 30 days buy new shares of the same
class, you will not pay a sales charge on the new purchase amount. The amount
eligible for this "Reinstatement Privilege" may not exceed the amount of your
redemption proceeds. To exercise the privilege, contact your financial
consultant, selected securities dealer, other financial intermediary or the
Fund's Transfer Agent at 1-800-236-4479.
14
MERCURY HW MID-CAP VALUE FUND
<PAGE> 42
[CHECKMARK ICON] Account Choices
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
--------------------------------------------------------------------------------
The chart below summarizes how to buy, sell, transfer and exchange shares
through your financial consultant, selected securities dealer, broker,
investment adviser, service provider or other financial intermediary. You may
also buy shares through the Transfer Agent. To learn more about buying shares
through the Transfer Agent, call 1-800-236-4479. Because the selection of a
mutual fund involves many considerations, your financial consultant, selected
securities dealer or other financial intermediary may help you with this
decision. The Fund does not issue share certificates.
Because of the high cost of maintaining smaller shareholder accounts, the Fund
may redeem the shares in your account (without charging any deferred sales
charge) if the net asset value of your account falls below $500 due to
redemptions you have made. You will be notified that the value of your account
is less than $500 before the Fund makes an involuntary redemption. You will then
have 60 days to make an additional investment to bring the value of your account
to at least $500 before the Fund takes any action. This involuntary redemption
does not apply to retirement plans or Uniform Gifts or Transfers to Minors Act
accounts.
MERCURY HW MID-CAP VALUE FUND 15
<PAGE> 43
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BUY SHARES Determine the amount of your The minimum initial investment for the Fund is $1,000 for
investment all accounts except: - $500 for certain fee-based programs
- $100 for retirement plans (The minimums for initial
investments may be waived under certain circumstances.)
-------------------------------------------------------------------------------------------------
Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. Purchase orders
other financial intermediary placed prior to the close of regular trading on the New York
submit your purchase order Stock Exchange (generally, 4:00 p.m. Eastern time) are
priced at the net asset value determined that day. Certain
financial intermediaries, however, may require submission of
orders prior to that time.
Purchase orders placed after that time are priced at the net
asset value determined on the next business day. The Fund
may reject any order to buy shares and may suspend the sale
of shares at any time. Certain financial intermediaries may
charge a fee to process a purchase. For example, Merrill
Lynch, Pierce, Fenner & Smith Incorporated currently charges
a $5.35 processing fee. The fees charged by other financial
intermediaries may be higher or lower.
-------------------------------------------------------------------------------------------------
Or contact the Transfer Agent To purchase shares directly, call the Transfer Agent at
1-800-236-4479 and request a purchase application. Mail the
completed purchase application to the Transfer Agent at the
address on the back cover of this prospectus.
------------------------------------------------------------------------------------------------------------------------
ADD TO YOUR Purchase additional shares The minimum investment for additional purchases is generally
INVESTMENT $100 for all accounts except: - $50 for certain fee-based
programs - $1 for retirement plans (The minimums for
additional purchases may be waived under certain
circumstances.)
-------------------------------------------------------------------------------------------------
Acquire additional shares All dividends are automatically reinvested without a sales
through the automatic dividend charge.
reinvestment plan
-------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan your selected securities dealer or other financial
intermediary. The current minimum for such automatic
reinvestments is $100. The minimum may be waived or revised
under certain circumstances.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
16 MERCURY HW MID-CAP VALUE FUND
<PAGE> 44
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
TRANSFER SHARES TO Transfer to a participating You may transfer your Fund shares to another selected
ANOTHER SECURITIES securities dealer or other securities dealer or other financial intermediary if
DEALER OR OTHER financial intermediary authorized dealer agreements are in place between the
FINANCIAL Distributor and the transferring intermediary and the
INTERMEDIARY Distributor and the receiving intermediary. Certain
shareholder services may not be available for all
transferred shares. You may only purchase additional shares
of funds previously owned before the transfer. All future
trading of these assets must be coordinated by the receiving
intermediary.
-------------------------------------------------------------------------------------------------
Transfer to a non-participating You must either: - Transfer your shares to an account with
securities dealer or other the Transfer Agent; or - Sell your shares, paying any
financial intermediary applicable deferred sales charge.
------------------------------------------------------------------------------------------------------------------------
SELL YOUR SHARES Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. For your
other financial intermediary redemption request to be priced at the net asset value on
submit your sales order the day of your request, you must submit your request to
your selected securities dealer or other financial
intermediary prior to that day's close of regular trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern
time). Certain financial intermediaries, however, may
require submission of orders prior to that time. Redemption
requests placed after that time are priced at the net asset
value at the close of regular trading on the next business
day.
Certain financial intermediaries may charge a fee to process
a sale of shares. For example, Merrill Lynch, Pierce, Fenner
& Smith Incorporated currently charges a $5.35 processing
fee. No processing fee is charged if you redeem the shares
directly through the Transfer Agent. The fees charged by
other financial intermediaries may be higher or lower.
The Fund may reject an order to sell shares under certain
circumstances.
-------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by writing to
the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter. A signature guarantee will generally be
required but may be waived in certain limited circumstances.
You can obtain a signature guarantee from a bank, securities
dealer, securities broker, credit union, savings
association, national securities exchange and registered
securities association. A notary public seal will not be
acceptable. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY HW MID-CAP VALUE FUND 17
<PAGE> 45
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SELL SHARES Participate in the Fund's You can choose to receive systematic payments from your Fund
SYSTEMATICALLY Systematic Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. You can
generally arrange through your selected securities dealer or
other financial intermediary for systematic sales of shares
of a fixed dollar amount on a monthly, bi-monthly,
quarterly, semi-annual or annual basis, subject to certain
conditions. Under either method, you must have dividends
automatically reinvested. Ask your financial intermediary
for details.
------------------------------------------------------------------------------------------------------------------------
EXCHANGE YOUR Select the fund into which you You can exchange your shares of the Fund for shares of other
SHARES want to exchange. Be sure to Mercury mutual funds or for shares of the Summit Cash
read that fund's prospectus Reserves Fund. You must have held the shares used in the
exchange for at least 15 calendar days before you can
exchange to another fund.
Each class of Fund shares is generally exchangeable for
shares of the same class of another Mercury fund. If you
wish to exchange into a fund in which you have no Class I
shares (and are not eligible to buy Class I shares), you
will exchange into Class A shares. If you wish to exchange
into Summit, you will exchange into Class A shares of
Summit.
Some of the Mercury mutual funds may impose a different
initial or deferred sales charge schedule. If you exchange
Class I shares for shares of a fund with a higher initial
sales charge than you originally paid, you may be charged
the difference at the time of exchange.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
18 MERCURY HW MID-CAP VALUE FUND
<PAGE> 46
[CHECKMARK ICON] Account Choices
NET ASSET VALUE -- the market value in U.S. dollars of the Fund's total assets
after deducting liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
--------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open as of the close of regular trading on the Exchange based on
prices at the time of closing. Regular trading on the Exchange generally closes
at 4:00 p.m. Eastern time. The net asset value used in determining your price is
the next one calculated after your purchase or redemption order is placed.
Foreign securities owned by the Fund may trade on weekends or other days when
the Fund does not price its shares. As a result, the Fund's net asset value may
change on days when you will not be able to purchase or redeem the Fund's
shares.
The Fund may accept orders from certain authorized financial intermediaries or
their designees. The Fund will be deemed to receive an order when accepted by
the intermediary or designee and the order will receive the net asset value next
computed by the Fund after such acceptance. If the payment for a purchase order
is not made by a designated later time, the order will be canceled and the
financial intermediary could be held liable for any losses.
FEE-BASED PROGRAMS
--------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by the Investment
Adviser or an affiliate of the Investment Adviser, or by selected securities
dealers or other financial intermediaries that have an agreement with the
Distributor, you may be able to buy Class I shares at net asset value, including
by exchanges from other share classes. Sales charges on the shares being
exchanged may be reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
MERCURY HW MID-CAP VALUE FUND 19
<PAGE> 47
[CHECKMARK ICON] Account Choices
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed ordinary income or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
If you leave one of these programs, your shares may be redeemed or automatically
exchanged into another class of the Fund's shares or into the Summit fund. The
class you receive may be the class you originally owned when you entered the
program, or in certain cases, a different class. Any redemption or exchange will
be at net asset value. However, if you participate in the program for less than
a specified period, you may be charged a fee in accordance with the terms of the
program.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your financial
consultant, selected securities dealer or other financial intermediary.
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
The Fund will distribute at any net investment income and any net realized
long-term or short-term capital gains least annually. The Fund may also pay a
special distribution at the end of the calendar year to comply with Federal tax
requirements. DIVIDENDS may be reinvested automatically in shares of the Fund at
net asset value without a sales charge or may be taken in cash. If your account
is with a selected securities dealer or other financial intermediary that has an
agreement with the Fund, contact your dealer or intermediary about which option
you would like. If your account is with the Transfer Agent and you would like to
receive dividends in cash, contact the Transfer Agent. The Fund anticipates that
the majority of its dividends, if any, will consist of ordinary income. Capital
gains, if any, may be taxable to you at different rates, depending, in part, on
how long the Fund has held the assets sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your shares and any
gain on the transaction may be subject to tax. Capital gain dividends are
generally taxed at different rates than ordinary income dividends.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax treaties between certain countries
and the U.S. may reduce or eliminate such taxes.
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
20
MERCURY HW MID-CAP VALUE FUND
<PAGE> 48
[CHECKMARK ICON] Account Choices
By law, the Fund must withhold 31% of your dividends and redemption proceeds if
you have not provided a taxpayer identification number or social security number
or if the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
MERCURY HW MID-CAP VALUE FUND 21
<PAGE> 49
[MANAGEMENT TEAM ICON] The Management Team
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
Mercury Advisors, the Fund's Investment Adviser, manages the Fund's investments
under the overall supervision of the Board of Trustees. The Investment Adviser
has the responsibility for making all investment decisions for the Fund. For the
fiscal year ended June 30, 2000, the Fund paid the Investment Adviser a fee at
the annual rate of 0.75% of the average daily net assets of the Fund.
The Investment Adviser was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
The Investment Adviser and its affiliates had approximately $555 billion in
investment company and other portfolio assets under management as of June 30,
2000.
Although not required to do so, the Investment Adviser has agreed to make
reimbursements so that the regular annual operating expenses of the Fund will be
limited as shown in the table on page 5. The Investment Adviser has agreed to
these expense limits through June 2001, and will thereafter give shareholders at
least 30 days' notice if this reimbursement policy will change.
The Investment Adviser is allowed to allocate brokerage based on sales of shares
of funds managed by the Investment Adviser.
22
MERCURY HW MID-CAP VALUE FUND
<PAGE> 50
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned on an investment in the
Fund (assuming reinvestment of all dividends and distributions). These financial
highlights were audited by PricewaterhouseCoopers LLP. The accountants' report
and the Fund's financial statements are included in the Fund's annual report,
which is available upon request. Further performance information is contained in
the annual report.
<TABLE>
<CAPTION>
CLASS I(1)
-----------------------------------------
FOR THE YEAR ENDED JUNE 30,
INCREASE (DECREASE) IN -----------------------------------------
NET ASSET VALUE: 2000 1999 1998 1997(2)
-------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
-------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $12.92 $11.65 $10.00
-------------------------------------------------------------------------------------------------------
Investment income -- net 0.16 0.13 0.07
-------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss) on investments -- net 0.46 1.60 1.64
-------------------------------------------------------------------------------------------------------
Total from investment operations 0.62 1.73 1.71
-------------------------------------------------------------------------------------------------------
Less dividends and distributions
-------------------------------------------------------------------------------------------------------
Investment income -- net -- (0.14) (0.06)
-------------------------------------------------------------------------------------------------------
Realized gain on investments -- net (1.51) (0.46) --
-------------------------------------------------------------------------------------------------------
Total dividends and distributions (1.51) (0.46) (0.06)
-------------------------------------------------------------------------------------------------------
Net asset value, end of year $12.03 $12.92 $11.65
-------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
-------------------------------------------------------------------------------------------------------
Based on net asset value per share 7.66% 15.00% 17.15%(++)
-------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
-------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement 1.05% 1.00% 1.00%(+)
-------------------------------------------------------------------------------------------------------
Expenses 2.02% 2.72% 8.26%(+)
-------------------------------------------------------------------------------------------------------
Investment income -- net 1.43% 1.20% 1.87%(+)
-------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
-------------------------------------------------------------------------------------------------------
Net assets, end of year (in millions) $ 6.90 $ 7.50 $ 2.00
-------------------------------------------------------------------------------------------------------
Portfolio turnover 113% 71% 23%(++)
-------------------------------------------------------------------------------------------------------
</TABLE>
(1) As of October , 2000, Investor Class shares were redesignated Class I
shares.
No sales loads were charged prior to this time.
(2) The Fund commenced operations on January 2, 1997.
* Total investment returns exclude the effects of sales charges.
(+) Annualized.
(++) Not annualized.
MERCURY HW MID-CAP VALUE FUND 23
<PAGE> 51
<TABLE>
<S> <C>
FUND
Mercury HW Mid-Cap Value Fund
of Mercury HW Funds
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(800-236-4479)
INVESTMENT ADVISER
Administrative Offices:
Mercury Advisors
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
725 South Figueroa Street,
Suite 4000
Los Angeles, California 90017-5400
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 41621
Jacksonville, Florida 32232-1621
(800-236-4479)
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
100 E. Wisconsin Ave., Suite 1500
Milwaukee, Wisconsin 53202
DISTRIBUTOR
FAM Distributors, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109-3661
COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610-4795
</TABLE>
<PAGE> 52
[TELEPHONE ICON] To Learn More
SHAREHOLDER REPORTS
Additional information about the Fund's investments will be available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report you will find a discussion of the relevant market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling
1-800-236-4479.
The Fund will send you one copy of each shareholder report and certain other
mailings regardless of the number of Fund accounts you have. To receive separate
shareholder reports for each account, call your financial consultant or other
financial intermediary or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and brokerage or mutual
fund account number. If you have any questions, please call your financial
consultant or the Transfer Agent at 1-800-236-4479.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at Financial Data Services, Inc., P.O. Box 41621, Jacksonville, Florida
32232-1621 or by calling 1-800-236-4479.
Contact your financial consultant or other financial intermediary or the Fund at
the telephone number or address indicated on the inside back cover of this
prospectus if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet Site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION IN THIS PROSPECTUS.
Investment Company Act File #811-4182.
CODE #MHW-1050-1000
(C) Mercury Advisors
Mercury HW
Mid-Cap Value Fund
OF MERCURY HW FUNDS
[ARTWORK]
PROSPECTUS - October , 2000
<PAGE> 53
Mercury HW Small Cap Value Fund
OF MERCURY HW FUNDS
ARTWORK
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING INFORMATION
ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST
AND KEEP IT FOR FUTURE REFERENCE.
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.
PROSPECTUS - October , 2000
<PAGE> 54
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
[GLOBE ICON]
FUND FACTS
-----------------------------------------------------------------
About the Mercury HW Small Cap Value Fund................... 2
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[MAGNIFYING GLASS ICON]
ABOUT THE DETAILS
-----------------------------------------------------------------
How the Fund Invests........................................ 7
Investment Risks............................................ 7
Statement of Additional Information......................... 11
[CHECKMARK ICON]
ACCOUNT CHOICES
-----------------------------------------------------------------
Pricing of Shares........................................... 12
How to Buy, Sell, Transfer and Exchange Shares.............. 15
How Shares are Priced....................................... 19
Fee-Based Programs.......................................... 19
Dividends and Taxes......................................... 20
[MANAGEMENT TEAM ICON]
THE MANAGEMENT TEAM
-----------------------------------------------------------------
Management of the Fund...................................... 22
Financial Highlights........................................ 23
[TELEPHONE ICON]
TO LEARN MORE
-----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERCURY HW SMALL CAP VALUE FUND
<PAGE> 55
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
COMMON STOCK -- units of ownership of a corporation.
PRICE-TO-EARNINGS RATIO -- price of a stock divided by its earnings per share.
[GLOBE ICON] Fund Facts
ABOUT THE MERCURY HW SMALL CAP VALUE FUND
--------------------------------------------------------------------------------
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to seek capital appreciation.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests primarily in COMMON STOCKS of U.S. companies with market
capitalizations of less than $2 billion. The Fund can invest up to 20% of its
total assets in foreign securities.
In investing the Fund's assets, Mercury Advisors (the "Investment Adviser")
follows a value style. This means that the Investment Adviser buys stocks that
it believes are currently undervalued by the market and thus have a lower price
than their true worth. Typical value characteristics include:
- low PRICE-TO-EARNINGS RATIO relative to the market
- low PRICE-TO-EARNINGS RATIO relative to expected growth rate
- financial strength
Stocks may be "undervalued" because they are part of an industry that is out of
favor with investors generally. Even in those industries, though, individual
companies may have high rates of growth of earnings and be financially sound. At
the same time, the price of their common stock may be depressed because
investors associate the companies with their industries.
This value discipline sometimes prevents or limits investments in stocks that
are in well-known indexes, like the Russell 2000 Index. Also, the return of the
Fund will not necessarily be similar to the return of the Russell 2000 Index.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of Fund shares, may go up or down. These changes may occur because the
stock market is rising or falling. At other times, there are specific factors
that may affect the value of a particular investment. If the value of the Fund's
investments goes down, you may lose money.
2
MERCURY HW SMALL CAP VALUE FUND
<PAGE> 56
[GLOBE ICON] Fund Facts
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
See "Investment Risks" for more information about the risks associated with the
Fund.
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are seeking long-term growth of capital and can withstand the
share price volatility of equity investing.
- Are seeking to diversify a portfolio of equity securities to
include small capitalization and foreign stocks.
- Want a professionally managed and diversified portfolio.
- Are willing to accept the risk that the value of your investment
may decline in order to seek long-term capital appreciation.
- Are not looking for current income.
- Are prepared to receive taxable distributions.
MERCURY HW SMALL CAP VALUE FUND 3
<PAGE> 57
[GLOBE ICON] Fund Facts
RISK/RETURN BAR CHART
--------------------------------------------------------------------------------
The bar chart and table below provide some indication of the risks of investing
in the Fund by showing changes in the year to year performance of the Class I
shares of the Fund and by showing how the Fund's average annual total returns
for 1, 5 and 10 years and for the life of the Class compare with those of a
broad measure of market performance. How the Fund has performed in the past is
not necessarily an indication of how the Fund will perform in the future.
<TABLE>
<CAPTION>
<S> <C>
1990 -9.01%
1991 48.24%
1992 13.73%
1993 12.59%
1994 1.12%
1995 18.43%
1996 14.26%
1997 39.52%
1998 -15.56%
1999 -12.53%
</TABLE>
Total return for the six months ended June 30, 2000: 0.42%.
During the period shown in the bar chart, the highest return for a quarter was
25.72% (quarter ended June 30, 1999) and the lowest return for a quarter was
-27.51% (quarter ended June 30, 1990).
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
(FOR THE PERIODS ENDED PAST PAST PAST SINCE
DECEMBER 31, 1999) ONE YEAR FIVE YEARS TEN YEARS INCEPTION
------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CLASS I*+ -12.53% 6.88% 9.31% 10.05%(1)
RUSSELL 2000 INDEX 21.26% 16.69% 13.40% 12.88%
------------------------------------------------------------------------------
CLASS A*++ N/A N/A N/A N/A
RUSSELL 2000 INDEX N/A N/A N/A N/A
------------------------------------------------------------------------------
</TABLE>
The Russell 2000 Index is a stock market index comprised of the 2,000 smallest
companies in the Russell 3000 Index, which represents approximately 8% of the
total market capitalization of the Russell 3000 Index.
* Includes the effect of sales charges, which were not imposed until October
, 2000.
+ As of October , 2000, Investor Class shares were redesignated Class I
shares.
++ As of October , 2000, Distributor Class shares were redesignated Class A
shares.
(1) Inception date is September 20, 1985.
4
MERCURY HW SMALL CAP VALUE FUND
<PAGE> 58
[GLOBE ICON] Fund Facts
UNDERSTANDING EXPENSES
Fund investors pay various expenses, either directly or indirectly. Listed below
are some of the main types of expenses, which all mutual funds may charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
INVESTMENT ADVISORY FEE -- a fee paid to the Investment Adviser for managing the
Fund.
SERVICE (ACCOUNT MAINTENANCE FEES -- fees used to compensate selected securities
dealers or other financial intermediaries for account maintenance activities.
FEES AND EXPENSES
--------------------------------------------------------------------------------
The Fund offers two different classes of shares. Although your money will be
invested the same way no matter which class of shares you buy, there are
differences among the fees and expenses associated with each class. Not everyone
is eligible to buy every class. Your financial consultant, selected securities
dealer or other financial intermediary can help you determine which classes you
are eligible to buy.
THIS TABLE SHOWS THE DIFFERENT FEES AND EXPENSES THAT YOU MAY PAY IF YOU BUY AND
HOLD THE DIFFERENT CLASSES OF SHARES OF THE FUND. FUTURE EXPENSES MAY BE GREATER
OR LESS THAN THOSE INDICATED BELOW.
<TABLE>
<CAPTION>
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)(a): CLASS I* CLASS A*
----------------------------------------------------------------------------------------
<S> <C> <C>
Maximum Sales Charge (Load) imposed on purchases (as a
percentage of offering price) 5.25%(b) 5.25%(b)
----------------------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a percentage of
original purchase price or redemption proceeds, whichever is
lower) None(c) None(c)
----------------------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend Reinvestments
----------------------------------------------------------------------------------------
Redemption Fee None None
----------------------------------------------------------------------------------------
Exchange Fee None None
----------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED
FROM THE FUND'S TOTAL ASSETS):
----------------------------------------------------------------------------------------
INVESTMENT ADVISORY FEE(d) 0.75% 0.75%
----------------------------------------------------------------------------------------
DISTRIBUTION AND/OR SERVICE (12b-1) FEES(e) None 0.25%
----------------------------------------------------------------------------------------
Other Expenses (including transfer agency and administrative
fees) 0.57% 0.57%
----------------------------------------------------------------------------------------
TOTAL ANNUAL OPERATING EXPENSES 1.32% 1.57%
----------------------------------------------------------------------------------------
Expense Reimbursement(d) 0.07% 0.07%
----------------------------------------------------------------------------------------
NET ANNUAL FUND OPERATING EXPENSES 1.25% 1.50%
----------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C>
( )* As of October , 2000, Investor Class shares were
redesignated Class I shares and Distributor Class shares
were redesignated Class A shares.
(a) Certain securities dealers or other financial intermediaries
may charge a fee to process a purchase or sale of shares.
See "How to Buy, Sell, Transfer and Exchange Shares."
(b) Some investors may qualify for reductions in the sales
charge (load).
(c) You may pay a deferred sales charge if you purchase $1
million or more and you redeem within one year.
(d) The Investment Adviser has contractually agreed to waive
management fees and/or reimburse expenses through June 30,
2001, as shown in the table.
(e) The Fund calls the "Service Fee" an "Account Maintenance
Fee." Account Maintenance Fee is the term used elsewhere in
this prospectus and in all other Fund materials.
</TABLE>
MERCURY HW SMALL CAP VALUE FUND 5
<PAGE> 59
[GLOBE ICON] Fund Facts
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, if any, that apply to the particular class and that the Fund's
operating expenses remain the same except for the expense reimbursement in
effect for the first year. This assumption is not meant to indicate you will
receive a 5% annual rate of return. Your annual return may be more or less than
the 5% used in these examples. Although your actual costs may be higher or
lower, based on these assumptions, your costs would be:
<TABLE>
<CAPTION>
CLASS I CLASS A
--------------------------------------------------------------------------------------
<S> <C> <C>
ONE YEAR $ 646 $ 670
--------------------------------------------------------------------------------------
THREE YEARS $ 915 $ 988
--------------------------------------------------------------------------------------
FIVE YEARS $1,204 $1,329
--------------------------------------------------------------------------------------
TEN YEARS $2,026 $2,289
--------------------------------------------------------------------------------------
</TABLE>
6
MERCURY HW SMALL CAP VALUE FUND
<PAGE> 60
ABOUT THE PORTFOLIO MANAGERS -- Jim Miles has served as a portfolio manager of
the Fund since it began in January 1997. Mr. Miles joined the Investment Adviser
in 1995. Before joining the Investment Adviser, Mr. Miles was with BT Securities
Corporation (an affiliate of Bankers Trust New York Corporation) as vice
president in the BT Securities Finance Group from 1988 to 1995.
David Green became a co-manager of the Fund when he joined the Investment
Adviser in 1997. Before that, Mr. Green was associated with Goldman Sachs Asset
Management, where he worked as an investment analyst from November 1995. Before
that, he was an investment manager and analyst with Prudential Investment
Advisors.
ABOUT THE INVESTMENT ADVISER -- Mercury Advisors manages the Fund
[MAGNIFYING GLASS ICON] About the Details
HOW THE FUND INVESTS
--------------------------------------------------------------------------------
The Fund's investment objective is capital appreciation.
The Fund invests at least 65% of its total assets in stocks of small U.S.
companies. A "small company" is one with a market capitalization of less than $2
billion at the time of investment.
The Fund can invest up to 20% of its total assets in foreign securities.
MONEY MARKET INVESTMENTS
To meet redemptions and when waiting to invest cash receipts, the Fund may
invest in short-term, investment grade bonds, money market mutual funds and
other money market instruments. Also, the Fund temporarily can invest up to 100%
of its assets in short-term, investment grade bonds and other money market
instruments in response to adverse market, economic or political conditions. The
Fund may not achieve its objectives using this type of investing.
INVESTMENT RISKS
--------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK
Market risk is the risk that the market will go down in value, including the
possibility that the market will go down sharply and unpredictably. Selection
risk is the risk that the investments that Fund management selects will
underperform the market or other funds with similar investment objectives and
investment strategies.
RISKS OF INVESTING IN SMALL COMPANIES
The Fund invests in the securities of small companies. Investment in small
companies involves more risk than investing in larger, more established
companies. Small companies may have limited product lines or markets. They may
be less financially secure than larger, more established companies. They may
depend on a small number of key personnel. If a product fails, or if management
changes, or there are other adverse developments, the Fund's investment in a
small cap company may lose substantial value.
MERCURY HW SMALL CAP VALUE FUND 7
<PAGE> 61
[MAGNIFYING GLASS ICON] About the Details
Securities of small companies generally trade in lower volumes and are subject
to greater and more unpredictable price changes than larger cap securities or
the stock market as a whole. Investing in securities of small companies requires
a long-term view.
FOREIGN MARKET RISK
The Fund may invest up to 20% of its total assets in foreign securities. Such
investments involve special risks not present in U.S. investments that can
increase the chances that the Fund will lose money. In particular, investments
in foreign securities involve the following risks, which are generally greater
for investments in emerging markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair the Fund's
ability to purchase or sell foreign securities or transfer its
assets or income back into the U.S., or otherwise adversely affect
the Fund's operations.
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal
remedies available to investors in some foreign countries may be
less extensive than those available to investors in the U.S.
8
MERCURY HW SMALL CAP VALUE FUND
<PAGE> 62
[MAGNIFYING GLASS ICON] About the Details
- Because there are generally fewer investors on foreign exchanges
and a smaller number of shares traded each day, it may be
difficult for the Fund to buy and sell securities on those
exchanges. In addition, prices of foreign securities may go up and
down more than prices of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and the Fund's assets may be uninvested
and not earning returns. The Fund also may miss investment
opportunities or be unable to sell an investment because of these
delays.
- The value of the Fund's foreign holdings (and hedging transactions
in foreign currencies) will be affected by changes in currency
exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- International trade barriers or economic sanctions against certain
foreign countries may adversely affect the Fund's foreign
holdings.
EUROPEAN ECONOMIC AND MONETARY UNION (EMU)
A number of European countries have entered into EMU in an effort to reduce
trade barriers between themselves and eliminate fluctuations in their
currencies. EMU establishes a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These securities trade and make dividend and other payments only in euros. Like
other investment companies and business organizations, including the companies
in which the Fund invests, the Fund could be adversely affected if the
transition to euro, or EMU as a whole, does not take effect as planned or if a
participating country withdraws from EMU.
MERCURY HW SMALL CAP VALUE FUND 9
<PAGE> 63
[MAGNIFYING GLASS ICON] About the Details
RISKS OF CONVERTIBLE SECURITIES
Convertibles are generally bonds or preferred stocks that may be converted into
common stock. Convertibles typically pay current income, as either interest
(bond convertibles) or dividends (preferred stocks). A convertible's value
usually reflects both the stream of current income payments and the value of the
underlying common stock. The market value of a convertible performs like regular
bonds; that is, if market interest rates rise, the value of a convertible
usually falls. Since it is convertible into common stock, the convertible also
has the same types of market and issuer risk as the underlying common stock.
DEBT SECURITIES
Debt securities, such as bonds, involve credit risk, which is the risk that the
borrower will not make timely payments of principal and interest. These
securities are also subject to interest rate risk, which is the risk that the
value of the security may fall when interest rates rise. In general, the market
price of debt securities with longer maturities will go up or down more in
response to changes in interest rates than shorter term securities.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD COMMITMENTS
When-issued securities, delayed-delivery securities and forward commitments
involve the risk that the security the Fund buys will lose value prior to its
delivery to the Fund. There also is the risk that the security will not be
issued or that the other party will not meet its obligation, in which case the
Fund loses the investment opportunity of the assets it has set aside to pay for
the security and any gain in the security's price.
DERIVATIVES
Derivatives involve the following risks:
- CREDIT RISK -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Fund.
- CURRENCY RISK -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
10
MERCURY HW SMALL CAP VALUE FUND
<PAGE> 64
[MAGNIFYING GLASS ICON] About the Details
- LEVERAGE RISK -- Leverage risk is the risk associated with certain
types of investments or trading strategies that relatively small
market movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- LIQUIDITY RISK -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time that
the seller would like or at the price that the seller believes the
security is currently worth.
- INDEX RISK -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
STATEMENT OF ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERCURY HW SMALL CAP VALUE FUND 11
<PAGE> 65
[CHECKMARK ICON] Account Choices
PRICING OF SHARES
--------------------------------------------------------------------------------
The Fund offers two classes of shares, each with its own sales charge and
expense structure. Each share class represents an ownership interest in the same
investment portfolio.
The Fund's shares are distributed by FAM Distributors, Inc. (the "Distributor").
Holders of Class I or A shares generally pay the Distributor a sales charge at
the time of purchase. If you buy Class A shares, you also pay out of Fund assets
an ongoing account maintenance fee of 0.25%. You may be eligible for a sales
charge reduction or waiver.
Certain financial institutions may charge you additional fees in connection with
transactions in fund shares. The Investment Adviser, the Distributor or their
affiliates may make payments out of their own resources to securities dealers
and other financial intermediaries for providing services intended to result in
the sale of Fund shares or for shareholder servicing activities.
To better understand the pricing of each class of the Fund's shares, we have
summarized the information below:
<TABLE>
<CAPTION>
CLASS I* CLASS A*
-------------------------------------------------------------------------------------------
<S> <C> <C>
Availability LIMITED TO CERTAIN INVESTORS GENERALLY AVAILABLE THROUGH
INCLUDING: - Investor Class SELECTED SECURITIES DEALERS
and current AND OTHER FINANCIAL
Class I INTERMEDIARIES.
shareholders.
- Certain retirement plans. Distributor Class
- Participants in certain shareholders.
sponsored programs.
- Certain affiliates or
customers of selected
securities dealers and
other financial
intermediaries.
-------------------------------------------------------------------------------------------
Initial Sales Charge? YES. PAYABLE AT TIME OF YES. PAYABLE AT TIME OF
PURCHASE. LOWER SALES CHARGES PURCHASE. LOWER SALES CHARGES
AVAILABLE FOR LARGER AVAILABLE FOR LARGER
INVESTMENTS. INVESTMENTS.
-------------------------------------------------------------------------------------------
Deferred Sales NO. (MAY BE CHARGED FOR NO. (MAY BE CHARGED FOR
Charge? PURCHASES OVER $1 MILLION PURCHASES OVER $1 MILLION
THAT ARE REDEEMED WITHIN ONE THAT ARE REDEEMED WITHIN ONE
YEAR.) YEAR.)
-------------------------------------------------------------------------------------------
Account Maintenance NO. 0.25% ACCOUNT MAINTENANCE
and Distribution FEE. NO DISTRIBUTION FEE.
Fees?
-------------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I shares
and Distributor Class shares were redesignated Class A shares.
12
MERCURY HW SMALL CAP VALUE FUND
<PAGE> 66
[CHECKMARK ICON] Account Choices
RIGHT OF ACCUMULATION -- permits you to pay the sales charge applicable to the
cost or value (whichever is higher) of all shares you own in the Mercury mutual
funds.
LETTER OF INTENT -- permits you to pay the sales charge that would be applicable
if you add up all shares of Mercury mutual funds that you agree to buy within a
13 month period. Certain restrictions apply.
CLASS I AND A SHARES* -- INITIAL SALES CHARGE OPTION
If you select Class I or A shares, you will pay a sales charge at the time of
purchase as shown in the following table. Securities dealers' compensation will
be as shown in the last column.
<TABLE>
<CAPTION>
DEALER
AS A % OF COMPENSATION
AS A % OF YOUR AS A % OF
YOUR INVESTMENT OFFERING PRICE INVESTMENT** OFFERING PRICE
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
LESS THAN $25,000 5.25% 5.54% 5.00%
---------------------------------------------------------------------------------------
$25,000 BUT LESS THAN
$50,000 4.75% 4.99% 4.50%
---------------------------------------------------------------------------------------
$50,000 BUT LESS THAN
$100,000 4.00% 4.17% 3.75%
---------------------------------------------------------------------------------------
$100,000 BUT LESS THAN
$250,000 3.00% 3.09% 2.75%
---------------------------------------------------------------------------------------
$250,000 BUT LESS THAN
$1,000,000 2.00% 2.04% 1.80%
---------------------------------------------------------------------------------------
$1,000,000 AND OVER*** 0.00% 0.00% 0.00%
---------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares and Distributor Class shares were redesignated Class A shares.
** Rounded to the nearest one-hundredth percent.
*** If you invest $1,000,000 or more in Class I or A shares, you may not pay an
initial sales charge. In that case, the Investment Adviser compensates the
selling dealer or other financial intermediary from its own resources. If
you redeem your shares within one year after purchase, you may be charged a
deferred sales charge. This charge is 1% of the lesser of the original cost
of the shares being redeemed or your redemption proceeds. A sales charge of
0.75% will be charged on purchases of $1,000,000 or more of Class I and A
shares by certain employer sponsored retirement or savings plans.
No initial sales charge applies to Class I or Class A shares that you buy
through reinvestment of dividends.
A reduced or waived sales charge on a purchase of Class I or A shares may apply
for:
- Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT
- Certain trusts managed by banks, thrifts or trust companies
including those affiliated with the Investment Adviser or its
affiliates
- Certain employer-sponsored retirement or savings plans
- Certain investors, including directors or trustees of mutual funds
sponsored by the Investment Adviser or its affiliates, employees
MERCURY HW SMALL CAP VALUE FUND 13
<PAGE> 67
[CHECKMARK ICON] Account Choices
of the Investment Adviser and its affiliates and employees or
customers of selected securities dealers
- Certain fee-based programs managed by the Investment Adviser or
its affiliates
- Certain fee-based programs managed by selected securities dealers
that have an agreement with the Distributor
- Purchases through certain financial advisers, selected securities
dealers, brokers, investment advisers, service providers and other
financial intermediaries
- Purchases through certain accounts over which the Investment
Adviser or an affiliate exercises investment discretion
Only certain investors are eligible to buy Class I shares, including former
Investor Class shareholders of the Fund, existing Class I shareholders of the
Fund, certain retirement plans and participants in certain programs sponsored by
the Investment Adviser or its affiliates. Your financial consultant, selected
securities dealer or other financial intermediary can help you determine whether
you are eligible to buy Class I shares or to participate in any of these
programs.
If you decide to buy shares under the initial sales charge alternative and you
are eligible to buy both Class I and Class A shares, you should buy Class I
since Class A shares are subject to a 0.25% account maintenance fee, while Class
I shares are not.
If you redeem Class I or Class A shares and within 30 days buy new shares of the
same class, you will not pay a sales charge on the new purchase amount. The
amount eligible for this "Reinstatement Privilege" may not exceed the amount of
your redemption proceeds. To exercise the privilege, contact your financial
consultant, selected securities dealer, other financial intermediary or the
Fund's Transfer Agent at 1-800-236-4479.
14
MERCURY HW SMALL CAP VALUE FUND
<PAGE> 68
[CHECKMARK ICON] Account Choices
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
--------------------------------------------------------------------------------
The chart below summarizes how to buy, sell, transfer and exchange shares
through your financial consultant, selected securities dealer, broker,
investment adviser, service provider or other financial intermediary. You may
also buy shares through the Transfer Agent. To learn more about buying shares
through the Transfer Agent, call 1-800-236-4479. Because the selection of a
mutual fund involves many considerations, your financial consultant, selected
securities dealer or other financial intermediary may help you with this
decision. The Fund does not issue share certificates.
Because of the high cost of maintaining smaller shareholder accounts, the Fund
may redeem the shares in your account (without charging any deferred sales
charge) if the net asset value of your account falls below $500 due to
redemptions you have made. You will be notified that the value of your account
is less than $500 before the Fund makes an involuntary redemption. You will then
have 60 days to make an additional investment to bring the value of your account
to at least $500 before the Fund takes any action. This involuntary redemption
does not apply to retirement plans or Uniform Gifts or Transfers to Minors Act
accounts.
MERCURY HW SMALL CAP VALUE FUND 15
<PAGE> 69
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BUY SHARES First, select the share class Refer to the pricing of shares table on page 12. Be sure to
appropriate for you read this prospectus carefully.
-------------------------------------------------------------------------------------------------
Next, determine the amount of The minimum initial investment for the Fund is $1,000 for
your investment all accounts except: - $500 for certain fee-based programs
- $100 for retirement plans (The minimums for initial
investments may be waived under certain circumstances.)
-------------------------------------------------------------------------------------------------
Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. Purchase orders
other financial intermediary placed prior to the close of regular trading on the New York
submit your purchase order Stock Exchange (generally, 4:00 p.m. Eastern time) are
priced at the net asset value determined that day. Certain
financial intermediaries, however, may require submission of
orders prior to that time.
Purchase orders placed after that time are priced at the net
asset value determined on the next business day. The Fund
may reject any order to buy shares and may suspend the sale
of shares at any time. Certain financial intermediaries may
charge a fee to process a purchase. For example, Merrill
Lynch, Pierce, Fenner & Smith Incorporated currently charges
a $5.35 processing fee. The fees charged by other financial
intermediaries may be higher or lower.
-------------------------------------------------------------------------------------------------
Or contact the Transfer Agent To purchase shares directly, call the Transfer Agent at
1-800-236-4479 and request a purchase application. Mail the
completed purchase application to the Transfer Agent at the
address on the back cover of this prospectus.
------------------------------------------------------------------------------------------------------------------------
ADD TO YOUR Purchase additional shares The minimum investment for additional purchases is generally
INVESTMENT $100 for all accounts except: - $50 for certain fee-based
programs - $1 for retirement plans (The minimums for
additional purchases may be waived under certain
circumstances.)
-------------------------------------------------------------------------------------------------
Acquire additional shares All dividends are automatically reinvested without a sales
through the automatic dividend charge.
reinvestment plan
-------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan your selected securities dealer or other financial
intermediary. The current minimum for such automatic
reinvestments is $100. The minimum may be waived or revised
under certain circumstances.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
16 MERCURY HW SMALL CAP VALUE FUND
<PAGE> 70
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
TRANSFER SHARES TO Transfer to a participating You may transfer your Fund shares to another selected
ANOTHER SECURITIES securities dealer or other securities dealer or other financial intermediary if
DEALER OR OTHER financial intermediary authorized dealer agreements are in place between the
FINANCIAL Distributor and the transferring intermediary and the
INTERMEDIARY Distributor and the receiving intermediary. Certain
shareholder services may not be available for all
transferred shares. You may only purchase additional shares
of funds previously owned before the transfer. All future
trading of these shares must be coordinated by the receiving
intermediary.
-------------------------------------------------------------------------------------------------
Transfer to a non-participating You must either: - Transfer your shares to an account with
securities dealer or other the Transfer Agent; or - Sell your shares, paying any
financial intermediary applicable deferred sales charge.
------------------------------------------------------------------------------------------------------------------------
SELL YOUR SHARES Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. For your
other financial intermediary redemption request to be priced at the net asset value on
submit your sales order the day of your request, you must submit your request to
your selected securities dealer or other financial
intermediary prior to that day's close of regular trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern
time). Certain financial intermediaries, however, may
require submission of orders prior to that time. Redemption
requests placed after that time are priced at the net asset
value at the close of regular trading on the next business
day.
Certain financial intermediaries may charge a fee to process
a sale of shares. For example, Merrill Lynch, Pierce, Fenner
& Smith Incorporated currently charges a $5.35 processing
fee. No processing fee is charged if you redeem the shares
directly through the Transfer Agent. The fees charged by
other financial intermediaries may be higher or lower.
The Fund may reject an order to sell shares under certain
circumstances.
-------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by writing to
the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter. A signature guarantee will generally be
required but may be waived in certain limited circumstances.
You can obtain a signature guarantee from a bank, securities
dealer, securities broker, credit union, savings
association, national securities exchange and registered
securities association. A notary public seal will not be
acceptable. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY HW SMALL CAP VALUE FUND 17
<PAGE> 71
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SELL SHARES Participate in the Fund's You can choose to receive systematic payments from your Fund
SYSTEMATICALLY Systematic Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. You can
generally arrange through your selected securities dealer or
other financial intermediary for systematic sales of shares
of a fixed dollar amount on a monthly, bi-monthly,
quarterly, semi-annual or annual basis, subject to certain
conditions. Under either method, you must have dividends
automatically reinvested. Ask your financial intermediary
for details.
------------------------------------------------------------------------------------------------------------------------
EXCHANGE YOUR Select the fund into which you You can exchange your shares of the Fund for shares of other
SHARES want to exchange. Be sure to Mercury mutual funds or for shares of the Summit Cash
read that fund's prospectus Reserves Fund. You must have held the shares used in the
exchange for at least 15 calendar days before you can
exchange to another fund.
Each class of Fund shares is generally exchangeable for
shares of the same class of another Mercury fund. If you own
Class I shares and wish to exchange into a fund in which you
have no Class I shares (and are not eligible to buy Class I
shares), you will exchange into Class A shares. If you own
Class I or Class A shares and wish to exchange into Summit,
you will exchange into Class A shares of Summit.
Some of the Mercury mutual funds may impose a different
initial or deferred sales charge schedule. If you exchange
Class I or A shares for shares of a fund with a higher
initial sales charge than you originally paid, you may be
charged the difference at the time of exchange.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
18 MERCURY HW SMALL CAP VALUE FUND
<PAGE> 72
[CHECKMARK ICON] Account Choices
NET ASSET VALUE -- the market value in U.S. dollars of the Fund's total assets
after deducting liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
--------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open as of the close of regular trading on the Exchange based on
prices at the time of closing. Regular trading on the Exchange generally closes
at 4:00 p.m. Eastern time. The net asset value used in determining your price is
the next one calculated after your purchase or redemption order is placed.
Foreign securities owned by the Fund may trade on weekends or other days when
the Fund does not price its shares. As a result, the Fund's net asset value may
change on days when you will not be able to purchase or redeem the Fund's
shares.
The Fund may accept orders from certain authorized financial intermediaries or
their designees. The Fund will be deemed to receive an order when accepted by
the intermediary or designee and the order will receive the net asset value next
computed by the Fund after such acceptance. If the payment for a purchase order
is not made by a designated later time, the order will be canceled and the
financial intermediary could be held liable for any losses.
Generally, Class I shares will have the higher net asset value because that
class has lower expenses.
FEE-BASED PROGRAMS
--------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by the Investment
Adviser or an affiliate of the Investment Adviser, or by selected securities
dealers or other financial intermediaries that have an agreement with the
Distributor, you may be able to buy Class I shares at net asset value, including
by exchanges from other share classes. Sales charges on the shares being
exchanged may be reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
MERCURY HW SMALL CAP VALUE FUND 19
<PAGE> 73
[CHECKMARK ICON] Account Choices
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed ordinary income or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
If you leave one of these programs, your shares may be redeemed or automatically
exchanged into another class of the Fund's shares or into the Summit fund. The
class you receive may be the class you originally owned when you entered the
program, or in certain cases, a different class. Any redemption or exchange will
be at net asset value. However, if you participate in the program for less than
a specified period, you may be charged a fee in accordance with the terms of the
program.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your financial
consultant, selected securities dealer or other financial intermediary.
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
The Fund will distribute any net investment income and any net realized long-
term or short-term capital gains at least annually. The Fund may also pay a
special distribution at the end of the calendar year to comply with Federal tax
requirements. DIVIDENDS may be reinvested automatically in shares of the Fund at
net asset value without a sales charge or may be taken in cash. If your account
is with a selected securities dealer or other financial intermediary that has an
agreement with the Fund, contact your dealer or intermediary about which option
you would like. If your account is with the Transfer Agent and you would like to
receive dividends in cash, contact the Transfer Agent. The Fund anticipates that
the majority of its dividends, if any, will consist of ordinary income. Capital
gains, if any, may be taxable to you at different rates, depending, in part, on
how long the Fund has held the assets sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your shares and any
gain on the transaction may be subject to tax. Capital gain dividends are
generally taxed at different rates than ordinary income dividends.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax treaties between certain countries
and the U.S. may reduce or eliminate such taxes.
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
20
MERCURY HW SMALL CAP VALUE FUND
<PAGE> 74
[CHECKMARK ICON] Account Choices
By law, the Fund must withhold 31% of your dividends and redemption proceeds if
you have not provided a taxpayer identification number or social security number
or if the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
MERCURY HW SMALL CAP VALUE FUND 21
<PAGE> 75
[MANAGEMENT TEAM ICON] The Management Team
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
Mercury Advisors, the Fund's Investment Adviser, manages the Fund's investments
under the overall supervision of the Board of Trustees. The Investment Adviser
has the responsibility for making all investment decisions for the Fund. For the
fiscal year ended June 30, 2000, the Fund paid the Investment Adviser a fee at
the annual rate of 0.75% of the average daily net assets of the Fund.
The Investment Adviser was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
The Investment Adviser and its affiliates had approximately $558 billion in
investment company and other portfolio assets under management as of June 30,
2000.
Although not required to do so, the Investment Adviser has agreed to make
reimbursements so that the regular annual operating expenses of the Fund will be
limited as shown in the table on page 5. The Investment Adviser has agreed to
these expense limits through June 2001, and will thereafter give shareholders at
least 30 days' notice if this reimbursement policy will change.
The Investment Adviser is allowed to allocate brokerage based on sales of shares
of funds managed by the Investment Adviser.
22
MERCURY HW SMALL CAP VALUE FUND
<PAGE> 76
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned on an investment in the
Fund (assuming reinvestment of all dividends and distributions). These financial
highlights were audited by PricewaterhouseCoopers LLP. The accountants' report
and the Fund's financial statements are included in the Fund's annual report,
which is available upon request. Further performance information is contained in
the annual report.
<TABLE>
<CAPTION>
CLASS I(1)
-----------------------------------------------------
FOR THE YEAR ENDED JUNE 30,
INCREASE (DECREASE) IN -----------------------------------------------------
NET ASSET VALUE: 2000 1999 1998 1997 1996
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
-------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $ 26.48 $23.83 $21.33 $ 21.53
-------------------------------------------------------------------------------------------------------------------
Investment income -- net (0.05)(4) (0.06)(3) 0.03 0.05(3)
-------------------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss) on investments -- net (3.88) 5.13 5.62 2.80
-------------------------------------------------------------------------------------------------------------------
Total from investment operations (3.93) 5.07 5.65 2.85
-------------------------------------------------------------------------------------------------------------------
Less dividends and distributions
Investment income -- net -- (0.05) (0.09) --
Realized gain on investments -- net (1.53) (2.37) (3.06) (3.05)
-------------------------------------------------------------------------------------------------------------------
Total dividends and distributions (1.53) (2.42) (3.15) (3.05)
-------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $ 21.02 $26.48 $23.83 $ 21.33
-------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
-------------------------------------------------------------------------------------------------------------------
Based on net asset value per share (14.26)% 22.24% 29.74% 14.24%
-------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
-------------------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement 1.05% 0.94% 1.00% 1.00%
-------------------------------------------------------------------------------------------------------------------
Expenses 1.19% 0.94% 1.30% 1.21%
-------------------------------------------------------------------------------------------------------------------
Investment income -- net (0.26)% (0.23)% 0.10% 0.24%
-------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
-------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in millions) $ 53.40 $94.90 $27.50 $ 16.50
-------------------------------------------------------------------------------------------------------------------
Portfolio turnover 105% 85% 88% 119%
-------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) As of October , 2000, Investor Class shares were redesignated Class I
shares. No Distributor Class shares, which were redesignated Class A shares,
were outstanding on such date. No sales loads were charged prior to this
time.
(2) Net investment income per share represents net investment income divided by
the average shares outstanding throughout the year.
(3) Net investment income per share is calculated using ending balances prior to
consideration of adjustments for permanent book and tax differences.
* Total investment return excludes the effects of sales charges.
MERCURY HW SMALL CAP VALUE FUND 23
<PAGE> 77
<TABLE>
<S> <C>
FUND
Mercury HW Small Cap Value Fund
of Mercury HW Funds
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(800-236-4479)
INVESTMENT ADVISER
Administrative Offices:
Mercury Advisors
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
725 South Figueroa Street,
Suite 4000
Los Angeles, California 90017-5400
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 41621
Jacksonville, Florida 32232-1621
(800-236-4479)
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
100 E. Wisconsin Ave., Suite 1500
Milwaukee, Wisconsin 53202
DISTRIBUTOR
FAM Distributors, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109-3661
COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610-4795
</TABLE>
<PAGE> 78
[TELEPHONE ICON] TO LEARN MORE
SHAREHOLDER REPORTS
Additional information about the Fund's investments will be available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report you will find a discussion of the relevant market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling
1-800-236-4479.
The Fund will send you one copy of each shareholder report and certain other
mailings regardless of the number of Fund accounts you have. To receive separate
shareholder reports for each account, call your financial consultant or other
financial intermediary or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and brokerage or mutual
fund account number. If you have any questions, please call your financial
consultant or other financial intermediary or the Transfer Agent at
1-800-236-4479.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at Financial Data Services, Inc., P.O. Box 41621, Jacksonville, Florida
32232-1621 or by calling 1-800-236-4479.
Contact your financial consultant or other financial intermediary or the Fund at
the telephone number or address indicated on the inside back cover of this
prospectus if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet Site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION IN THIS PROSPECTUS.
Investment Company Act File #811-4182.
CODE #MHW-1060-1000
(C) Mercury Advisors
MERCURY HW
SMALL CAP VALUE FUND
OF MERCURY HW FUNDS
ARTWORK
PROSPECTUS - October , 2000
<PAGE> 79
PROSPECTUS - October , 2000
Mercury HW International Value Fund
OF MERCURY HW FUNDS
[MERCURY HW ARTWORK]
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING INFORMATION
ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST
AND KEEP IT FOR FUTURE REFERENCE.
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.
<PAGE> 80
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
[FUND FACTS ICON]
FUND FACTS
-----------------------------------------------------------------
About the Mercury HW International Value Fund............... 2
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[ABOUT THE DETAILS ICON]
ABOUT THE DETAILS
-----------------------------------------------------------------
How the Fund Invests........................................ 7
Investment Risks............................................ 7
Statement of Additional Information......................... 11
[ACCOUNT CHOICE ICON]
ACCOUNT CHOICES
-----------------------------------------------------------------
Pricing of Shares........................................... 12
How to Buy, Sell, Transfer and Exchange Shares.............. 18
How Shares are Priced....................................... 22
Fee-Based Programs.......................................... 22
Dividends and Taxes......................................... 23
[THE MANAGEMENT TEAM ICON]
THE MANAGEMENT TEAM
-----------------------------------------------------------------
Management of the Fund...................................... 25
Financial Highlights........................................ 26
[TO LEARN MORE ICON]
TO LEARN MORE
-----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 81
[FUND FACTS ICON] Fund Facts
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
COMMON STOCK -- units of ownership of a corporation.
CONVERTIBLE SECURITIES -- fixed-income securities, such as corporate bonds or
preferred stock, that are exchangeable for shares of common stock of the issuer
or another company.
PREFERRED STOCK -- class of stock that often pays dividends at a specified rate
and has preference over common stock in dividend payments and liquidation of
assets. Preferred stock may also be convertible into common stock.
PRICE-TO-EARNINGS RATIO -- price of a stock divided by its earnings per share.
YIELD -- percentage rate of return paid on a stock in dividends and share
repurchases.
PRICE-TO-BOOK VALUE RATIO -- price of a stock divided by its book value per
share.
ABOUT THE MERCURY HW INTERNATIONAL VALUE FUND
--------------------------------------------------------------------------------
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to seek current income and long-term growth
of income, accompanied by growth of capital.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests primarily in stocks of companies located outside the U.S. The
Fund may purchase COMMON STOCK, PREFERRED STOCK, CONVERTIBLE SECURITIES and
other instruments.
In investing the Fund's assets, Mercury Advisors (the "Investment Adviser")
follows a value style. This means that the Investment Adviser buys stocks that
it believes are currently undervalued by the market and thus have a lower price
than their true worth. Typical value characteristics include:
- low PRICE-TO-EARNINGS RATIO relative to the market
- high YIELD relative to the market
- low PRICE-TO-BOOK VALUE RATIO relative to the market
- financial strength
Stocks may be "undervalued" because they are part of an industry that is out of
favor with investors generally. Even in those industries, though, individual
companies may have high rates of growth of earnings and be financially sound. At
the same time, the price of their common stock may be depressed because
investors associate the companies with their industries.
This value discipline sometimes prevents or limits investments in stocks that
are in well-known indexes, like the MSCI EAFE Index. Also, the return of the
Fund will not necessarily be similar to the return of the MSCI EAFE Index.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of your Fund shares, may go up or down. If the value of the Fund's
investments goes down, you may lose money. The value changes in the Fund's
investments may occur because a particular stock market is rising or falling. At
other times, there are specific factors that may affect the value of a
particular investment. The Fund is also subject to the risk that the stocks the
Fund's Investment Adviser selects will underperform the stock markets or other
funds with similar investment objective and investment strategies.
In addition, because the Fund invests most of its assets in foreign securities,
the Fund is subject to additional risks. For example, the Fund's securities may
go up or down in value depending on foreign exchange rates, political and
2 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 82
[FUND FACTS ICON] Fund Facts
economic developments and U.S. and foreign laws relating to foreign investment.
Foreign securities may also be less liquid, more volatile and harder to value
than U.S. securities. These risks are heightened for investments in emerging
markets.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
See "Investment Risks" for more information about the risks associated with the
Fund.
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are seeking long-term growth of capital and can withstand the
share price volatility of equity investing.
- Are seeking to diversify a portfolio of equity securities to
include foreign securities.
- Can tolerate the increased volatility and currency fluctuations
associated with investments in foreign securities.
- Want a professionally managed and diversified portfolio.
- Are willing to accept the risk that the value of your investment
may decline in order to seek long-term capital appreciation.
- Are prepared to receive taxable distributions.
MERCURY HW INTERNATIONAL VALUE FUND 3
<PAGE> 83
[FUND FACTS ICON] Fund Facts
RISK/RETURN BAR CHART
--------------------------------------------------------------------------------
The bar chart and table below provide some indication of the risks of investing
in the Fund by showing changes in the year to year performance of the Class I
shares of the Fund and by showing how the Fund's average annual total returns
for 1 and 5 years and for the life of the Class compare with those of a broad
measure of market performance. How the Fund has performed in the past is not
necessarily an indication of how the Fund will perform in the future.
[RISK/RETURN BAR CHART]
<TABLE>
<S> <C>
1991 20.35%
1992 -2.66%
1993 45.76%
1994 -2.93%
1995 19.89%
1996 18.29%
1997 5.33%
1998 6.41%
1999 23.41%
</TABLE>
Total return for the six months ended June 30, 2000: 3.52%.
During the period shown in the bar chart, the highest return for a quarter was
15.50% (quarter ended December 31, 1998) and the lowest return for a quarter
was - 18.36% (quarter ended September 30, 1998).
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS PAST PAST SINCE
(FOR THE PERIODS ENDED DECEMBER 31, 1999) ONE YEAR FIVE YEARS INCEPTION
----------------------------------------------------------------------------------------
<S> <C> <C> <C>
CLASS I*+ 23.41% 14.43% 13.65%(1)
MSCI EAFE INDEX 27.30% 13.15% 12.30%
----------------------------------------------------------------------------------------
CLASS A*++ N/A N/A 13.82%(2)
MSCI EAFE INDEX N/A N/A 27.08%(3)
----------------------------------------------------------------------------------------
CLASS B* N/A N/A N/A
MSCI EAFE INDEX N/A N/A N/A
----------------------------------------------------------------------------------------
CLASS C* N/A N/A N/A
MSCI EAFE INDEX N/A N/A N/A
----------------------------------------------------------------------------------------
</TABLE>
The Morgan Stanley Capital International Europe, Australia, Far East Index (MSCI
EAFE) is an arithmetical average weighted by market value of the performance of
over 1,000 non-U.S. companies representing 20 stock markets in Europe,
Australia, New Zealand and the Far East.
* Includes the effect of sales charges, which were not imposed until October
, 2000.
+ As of October , 2000, Investor Class shares were redesignated Class I
shares.
++ As of October , 2000, Distributor Class shares were redesignated Class A
shares.
(1) Inception date is October 1, 1990.
(2) Inception date is June 2, 1999.
(3) Since June 1, 1999.
4 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 84
[FUND FACTS ICON] Fund Facts
UNDERSTANDING EXPENSES
Fund investors pay various expenses, either directly or indirectly. Listed below
are some of the main types of expenses, which all mutual funds may charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
MANAGEMENT FEE -- a fee paid to the Investment Adviser for managing the Fund.
DISTRIBUTION FEES -- fees used to support the Fund's marketing and distribution
efforts, such as compensating financial consultants, other financial
intermediaries, advertising and promotion.
SERVICE (ACCOUNT MAINTENANCE) FEES -- fees used to compensate selected
securities dealers or other financial intermediaries for account maintenance
activities.
FEES AND EXPENSES
--------------------------------------------------------------------------------
The Fund offers four different classes of shares. Although your money will be
invested the same way no matter which class of shares you buy, there are
differences among the fees and expenses associated with each class. Not everyone
is eligible to buy every class. After determining which classes you are eligible
to buy, decide which class best suits your needs. Your financial consultant,
selected securities dealer or other financial intermediary can help you with
this decision.
THIS TABLE SHOWS THE DIFFERENT FEES AND EXPENSES THAT YOU MAY PAY IF YOU BUY AND
HOLD THE DIFFERENT CLASSES OF SHARES OF THE FUND. FUTURE EXPENSES MAY BE GREATER
OR LESS THAN THOSE INDICATED BELOW.
<TABLE>
<CAPTION>
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR
INVESTMENT)(a): CLASS I* CLASS A* CLASS B(b) CLASS C
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Maximum Sales Charge (Load) imposed on purchases
(as a percentage of offering price) 5.25%(c) 5.25%(c) None None
---------------------------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a
percentage of original purchase price or redemption
proceeds, whichever is lower) None(d) None(d) 4.00%(c) 1.00%(c)
---------------------------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend
Reinvestments None None None None
---------------------------------------------------------------------------------------------
Redemption Fee None None None None
---------------------------------------------------------------------------------------------
Exchange Fee None None None None
---------------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE
DEDUCTED FROM THE FUND'S TOTAL ASSETS)(e):
---------------------------------------------------------------------------------------------
MANAGEMENT FEE 0.75% 0.75% 0.75% 0.75%
---------------------------------------------------------------------------------------------
DISTRIBUTION AND/OR SERVICE (12b-1) FEES(e) None 0.25% 1.00% 1.00%
---------------------------------------------------------------------------------------------
Other Expenses (including transfer agency fees) 0.31% 0.31% 0.31% 0.31%
---------------------------------------------------------------------------------------------
TOTAL ANNUAL OPERATING EXPENSES 1.06% 1.31% 2.06% 2.06%
---------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C>
( )* As of October , 2000, Investor Class shares were
redesignated Class I shares and Distributor Class shares
were redesignated Class A shares.
(a) Certain securities dealers or other financial intermediaries
may charge a fee to process a purchase or sale of shares.
See "How to Buy, Sell, Transfer and Exchange Shares."
(b) Class B shares automatically convert to Class A shares about
eight years after you buy them and will no longer be subject
to distribution fees.
(c) Some investors may qualify for reductions in the sales
charge (load).
(d) You may pay a deferred sales charge if you purchase $1
million or more and you redeem within one year.
(e) The Fund calls the "Service Fee" an "Account Maintenance
Fee." Account Maintenance Fee is the term used elsewhere in
this prospectus and in all other Fund materials. If you hold
Class B or C shares for a long time, it may cost you more in
distribution (12b-1) fees than the maximum sales charge that
you would have paid if you had bought one of the other
classes.
</TABLE>
MERCURY HW INTERNATIONAL VALUE FUND 5
<PAGE> 85
[FUND FACTS ICON] Fund Facts
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, if any, that apply to the particular class and that the Fund's
operating expenses remain the same. This assumption is not meant to indicate you
will receive a 5% annual rate of return. Your annual return may be more or less
than the 5% used in these examples. Although your actual costs may be higher or
lower, based on these assumptions, your costs would be:
Expenses if you did redeem your shares:
<TABLE>
<CAPTION>
CLASS I CLASS A CLASS B CLASS C
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ONE YEAR $ 627 $ 651 $ 609 $ 309
-----------------------------------------------------------------------------------------
THREE YEARS $ 845 $ 918 $ 946 $ 646
-----------------------------------------------------------------------------------------
FIVE YEARS $ 1,079 $ 1,205 $ 1,308 $ 1,108
-----------------------------------------------------------------------------------------
TEN YEARS $ 1,751 $ 2,021 $ 2,197 $ 2,390
-----------------------------------------------------------------------------------------
</TABLE>
Expenses if you did not redeem your shares:
<TABLE>
<CAPTION>
CLASS I CLASS A CLASS B CLASS C
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ONE YEAR $ 627 $ 651 $ 209 $ 209
-----------------------------------------------------------------------------------------
THREE YEARS $ 845 $ 918 $ 646 $ 646
-----------------------------------------------------------------------------------------
FIVE YEARS $ 1,079 $ 1,205 $ 1,108 $ 1,108
-----------------------------------------------------------------------------------------
TEN YEARS $ 1,751 $ 2,021 $ 2,197 $ 2,390
-----------------------------------------------------------------------------------------
</TABLE>
6 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 86
[ABOUT THE DETAILS ICON] About the Details
ABOUT THE PORTFOLIO MANAGERS -- Sarah Ketterer is a managing director of the
Investment Adviser and has served as portfolio manager of the Fund since it
began in October 1990. Before joining the Investment Adviser, Ms. Ketterer was
with Bankers Trust Company as an associate from 1987 to 1990 and a financial
analyst with Dean Witter Reynolds from 1983 to 1985.
Harry Hartford is a managing director of the Investment Adviser and has served
as a portfolio manager of the Fund since May 1994. Before joining the Investment
Adviser, Mr. Hartford was with the Investment Bank of Ireland (now Bank of
Ireland Asset Management) as a senior manager of International and Global
Equities from 1985 to 1994.
David Chambers is a managing director of the Investment Adviser and has served
as a portfolio manager of the Fund since October 1996. He has been associated
with Merrill Lynch Investment Managers International Limited in London since
July 1998. Before joining the Investment Adviser, Mr. Chambers was with Baring
Asset Management, Inc. as senior vice president of Global Equities from 1992 to
1995 and Baring Brothers, London, as assistant director of Corporate Finance
from 1990 to 1991.
ABOUT THE INVESTMENT ADVISER -- Mercury Advisors manages the Fund.
ABOUT THE SUBADVISERS -- Merrill Lynch Investment Managers International Limited
and Merrill Lynch Asset Management U.K. Limited are subadvisers to the Fund and
provide investment research, recommendations and other investment-related
services.
HOW THE FUND INVESTS
--------------------------------------------------------------------------------
The Fund's investment objective is to provide current income and long-term
growth of income, accompanied by growth of capital.
The Fund invests at least 65% of its total assets in stocks in at least ten
foreign markets. Ordinarily, the Fund invests in stocks of companies located in
the developed foreign markets and invests at least 80% of its total assets in
stocks that pay dividends. It also may invest in stocks that don't pay
dividends, but have growth potential unrecognized by the market or changes in
business or management that indicate growth potential.
MONEY MARKET INVESTMENTS
To meet redemptions and when waiting to invest cash receipts, the Fund may
invest in short-term, investment grade bonds, money market mutual funds and
other money market instruments. Also, the Fund temporarily can invest up to 100%
of its assets in short-term, investment grade bonds, and other money market
instruments in response to adverse market, economic or political conditions. The
Fund may not achieve its objective using this type of investing.
INVESTMENT RISKS
--------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK
Market risk is the risk that the market will go down in value, including the
possibility that the market will go down sharply and unpredictably. Selection
risk is the risk that the investments that Fund management selects will
underperform the market or other funds with similar investment objectives and
investment strategies.
FOREIGN MARKET RISK
Since the Fund invests in foreign securities, it offers the potential for more
diversification than an investment only in the U.S. This is because stocks
traded on foreign markets have often (though not always) performed differently
than stocks in the U.S. However, such investments involve special risks not
present in U.S. investments that can increase the chances that the Fund will
lose
MERCURY HW INTERNATIONAL VALUE FUND 7
<PAGE> 87
[ABOUT THE DETAIL ICON] About the Details
money. In particular, investments in foreign securities involve the following
risks, which are generally greater for investments in emerging markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair the Fund's
ability to purchase or sell foreign securities or transfer its
assets or income back into the U.S., or otherwise adversely affect
the Fund's operations.
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal
remedies available to investors in some foreign countries may be
less extensive than those available to investors in the U.S.
- Because there are generally fewer investors on foreign exchanges
and a smaller number of shares traded each day, it may be
difficult for the Fund to buy and sell securities on those
exchanges. In addition, prices of foreign securities may go up and
down more than prices of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and the Fund's assets may be
8 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 88
[ABOUT THE DETAIL ICON] About the Details
uninvested and not earning returns. The Fund also may miss
investment opportunities or be unable to sell an investment
because of these delays.
- The value of the Fund's foreign holdings (and hedging transactions
in foreign currencies) will be affected by changes in currency
exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- International trade barriers or economic sanctions against certain
foreign countries may adversely affect the Fund's foreign
holdings.
EUROPEAN ECONOMIC AND MONETARY UNION (EMU)
A number of European countries have entered into EMU in an effort to reduce
trade barriers between themselves and eliminate fluctuations in their
currencies. EMU establishes a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These securities trade and make dividend and other payments only in euros. Like
other investment companies and business organizations, including the companies
in which the Fund invests, the Fund could be adversely affected if the
transition to euro, or EMU as a whole, does not take effect as planned or if a
participating country withdraws from EMU.
RISKS OF CONVERTIBLE SECURITIES
Convertibles are generally bonds or preferred stocks that may be converted into
common stock. Convertibles typically pay current income, as either interest
(bond convertibles) or dividends (preferred stocks). A convertible's value
usually reflects both the stream of current income payments and the value of the
underlying common stock. The market value of a convertible performs like regular
bonds; that is, if market interest rates rise, the value of a convertible
MERCURY HW INTERNATIONAL VALUE FUND 9
<PAGE> 89
[ABOUT THE DETAIL ICON] About the Details
usually falls. Since it is convertible into common stock, the convertible also
has the same types of market and issuer risk as the underlying common stock.
DEBT SECURITIES
Debt securities, such as bonds, involve credit risk, which is the risk that the
borrower will not make timely payments of principal and interest. These
securities are also subject to interest rate risk, which is the risk that the
value of the security may fall when interest rates rise. In general, the market
price of debt securities with longer maturities will go up or down more in
response to changes in interest rates than shorter term securities.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD COMMITMENTS
When-issued securities, delayed-delivery securities and forward commitments
involve the risk that the security the Fund buys will lose value prior to its
delivery to the Fund. There also is the risk that the security will not be
issued or that the other party will not meet its obligation, in which case the
Fund loses the investment opportunity of the assets it has set aside to pay for
the security and any gain in the security's price.
DERIVATIVES
Derivatives involve the following risks:
- CREDIT RISK -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Fund.
- CURRENCY RISK -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
- LEVERAGE RISK -- Leverage risk is the risk associated with certain
types of investments or trading strategies that relatively small
market movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- LIQUIDITY RISK -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time that
the seller would like or at the price that the seller believes the
security is currently worth.
- INDEX RISK -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
10 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 90
[ABOUT THE DETAIL ICON] About the Details
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
STATEMENT OF ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERCURY HW INTERNATIONAL VALUE FUND 11
<PAGE> 91
[ACCOUNT CHOICES ICON] Account Choices
PRICING OF SHARES
--------------------------------------------------------------------------------
The Fund offers four classes of shares, each with its own sales charge and
expense structure, allowing you to invest in the way that best suits your needs.
Each share class represents an ownership interest in the same investment
portfolio. When you choose your class of shares, you should consider the size of
your investment and how long you plan to hold your shares. Your financial
consultant or other financial intermediary can help you determine which share
class is best suited to your personal financial goals.
The Fund's shares are distributed by FAM Distributors, Inc. (the "Distributor").
For example, if you select Class I or A shares, you generally pay the
Distributor a sales charge at the time of purchase. If you buy Class A shares,
you also pay out of Fund assets an ongoing account maintenance fee of 0.25%. You
may be eligible for a sales charge reduction or waiver.
If you select Class B or C shares, you will invest the full amount of your
purchase price, but you will be subject to a distribution fee of 0.75% and an
account maintenance fee of 0.25%. Because these fees are paid out of the Fund's
assets on an ongoing basis, over time these fees increase the cost of your
investment and may cost you more than paying an initial sales charge. In
addition, you may be subject to a deferred sales charge when you sell Class B or
C shares.
Certain financial institutions may charge you additional fees in connection with
transactions in fund shares. The Investment Adviser, the Distributor or their
affiliates may make payments out of their own resources to securities dealers
and other financial intermediaries for providing services intended to result in
the sale of Fund shares or for shareholder servicing activities.
12 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 92
[ACCOUNT CHOICES ICON] Account Choices
To better understand the pricing of each class of the Fund's shares, we have
summarized the information below:
<TABLE>
<CAPTION>
CLASS I* CLASS A* CLASS B
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Availability LIMITED TO CERTAIN GENERALLY AVAILABLE GENERALLY AVAILABLE
INVESTORS INCLUDING: THROUGH SELECTED THROUGH SELECTED
- Investor Class and SECURITIES DEALERS AND SECURITIES DEALERS AND
current Class I OTHER FINANCIAL OTHER FINANCIAL
shareholders. INTERMEDIARIES. INTERMEDIARIES.
- Certain retirement
plans. Distributor Class
- Participants in shareholders.
certain sponsored
programs.
- Certain affiliates or
customers of selected
securities dealers and
other financial
intermediaries.
---------------------------------------------------------------------------------------------------------------
Initial Sales Charge? YES. PAYABLE AT TIME OF YES. PAYABLE AT TIME OF NO. ENTIRE PURCHASE
PURCHASE. LOWER SALES PURCHASE. LOWER SALES PRICE IS INVESTED IN
CHARGES AVAILABLE FOR CHARGES AVAILABLE FOR SHARES OF THE FUND.
LARGER INVESTMENTS. LARGER INVESTMENTS.
---------------------------------------------------------------------------------------------------------------
Deferred Sales NO. (MAY BE CHARGED FOR NO. (MAY BE CHARGED FOR YES. PAYABLE IF YOU
Charge? PURCHASES OVER $1 PURCHASES OVER $1 REDEEM WITHIN SIX YEARS
MILLION THAT ARE MILLION THAT ARE OF PURCHASE.
REDEEMED WITHIN ONE REDEEMED WITHIN ONE
YEAR.) YEAR.)
---------------------------------------------------------------------------------------------------------------
Account Maintenance NO. 0.25% ACCOUNT 0.25% ACCOUNT
and Distribution MAINTENANCE FEE NO MAINTENANCE FEE 0.75%
Fees? DISTRIBUTION FEE. DISTRIBUTION FEE.
---------------------------------------------------------------------------------------------------------------
Conversion to Class A NO. NO. YES, AUTOMATICALLY AFTER
shares? APPROXIMATELY EIGHT
YEARS.
---------------------------------------------------------------------------------------------------------------
<CAPTION>
CLASS C
-------------------------------------------------
<S> <C>
Availability GENERALLY AVAILABLE
THROUGH SELECTED
SECURITIES DEALERS AND
OTHER FINANCIAL
INTERMEDIARIES.
-------------------------------------------------
Initial Sales Charge? NO. ENTIRE PURCHASE
PRICE IS INVESTED IN
SHARES OF THE FUND.
-------------------------------------------------
Deferred Sales YES. PAYABLE IF YOU
Charge? REDEEM WITHIN ONE YEAR
OF PURCHASE.
-------------------------------------------------
Account Maintenance 0.25% ACCOUNT
and Distribution MAINTENANCE FEE 0.75%
Fees? DISTRIBUTION FEE.
-------------------------------------------------
Conversion to Class A NO.
shares?
-------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I shares
and Distributor Class shares were redesignated Class A shares.
MERCURY HW INTERNATIONAL VALUE FUND 13
<PAGE> 93
[ACCOUNT CHOICES ICON] Account Choices
RIGHT OF ACCUMULATION -- permits you to pay the sales charge applicable to the
cost or value (whichever is higher) of all shares you own in the Mercury mutual
funds.
LETTER OF INTENT -- permits you to pay the sales charge that would be applicable
if you add up all shares of Mercury mutual funds that you agree to buy within a
13 month period. Certain restrictions apply.
CLASS I AND A SHARES* -- INITIAL SALES CHARGE OPTIONS
If you select Class I or A shares, you will pay a sales charge at the time of
purchase as shown in the following table. Securities dealers' compensation will
be as shown in the last column.
<TABLE>
<CAPTION>
DEALER
AS A % OF COMPENSATION
AS A % OF YOUR AS A % OF
YOUR INVESTMENT OFFERING PRICE INVESTMENT** OFFERING PRICE
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
LESS THAN $25,000 5.25% 5.54% 5.00%
---------------------------------------------------------------------------------------
$25,000 BUT LESS THAN
$50,000 4.75% 4.99% 4.50%
---------------------------------------------------------------------------------------
$50,000 BUT LESS THAN
$100,000 4.00% 4.17% 3.75%
---------------------------------------------------------------------------------------
$100,000 BUT LESS THAN
$250,000 3.00% 3.09% 2.75%
---------------------------------------------------------------------------------------
$250,000 BUT LESS THAN
$1,000,000 2.00% 2.04% 1.80%
---------------------------------------------------------------------------------------
$1,000,000 AND OVER*** 0.00% 0.00% 0.00%
---------------------------------------------------------------------------------------
</TABLE>
*As of October , 2000, Investor Class shares were redesignated Class I
shares and Distributor Class shares were redesignated Class A shares.
** Rounded to the nearest one-hundredth percent.
***If you invest $1,000,000 or more in Class I or A shares, you may not pay an
initial sales charge. In that case, the Investment Adviser compensates the
selling dealer or other financial intermediary from its own resources. If you
redeem your shares within one year after purchase, you may be charged a
deferred sales charge. This charge is 1% of the lesser of the original cost
of the shares being redeemed or your redemption proceeds. A sales charge of
0.75% will be charged on purchases of $1,000,000 or more of Class I and A
shares by certain employer sponsored retirement or savings plans.
No initial sales charge applies to Class I or Class A shares that you buy
through reinvestment of dividends.
A reduced or waived sales charge on a purchase of Class I or A shares may apply
for:
- Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT
- Certain trusts managed by banks, thrifts or trust companies
including those affiliated with the Investment Adviser or its
affiliates
- Certain employer-sponsored retirement or savings plans
- Certain investors, including directors or trustees of mutual funds
sponsored by the Investment Adviser or its affiliates, employees
14 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 94
[ACCOUNT CHOICES ICON] Account Choices
of the Investment Adviser and its affiliates and employees or
customers of selected securities dealers
- Certain fee-based programs managed by the Investment Adviser or
its affiliates
- Certain fee-based programs managed by selected securities dealers
that have an agreement with the Distributor
- Purchases through certain financial advisers, selected securities
dealers, brokers, investment advisers, service providers and other
financial intermediaries
- Purchases through certain accounts over which the Investment
Adviser or an affiliate exercises investment discretion
Only certain investors are eligible to buy Class I shares, including former
Investor Class shareholders of the Fund, existing Class I shareholders of the
Fund, certain retirement plans and participants in certain programs sponsored by
the Investment Adviser or its affiliates. Your financial consultant, selected
securities dealer or other financial intermediary can help you determine whether
you are eligible to buy Class I shares or to participate in any of these
programs.
If you decide to buy shares under the initial sales charge alternative and you
are eligible to buy both Class I and Class A shares, you should buy Class I
since Class A shares are subject to a 0.25% account maintenance fee, while Class
I shares are not.
If you redeem Class I or Class A shares and within 30 days buy new shares of the
same class, you will not pay a sales charge on the new purchase amount. The
amount eligible for this "Reinstatement Privilege" may not exceed the amount of
your redemption proceeds. To exercise the privilege, contact your financial
consultant, selected securities dealer, other financial intermediary or the
Fund's Transfer Agent at 1-800-236-4479.
CLASS B AND C SHARES -- DEFERRED SALES CHARGE OPTIONS
If you select Class B or Class C shares, you do not pay an initial sales charge
at the time of purchase. However, if you redeem your Class B shares within six
years after purchase or Class C shares within one year after purchase, you may
be required to pay a deferred sales charge. You will also pay distribution fees
of 0.75% and account maintenance fees of 0.25% each year under a distribution
plan that the Fund has adopted under Rule 12b-1. Because these fees are paid out
of the Fund's assets on an ongoing basis, over time these fees increase the cost
of your investment and may cost you more than paying an initial sales charge.
The Distributor uses the money that it receives from the deferred sales
MERCURY HW INTERNATIONAL VALUE FUND 15
<PAGE> 95
[ACCOUNT CHOICES ICON] Account Choices
charge and the distribution fees to cover the costs of marketing, advertising
and compensating the financial consultant, selected securities dealer or other
financial intermediary who assists you in purchasing Fund shares.
CLASS B SHARES
If you redeem Class B shares within six years after purchase, you may be charged
a deferred sales charge. The amount of the charge gradually decreases as you
hold your shares over time, according to the following schedule:
<TABLE>
<CAPTION>
YEAR SINCE PURCHASE SALES CHARGE*
------------------------------------------
<S> <C>
0 - 1 4.00%
------------------------------------------
1 - 2 4.00%
------------------------------------------
2 - 3 3.00%
------------------------------------------
3 - 4 3.00%
------------------------------------------
4 - 5 2.00%
------------------------------------------
5 - 6 1.00%
------------------------------------------
6 AND THEREAFTER 0.00%
------------------------------------------
</TABLE>
* The percentage charge will apply to the lesser of the original cost of the
shares being redeemed or the proceeds of your redemption. Shares acquired
through reinvestment of dividends are not subject to a deferred sales charge.
Not all Mercury funds have identical deferred sales charge schedules. If you
exchange your shares for shares of another Mercury fund, the higher charge
will apply, if any would apply.
The deferred sales charge relating to Class B shares may be reduced or waived in
certain circumstances, such as:
- Certain post-retirement withdrawals from an IRA or other
retirement plan if you are over 59 1/2 years old
- Redemption by certain eligible 401(a) and 401(k) plans and certain
retirement plan rollovers
- Redemption in connection with participation in certain fee-based
programs managed by the Investment Adviser or its affiliates
- Redemption in connection with participation in certain fee-based
programs managed by selected securities dealers or other financial
intermediaries that have agreements with the Distributor or its
affiliates
- Withdrawals resulting from shareholder death or disability as long
as the waiver request is made within one year after death or
disability or, if later, reasonably promptly following comple-
16 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 96
[ACCOUNT CHOICES ICON] Account Choices
tion of probate, or in connection with involuntary termination of
an account in which Fund shares are held
- Withdrawal through the Systematic Withdrawal Plan of up to 10% per
year of your Class B account value at the time the plan is
established
Your Class B shares convert automatically into Class A shares approximately
eight years after purchase. Any Class B shares received through reinvestment of
dividends paid on converting shares will also convert at that time. Class A
shares are subject to lower annual expenses than Class B shares. The conversion
of Class B shares to Class A shares is not a taxable event for Federal income
tax purposes.
Different conversion schedules may apply to Class B shares of different Mercury
mutual funds. If you acquire your Class B shares in an exchange from another
fund with a longer conversion schedule, the longer conversion schedule will
apply. If you exchange your Class B shares in the Fund for Class B shares of a
fund with a longer conversion schedule, the Fund's conversion schedule will
apply. The length of time that you hold both the original and exchanged Class B
shares in both funds will count toward the conversion schedule. The conversion
schedule may be modified in certain other cases as well.
CLASS C SHARES
If you redeem Class C shares within one year after purchase, you may be charged
a deferred sales charge of 1.00%. The charge will apply to the lesser of the
original cost of the shares being redeemed or the proceeds of your redemption.
You will not be charged a deferred sales charge when you redeem shares that you
acquire through reinvestment of Fund dividends. The deferred sales charge
relating to Class C shares may be reduced or waived in connection with
involuntary termination of an account in which Fund shares are held and
withdrawals through the Systematic Withdrawal Plan.
Class C shares do not offer a conversion privilege.
MERCURY HW INTERNATIONAL VALUE FUND 17
<PAGE> 97
[ACCOUNT CHOICES ICON] Account Choices
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
--------------------------------------------------------------------------------
The chart below summarizes how to buy, sell, transfer and exchange shares
through your financial consultant, selected securities dealer, broker,
investment adviser, service provider or other financial intermediary. You may
also buy shares through the Transfer Agent. To learn more about buying shares
through the Transfer Agent, call 1-800-236-4479. Because the selection of a
mutual fund involves many considerations, your financial consultant, selected
securities dealer or other financial intermediary may help you with this
decision. The Fund does not issue share certificates.
Because of the high cost of maintaining smaller shareholder accounts, the Fund
may redeem the shares in your account (without charging any deferred sales
charge) if the net asset value of your account falls below $500 due to
redemptions you have made. You will be notified that the value of your account
is less than $500 before the Fund makes an involuntary redemption. You will then
have 60 days to make an additional investment to bring the value of your account
to at least $500 before the Fund takes any action. This involuntary redemption
does not apply to retirement plans or Uniform Gifts or Transfers to Minors Act
accounts.
18 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 98
[ACCOUNT CHOICES ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BUY SHARES First, select the share class Refer to the pricing of shares table on page 13. Be sure to
appropriate for you read this prospectus carefully.
-------------------------------------------------------------------------------------------------
Next, determine the amount of The minimum initial investment for the Fund is $1,000 for
your investment all accounts except: - $500 for certain fee-based programs
- $100 for retirement plans (The minimums for initial
investments may be waived under certain circumstances.)
-------------------------------------------------------------------------------------------------
Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. Purchase orders
other financial intermediary placed prior to the close of regular trading on the New York
submit your purchase order Stock Exchange (generally, 4:00 p.m. Eastern time) are
priced at the net asset value determined that day. Certain
financial intermediaries, however, may require submission of
orders prior to that time.
Purchase orders placed after that time are priced at the net
asset value determined on the next business day. The Fund
may reject any order to buy shares and may suspend the sale
of shares at any time. Certain financial intermediaries may
charge a fee to process a purchase. For example, Merrill
Lynch, Pierce, Fenner & Smith Incorporated currently charges
a $5.35 processing fee. The fees charged by other financial
intermediaries may be higher or lower.
-------------------------------------------------------------------------------------------------
Or contact the Transfer Agent To purchase shares directly, call the Transfer Agent at
1-800-236-4479 and request a purchase application. Mail the
completed purchase application to the Transfer Agent at the
address on the back cover of this prospectus.
------------------------------------------------------------------------------------------------------------------------
ADD TO YOUR Purchase additional shares The minimum investment for additional purchases is generally
INVESTMENT $100 for all accounts except: - $50 for certain fee-based
programs - $1 for retirement plans (The minimums for
additional purchases may be waived under certain
circumstances.)
-------------------------------------------------------------------------------------------------
Acquire additional shares All dividends are automatically reinvested without a sales
through the automatic dividend charge.
reinvestment plan
-------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan your selected securities dealer or other financial
intermediary. The current minimum for such automatic
reinvestments is $100. The minimum may be waived or revised
under certain circumstances.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY HW INTERNATIONAL VALUE FUND 19
<PAGE> 99
[ACCOUNT CHOICES ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
TRANSFER SHARES TO Transfer to a participating You may transfer your Fund shares to another selected
ANOTHER SELECTED securities dealer or other securities dealer or other financial intermediary if
SECURITIES DEALER financial intermediary authorized dealer agreements are in place between the
OR OTHER FINANCIAL Distributor and the transferring intermediary and the
INTERMEDIARY Distributor and the receiving intermediary. Certain
shareholder services may not be available for all
transferred shares. You may only purchase additional shares
of funds previously owned before the transfer. All future
trading of these shares must be coordinated by the receiving
intermediary.
-------------------------------------------------------------------------------------------------
Transfer to a non-participating You must either:
securities dealer or other - Transfer your shares to an account with the Transfer
financial intermediary Agent; or
- Sell your shares, paying any applicable deferred sales
charge.
------------------------------------------------------------------------------------------------------------------------
SELL YOUR SHARES Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. For your
other financial intermediary redemption request to be priced at the net asset value on
submit your sales order the day of your request, you must submit your request to
your selected securities dealer or other financial
intermediary prior to that day's close of regular trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern
time). Certain financial intermediaries, however, may
require submission of orders prior to that time. Redemption
requests placed after that time are priced at the net asset
value at the close of regular business on the next business
day.
Certain financial intermediaries may charge a fee to process
a sale of shares. For example, Merrill Lynch, Pierce, Fenner
& Smith Incorporated currently charges a $5.35 processing
fee. No processing fee is charged if you redeem the shares
directly through the Transfer Agent. The fees charged by
other financial intermediaries may be higher or lower.
The Fund may reject an order to sell shares under certain
circumstances.
-------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by writing to
the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter. A signature guarantee will generally be
required but may be waived in certain limited circumstances.
You can obtain a signature guarantee from a bank, securities
dealer, securities broker, credit union, savings
association, national securities exchange and registered
securities association. A notary public seal will not be
acceptable. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
20 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 100
[ACCOUNT CHOICES ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SELL SHARES Participate in the Fund's You can choose to receive systematic payments from your Fund
SYSTEMATICALLY Systematic Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. You can
generally arrange through your selected securities dealer or
other financial intermediary for systematic sales of shares
of a fixed dollar amount on a monthly, bi-monthly,
quarterly, semi-annual or annual basis, subject to certain
conditions. Under either method, you must have dividends
automatically reinvested.
For Class B and C shares, your total annual withdrawals
cannot be more than 10% per year of the value of your shares
at the time your plan is established. The deferred sales
charge is waived for systematic redemptions. Ask your
financial intermediary for details.
------------------------------------------------------------------------------------------------------------------------
EXCHANGE YOUR Select the fund into which you You can exchange your shares of the Fund for shares of other
SHARES want to exchange. Be sure to Mercury mutual funds or for shares of the Summit Cash
read that fund's prospectus Reserves Fund. You must have held the shares used in the
exchange for at least 15 calendar days before you can
exchange to another fund.
Each class of Fund shares is generally exchangeable for
shares of the same class of another Mercury fund. If you own
Class I shares and wish to exchange into a fund in which you
have no Class I shares (and are not eligible to buy Class I
shares), you will exchange into Class A shares. If you own
Class I or Class A shares and wish to exchange into Summit,
you will exchange into Class A shares of Summit. Class B or
Class C shares can be exchanged for Class B shares of
Summit.
Some of the Mercury mutual funds may impose a different
initial or deferred sales charge schedule. If you exchange
Class I or A shares for shares of a fund with a higher
initial sales charge than you originally paid, you may be
charged the difference at the time of exchange. If you
exchange Class B or Class C shares for shares of a fund with
a different deferred sales charge schedule, the higher
schedule will apply. The time you hold Class B or C shares
in both funds will count when determining your holding
period for calculating a deferred sales charge at
redemption. Your time in both funds will also count when
determining the holding period for a conversion from Class B
to Class A shares.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY HW INTERNATIONAL VALUE FUND 21
<PAGE> 101
[ACCOUNT CHOICES ICON] Account Choices
NET ASSET VALUE -- the market value in U.S. dollars of the Fund's total assets
after deducting liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
--------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open as of the close of regular trading on the Exchange based on
prices at the time of closing. Regular trading on the Exchange generally closes
at 4:00 p.m. Eastern time. The net asset value used in determining your price is
the next one calculated after your purchase or redemption order is placed.
Foreign securities owned by the Fund may trade on weekends or other days when
the Fund does not price its shares. As a result, the Fund's net asset value may
change on days when you will not be able to purchase or redeem the Fund's
shares.
The Fund may accept orders from certain authorized financial intermediaries or
their designees. The Fund will be deemed to receive an order when accepted by
the intermediary or designee and the order will receive the net asset value next
computed by the Fund after such acceptance. If the payment for a purchase order
is not made by a designated later time, the order will be canceled and the
financial intermediary could be held liable for any losses.
Generally, Class I shares will have the highest net asset value because that
class has the lowest expenses, and Class A shares will have a higher net asset
value than Class B or Class C shares. Also dividends paid on Class I and Class A
shares will generally be higher than dividends paid on Class B and Class C
shares because Class I and Class A shares have lower expenses.
FEE-BASED PROGRAMS
--------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by the Investment
Adviser or an affiliate of the Investment Adviser, or by selected securities
dealers or other financial intermediaries that have an agreement with the
Distributor, you may be able to buy Class I shares at net asset value, including
by exchanges from other share classes. Sales charges on the shares being
exchanged may be reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
22 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 102
[ACCOUNT CHOICES ICON] Account Choices
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed ordinary income or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
If you leave one of these programs, your shares may be redeemed or automatically
exchanged into another class of the Fund's shares or into the Summit fund. The
class you receive may be the class you originally owned when you entered the
program, or in certain cases, a different class. If the exchange is into Class B
shares, the period before conversion to Class A shares may be modified. Any
redemption or exchange will be at net asset value. However, if you participate
in the program for less than a specified period, you may be charged a fee in
accordance with the terms of the program.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your financial
consultant, selected securities dealer or other financial intermediary.
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
The Fund will distribute any net investment income and any net realized long-
term or short-term capital gains at least annually. The Fund may also pay a
special distribution at the end of the calendar year to comply with Federal tax
requirements. DIVIDENDS may be reinvested automatically in shares of the Fund at
net asset value without a sales charge or may be taken in cash. If your account
is with a selected securities dealer or other financial intermediary that has an
agreement with the Fund, contact your dealer or intermediary about which option
you would like. If your account is with the Transfer Agent and you would like to
receive dividends in cash, contact the Transfer Agent. The Fund anticipates that
the majority of its dividends, if any, will consist of ordinary income. Capital
gains, if any, may be taxable to you at different rates, depending, in part, on
how long the Fund has held the assets sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your shares and any
gain on the transaction may be subject to tax. Capital gain dividends are
generally taxed at different rates than ordinary income dividends.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax treaties between certain countries
and the U.S. may reduce or eliminate such taxes.
MERCURY HW INTERNATIONAL VALUE FUND 23
<PAGE> 103
[ACCOUNT CHOICES ICON] Account Choices
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
By law, the Fund must withhold 31% of your dividends and redemption proceeds if
you have not provided a taxpayer identification number or social security number
or if the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
24 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 104
[THE MANAGEMENT TEAM ICON] The Management Team
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
Mercury Advisors, the Fund's Investment Adviser, manages the Fund's investments
under the overall supervision of the Board of Trustees. The Investment Adviser
has the responsibility for making all investment decisions for the Fund. For the
fiscal year ended June 30, 2000, the Fund paid the Investment Adviser a fee at
the annual rate of 0.75% of the average daily net assets of the Fund.
The Investment Adviser was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
The Investment Adviser and its affiliates had approximately $555 billion in
investment company and other portfolio assets under management as of June 30,
2000.
The Investment Adviser has entered into subadvisory agreements with Merrill
Lynch Investment Managers International Limited, 33 King William Street, London,
England EC4R 9AS, and Merrill Lynch Asset Management U.K. Limited, Ropemaker
Place, 25 Ropemaker Street, London, England E2Y 9LY, affiliated investment
advisers that are indirect wholly-owned subsidiaries of Merrill Lynch & Co.,
Inc. The subadvisory arrangements are for investment research, recommendations
and other investment-related services. There is no increase in the aggregate
fees paid by the Fund for these services.
The Investment Adviser is allowed to allocate brokerage based on sales of shares
of funds managed by the Investment Adviser.
MERCURY HW INTERNATIONAL VALUE FUND 25
<PAGE> 105
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned on an investment in the
Fund (assuming reinvestment of all dividends and distributions). These financial
highlights were audited by PricewaterhouseCoopers LLP. The accountants' report
and the Fund's financial statements are included in the Fund's annual report,
which is available upon request. Further performance information is contained in
the annual report.
<TABLE>
<CAPTION>
CLASS I(1) CLASS A(1)
------------------------------------------------------------- ----------------------------
FOR THE YEAR ENDED JUNE 30, FOR THE YEAR ENDED JUNE 30,
INCREASE (DECREASE) IN ------------------------------------------------------------- ----------------------------
NET ASSET VALUE: 2000 1999 1998 1997 1996 2000 1999(2)
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
-------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of
year $ 25.33 $ 24.17 $ 20.44 $ 17.70 $ 25.20
-------------------------------------------------------------------------------------------------------------------------------
Investment income -- net 0.59 0.59 0.59(3) 0.56(3) 0.05
-------------------------------------------------------------------------------------------------------------------------------
Realized and unrealized gain
(loss) on investments -- net (0.40) 1.23 3.78 2.51 0.47
-------------------------------------------------------------------------------------------------------------------------------
Total from investment operations 0.99 1.82 4.37 3.07 0.52
-------------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions
Investment income -- net (0.25) (0.66) (0.48) (0.14) --
Realized gain on
investments -- net (0.34) -- (0.16) (0.19) --
-------------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions (0.59) (0.66) (0.64) (0.33) --
-------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $ 25.73 $ 25.33 $ 24.17 $ 20.44 $ 25.72
-------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
-------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per
share 4.22% 7.77% 21.59% 18.61% 2.06%(++)
-------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
-------------------------------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement 0.95% 0.89% 1.00% 1.00% 1.30%(+)
-------------------------------------------------------------------------------------------------------------------------------
Expenses 0.95% 0.89% 1.07% 1.11% 1.30%(+)
-------------------------------------------------------------------------------------------------------------------------------
Investment income -- net 1.98% 2.32% 2.66% 2.78% 2.77%(+)
-------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
-------------------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in
millions) $1,378.90 $1,476.80 $888.50 $331.00 $1.10
-------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover 41% 20% 18% 12% 41%(++)
-------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) As of October , 2000, Investor Class shares were redesignated Class I
shares and Distributor Class shares were redesignated Class A shares.
No sales loads were charged prior to this time.
(2) The Class commenced operations on June 2, 1999.
(3) Net investment income per share represents net investment income divided by
average shares outstanding throughout the year.
(*) Total investment return excludes the effects of sales charges.
(+) Annualized.
(++) Not annualized.
26 MERCURY HW INTERNATIONAL VALUE FUND
<PAGE> 106
<TABLE>
<S> <C>
FUND
Mercury HW International Value Fund
of Mercury HW Funds
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(800-236-4479)
INVESTMENT ADVISER
Administrative Offices:
Mercury Advisors
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
725 South Figueroa Street,
Suite 4000
Los Angeles, California 90017-5400
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 41621
Jacksonville, Florida 32232-1621
(800-236-4479)
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
100 E. Wisconsin Ave., Suite 1500
Milwaukee, Wisconsin 53202
DISTRIBUTOR
FAM Distributors, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109-3661
COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610-4795
</TABLE>
<PAGE> 107
[TO LEARN MORE ICON] To Learn More
SHAREHOLDER REPORTS
Additional information about the Fund's investments will be available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report you will find a discussion of the relevant market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling
1-800-236-4479.
The Fund will send you one copy of each shareholder report and certain other
mailings regardless of the number of Fund accounts you have. To receive separate
shareholder reports for each account, call your financial consultant or other
financial intermediary or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and brokerage or mutual
fund account number. If you have any questions, please call your financial
consultant or other financial intermediary or the Transfer Agent at
1-800-236-4479.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at Financial Data Services, Inc., P.O. Box 41621, Jacksonville, Florida
32232-1621 or by calling 1-800-236-4479.
Contact your financial consultant or other financial intermediary or the Fund at
the telephone number or address indicated on the inside back cover of this
prospectus if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet Site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION IN THIS PROSPECTUS.
Investment Company Act File #811-4182.
CODE #MHW-1030-1000
(C) Mercury Advisors
Mercury HW
International Value Fund
OF MERCURY HW FUNDS
[ART WORK]
PROSPECTUS - October , 2000
<PAGE> 108
Mercury HW Global Value Fund
OF MERCURY HW FUNDS
ARTWORK
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING INFORMATION
ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST
AND KEEP IT FOR FUTURE REFERENCE.
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.
PROSPECTUS - October , 2000
<PAGE> 109
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
[GLOBE ICON]
FUND FACTS
-----------------------------------------------------------------
About the Mercury HW Global Value Fund...................... 2
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[MAGNIFYING GLASS ICON]
ABOUT THE DETAILS
-----------------------------------------------------------------
How the Fund Invests........................................ 7
Investment Risks............................................ 7
Statement of Additional Information......................... 11
[CHECKMARK ICON]
ACCOUNT CHOICES
-----------------------------------------------------------------
Pricing of Shares........................................... 12
How to Buy, Sell, Transfer and Exchange Shares.............. 14
How Shares are Priced....................................... 18
Fee-Based Programs.......................................... 18
Dividends and Taxes......................................... 19
[MANAGEMENT TEAM ICON]
THE MANAGEMENT TEAM
-----------------------------------------------------------------
Management of the Fund...................................... 21
Financial Highlights........................................ 22
[TELEPHONE ICON]
TO LEARN MORE
-----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERCURY HW GLOBAL VALUE FUND
<PAGE> 110
[GLOBE ICON] Fund Facts
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
COMMON STOCK -- units of ownership of a corporation.
PREFERRED STOCK -- class of stock that often pays dividends at a specified rate
and has preference over common stock in dividend payments and liquidation of
assets. Preferred stock may also be convertible into common stock.
CONVERTIBLE SECURITIES -- fixed income securities, such as corporate bonds or
preferred stock, that are exchangeable for shares of common stock of the issuer
or another company.
PRICE-TO-EARNINGS RATIO -- price of stock divided by its earnings per share.
YIELD -- percentage rate of return paid on a stock in dividends and share
repurchases.
PRICE-TO-BOOK VALUE RATIO -- price of a stock divided by its book value per
share.
ABOUT THE MERCURY HW GLOBAL VALUE FUND
--------------------------------------------------------------------------------
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to seek current income and long-term growth
of income, accompanied by growth of capital.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests in U.S. and international stocks. The Fund may purchase COMMON
STOCK, PREFERRED STOCK, CONVERTIBLE SECURITIES and other instruments.
In investing the Fund's assets, Mercury Advisors (the "Investment Adviser")
follows a value style. This means that the Investment Adviser buys stocks that
it believes are currently undervalued by the market and thus have a lower price
than their true worth. Typical value characteristics include:
- low PRICE-TO-EARNINGS RATIO relative to the market
- high YIELD relative to the market
- low PRICE-TO-BOOK VALUE RATIO relative to the market
- financial strength
Stocks may be "undervalued" because they are part of an industry that is out of
favor with investors generally. Even in those industries, though, individual
companies may have high rates of growth of earnings and be financially sound. At
the same time, the price of their common stock may be depressed because
investors associate the companies with their industries.
This value discipline sometimes prevents or limits investments in stocks that
are in well-known indexes, like the MSCI World Index. Also, the return of the
Fund will not necessarily be similar to the return of the MSCI World Index.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of your Fund shares, may go up or down. If the value of the Fund's
investments goes down, you may lose money. The value changes in the Fund's
investments may occur because a particular stock market is rising or falling. At
other times, there are specific factors that may affect the value of a
particular investment. The Fund is also subject to the risk that the stocks the
Fund's Adviser selects will underperform the stock markets or other funds with
similar investment objectives and investment strategies.
In addition, because the Fund invests most of its assets in foreign securities,
the Fund is subject to additional risks. For example, the Fund's securities may
go
2
MERCURY HW GLOBAL VALUE FUND
<PAGE> 111
[GLOBE ICON] Fund Facts
up or down in value depending on foreign exchange rates, political and economic
developments and U.S. foreign laws relating to foreign investment. Foreign
securities may also be less liquid, more volatile and harder to value than U.S.
securities. These risks are heightened for investments in emerging markets.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
See "Investment Risks" for more information about the risks associated with the
Fund.
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are seeking long-term growth of capital and can withstand the
share price volatility of equity investing.
- Are seeking to diversify a portfolio of equity securities to
include foreign securities.
- Can tolerate the increased volatility and currency fluctuations
associated with investments in foreign securities.
- Want a professionally managed and diversified portfolio.
- Are willing to accept the risk that the value of your investment
may decline in order to seek long-term capital appreciation.
- Are prepared to receive taxable distributions.
MERCURY HW GLOBAL VALUE FUND 3
<PAGE> 112
[GLOBE ICON] Fund Facts
RISK/RETURN BAR CHART
--------------------------------------------------------------------------------
The bar chart and table below provides some indication of the risks of investing
in the Fund by showing changes in the year to year performance of the Fund and
by showing how the Fund's average annual total returns for 1 year and for its
life compare with those of a broad measure of market performance. How the Fund
has performed in the past is not necessarily an indication of how the Fund will
perform in the future.
<TABLE>
<S> <C>
1997 7.80%
1998 6.71%
1999 12.37%
</TABLE>
Total return for the six months ended June 30, 2000: -2.77%.
During the period shown in the bar chart, the highest return for a quarter was
15.83% (quarter ended December 31, 1998) and the lowest return for a quarter was
-17.84% (quarter ended September 30, 1998).
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS PAST SINCE
(FOR THE PERIODS ENDED DECEMBER 31, 1999) ONE YEAR INCEPTION
-------------------------------------------------------------------------------------
<S> <C> <C>
CLASS I*+ 12.37% 8.93%(1)
MSCI WORLD INDEX 25.34% 22.05%(2)
-------------------------------------------------------------------------------------
</TABLE>
The Morgan Stanley Capital International World Index (MSCI World) is an
arithmetical average weighted by market value of the performance of over 1,400
companies listed on stock exchanges in the 22 countries that make up the MSCI
Network Indexes.
* Includes the effect of sales charges, which were not imposed until October
, 2000.
+ As of October , 2000, Investor Class shares were redesignated Class I
shares.
(1) Inception date is January 2, 1997.
(2) Since January 1, 1997.
4
MERCURY HW GLOBAL VALUE FUND
<PAGE> 113
[GLOBE ICON] Fund Facts
UNDERSTANDING EXPENSES
Fund investors pay various expenses, either directly or indirectly. Listed below
are some of the main types of expenses, which all mutual funds may charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
INVESTMENT ADVISORY FEE -- a fee paid to the Investment Adviser for managing the
Fund.
FEES AND EXPENSES
--------------------------------------------------------------------------------
The Fund offers a single class of shares.
THIS TABLE SHOWS THE DIFFERENT FEES AND EXPENSES THAT YOU MAY PAY IF YOU BUY AND
HOLD SHARES OF THE FUND. FUTURE EXPENSES MAY BE GREATER OR LESS THAN THOSE
INDICATED BELOW.
<TABLE>
<CAPTION>
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)(a): CLASS I*
------------------------------------------------------------------------
<S> <C>
Maximum Sales Charge (Load) imposed on purchases (as a
percentage of offering price) 5.25%(b)
------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a percentage of
original purchase price or redemption proceeds, whichever is
lower) None(c)
------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend Reinvestments None
------------------------------------------------------------------------
Redemption Fee None
------------------------------------------------------------------------
Exchange Fee None
------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED
FROM THE FUND'S TOTAL ASSETS):
------------------------------------------------------------------------
INVESTMENT ADVISORY FEE(d) 0.75%
------------------------------------------------------------------------
DISTRIBUTION AND/OR SERVICE (12b-1) FEES None
------------------------------------------------------------------------
Other Expenses (including transfer agency fees) 1.38%
------------------------------------------------------------------------
TOTAL ANNUAL OPERATING EXPENSES 2.13%
------------------------------------------------------------------------
Expense Reimbursement(d) 0.88%
------------------------------------------------------------------------
NET ANNUAL FUND OPERATING EXPENSES 1.25%
------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C>
( )* As of October , 2000, Investor Class shares were
redesignated Class I shares.
(a) Certain securities dealers or other financial intermediaries
may charge a fee to process a purchase or sale of shares.
See "How to Buy, Sell, Transfer and Exchange Shares."
(b) Some investors may qualify for reductions in the sales
charge (load).
(c) You may pay a deferred sales charge if you purchase $1
million or more and you redeem within one year.
(d) The Investment Adviser has contractually agreed to waive
management fees and/or reimburse expenses through June 30,
2001, as shown in the table.
</TABLE>
MERCURY HW GLOBAL VALUE FUND 5
<PAGE> 114
[GLOBE ICON] Fund Facts
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, and that the Fund's operating expenses remain the same except for
the expense reimbursement in effect for the first year. This assumption is not
meant to indicate you will receive a 5% annual rate of return. Your annual
return may be more or less than the 5% used in these examples. Although your
actual costs may be higher or lower, based on these assumptions, your costs
would be:
<TABLE>
<CAPTION>
CLASS I
------------------------------------------------------------------------------
<S> <C>
ONE YEAR $ 646
------------------------------------------------------------------------------
THREE YEARS $1,077
------------------------------------------------------------------------------
FIVE YEARS $1,532
------------------------------------------------------------------------------
TEN YEARS $2,792
------------------------------------------------------------------------------
</TABLE>
6
MERCURY HW GLOBAL VALUE FUND
<PAGE> 115
[MAGNIFYING GLASS ICON] About the Details
ABOUT THE PORTFOLIO MANAGERS -- James Doyle became a portfolio manager of the
Fund effective July 1, 2000. Mr. Doyle is a vice president of the Investment
Adviser and has been an investment professional with the Investment Adviser
since 1997. From 1992 to 1995, Mr. Doyle was a financial analyst at LaSalle
Partners, a real estate investment firm.
Mark Morris became a portfolio manager of the Fund effective July 1, 2000. Mr.
Morris is a director of the Investment Adviser and has been with the Investment
Adviser since 1998. Mr. Morris was a portfolio manager with Trust Company of the
West from 1996 to 1998, and a technology analyst from 1991 to 1998.
ABOUT THE INVESTMENT ADVISER -- Mercury Advisors manages the Fund.
ABOUT THE SUBADVISERS -- Merrill Lynch Investment Managers International Limited
and Merrill Lynch Asset Management U.K. Limited are subadvisers to the Fund and
provide investment research, recommendations and other investment-related
services.
HOW THE FUND INVESTS
--------------------------------------------------------------------------------
The Fund's investment objective is to provide current income and long-term
growth of income, accompanied by growth of capital.
The Fund invests in stocks in at least ten different countries with developed
stock markets, including the U.S. No country other than the U.S. will represent
more than 30% of assets. Normally, the Fund invests at least 80% of its total
assets in stocks that pay dividends. It also may invest in stocks that don't pay
dividends or interest, but have growth potential unrecognized by the market or
changes in business or management that indicate growth potential.
MONEY MARKET INVESTMENTS
To meet redemptions and when waiting to invest cash receipts, the Fund may
invest in short-term, investment grade bonds, money market mutual funds and
other money market instruments. Also, the Fund temporarily can invest up to 100%
of its assets in short-term, investment grade bonds and other money market
instruments in response to adverse market, economic or political conditions. The
Fund may not achieve its objective using this type of investing.
INVESTMENT RISKS
--------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK
Market risk is the risk that the market will go down in value, including the
possibility that the market will go down sharply and unpredictably. Selection
risk is the risk that the investments that Fund management selects will
underperform the market or other funds with similar investment objectives and
investment strategies.
FOREIGN MARKET RISK
Since the Fund invests in foreign securities, it offers the potential for more
diversification than an investment only in the U.S. This is because stocks
traded on foreign markets have often (though not always) performed differently
than stocks in the U.S. However, such investments involve special risks not
present in U.S. investments that can increase the chances that the Fund will
lose
MERCURY HW GLOBAL VALUE FUND 7
<PAGE> 116
[MAGNIFYING GLASS ICON] About the Details
money. In particular, investments in foreign securities involve the following
risks, which are generally greater for investments in emerging markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair the Fund's
ability to purchase or sell foreign securities or transfer its
assets or income back into the U.S., or otherwise adversely affect
the Fund's operations.
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal
remedies available to investors in some foreign countries may be
less extensive than those available to investors in the U.S.
- Because there are generally fewer investors on foreign exchanges
and a smaller number of shares traded each day, it may be
difficult for the Fund to buy and sell securities on those
exchanges. In addition, prices of foreign securities may go up and
down more than prices of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and the Fund's assets may be
8
MERCURY HW GLOBAL VALUE FUND
<PAGE> 117
[MAGNIFYING GLASS ICON] About the Details
uninvested and not earning returns. The Fund also may miss
investment opportunities or be unable to sell an investment
because of these delays.
- The value of the Fund's foreign holdings (and hedging transactions
in foreign currencies) will be affected by changes in currency
exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- International trade barriers or economic sanctions against certain
foreign countries may adversely affect a Fund's foreign holdings.
EUROPEAN ECONOMIC AND MONETARY UNION (EMU)
A number of European countries have entered into EMU in an effort to reduce
trade barriers between themselves and eliminate fluctuations in their
currencies. EMU establishes a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These securities trade and make dividend and other payments only in euros. Like
other investment companies and business organizations, including the companies
in which the Fund invests, the Fund could be adversely affected if the
transition to euro, or EMU as a whole, does not take effect as planned, or if a
participating country withdraws from EMU.
RISKS OF CONVERTIBLE SECURITIES
Convertibles are generally bonds or preferred stocks that may be converted into
common stock. Convertibles typically pay current income, as either interest
(bond convertibles) or dividends (preferred stocks). A convertible's value
usually reflects both the stream of current income payments and the value of the
underlying common stock. The market value of a convertible performs like regular
bonds; that is, if market interest rates rise, the value of a convertible
MERCURY HW GLOBAL VALUE FUND 9
<PAGE> 118
[MAGNIFYING GLASS ICON] About the Details
usually falls. Since it is convertible into common stock, the convertible also
has the same types of market and issuer risk as the underlying common stock.
DEBT SECURITIES
Debt securities, such as bonds, involve credit risk, which is the risk that the
borrower will not make timely payments of principal and interest. These
securities are also subject to interest rate risk, which is the risk that the
value of the security may fall when interest rates rise. In general, the market
price of debt securities with longer maturities will go up or down more in
response to changes in interest rates than shorter term securities.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD COMMITMENTS
When-issued securities, delayed-delivery securities and forward commitments
involve the risk that the security the Fund buys will lose value prior to its
delivery to the Fund. There also is the risk that the security will not be
issued or that the other party will not meet its obligation, in which case the
Fund loses the investment opportunity of the assets it has set aside to pay for
the security and any gain in the security's price.
DERIVATIVES
Derivatives involve the following risks:
- CREDIT RISK -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Fund.
- CURRENCY RISK -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
- LEVERAGE RISK -- Leverage risk is the risk associated with certain
types of investments or trading strategies that relatively small
market movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- LIQUIDITY RISK -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time that
the seller would like or at the price that the seller believes the
security is currently worth.
- INDEX RISK -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
10
MERCURY HW GLOBAL VALUE FUND
<PAGE> 119
[MAGNIFYING GLASS ICON] About the Details
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
STATEMENT OF ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERCURY HW GLOBAL VALUE FUND 11
<PAGE> 120
[CHECKMARK ICON] Account Choices
PRICING OF SHARES
--------------------------------------------------------------------------------
The Fund offers a single class of shares.
The Fund's shares are distributed by FAM Distributors, Inc. (the "Distributor").
Certain financial institutions may charge you additional fees in connection with
transactions in fund shares. The Investment Adviser, the Distributor or their
affiliates may make payments out of their own resources to securities dealers
and other financial intermediaries for providing services intended to result in
the sale of Fund shares or for shareholder servicing activities.
To better understand the pricing of the Fund's shares, we have summarized the
information below:
<TABLE>
<CAPTION>
CLASS I*
-------------------------------------------------------------------------------------
<S> <C>
Availability LIMITED TO CERTAIN INVESTORS INCLUDING:
- Investor Class and current Class I shareholders.
- Certain retirement plans.
- Participants in certain sponsored programs.
- Certain affiliates or customers of selected
securities dealers or other financial intermediaries.
[- Certain institutional investors.]
-------------------------------------------------------------------------------------
Initial Sales Charge? YES. PAYABLE AT TIME OF PURCHASE. LOWER SALES CHARGES
AVAILABLE FOR LARGER INVESTMENTS.
-------------------------------------------------------------------------------------
Deferred Sales Charge? NO. (MAY BE CHARGED FOR PURCHASES OVER $1 MILLION THAT
ARE REDEEMED WITHIN ONE YEAR.)
-------------------------------------------------------------------------------------
Account Maintenance and NO.
Distribution Fees?
-------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares.
12
MERCURY HW GLOBAL VALUE FUND
<PAGE> 121
[CHECKMARK ICON] Account Choices
RIGHT OF ACCUMULATION -- permits you to pay the sales charge applicable to the
cost or value (whichever is higher) of all shares you own in the Mercury mutual
funds.
LETTER OF INTENT -- permits you to pay the sales charge that would be applicable
if you add up all shares of Mercury mutual funds that you agree to buy within a
13 month period. Certain restrictions apply.
CLASS I SHARES* -- INITIAL SALES CHARGE OPTION
If you buy shares of the Fund, you will pay a sales charge at the time of
purchase as shown in the following table. Securities dealers' compensation will
be as shown in the last column.
<TABLE>
<CAPTION>
DEALER
AS A % OF COMPENSATION
AS A % OF YOUR AS A % OF
YOUR INVESTMENT OFFERING PRICE INVESTMENT** OFFERING PRICE
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
LESS THAN $25,000 5.25% 5.54% 5.00%
---------------------------------------------------------------------------------------
$25,000 BUT LESS THAN
$50,000 4.75% 4.99% 4.50%
---------------------------------------------------------------------------------------
$50,000 BUT LESS THAN
$100,000 4.00% 4.17% 3.75%
---------------------------------------------------------------------------------------
$100,000 BUT LESS THAN
$250,000 3.00% 3.09% 2.75%
---------------------------------------------------------------------------------------
$250,000 BUT LESS THAN
$1,000,000 2.00% 2.04% 1.80%
---------------------------------------------------------------------------------------
$1,000,000 AND OVER*** 0.00% 0.00% 0.00%
---------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares.
** Rounded to the nearest one-hundredth percent.
*** If you invest $1,000,000 or more in Class I shares, you may not pay an
initial sales charge. In that case, the Investment Adviser compensates the
selling dealer or other financial intermediary from its own resources. If
you redeem your shares within one year after purchase, you may be charged a
deferred sales charge. This charge is 1% of the lesser of the original cost
of the shares being redeemed or your redemption proceeds. A sales charge of
0.75% will be charged on purchases of $1,000,000 or more of Class I shares
by certain employer sponsored retirement or savings plans.
No initial sales charge applies to shares that you buy through reinvestment of
dividends.
A reduced or waived sales charge on a purchase of Class I shares may apply for:
- Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT
- Certain trusts managed by banks, thrifts or trust companies
including those affiliated with the Investment Adviser or its
affiliates
- Certain employer-sponsored retirement or savings plans
- Certain investors, including directors or trustees of mutual funds
sponsored by the Investment Adviser or its affiliates, employees
of the Investment Adviser and its affiliates and employees or
customers of selected dealers
MERCURY HW GLOBAL VALUE FUND 13
<PAGE> 122
[CHECKMARK ICON] Account Choices
- Certain fee-based programs managed by the Investment Adviser or
its affiliates
- Certain fee-based programs managed by selected dealers that have
an agreement with the Distributor
- Purchases through certain financial advisers, selected dealers,
brokers, investment advisers, service providers and other
financial intermediaries
- Purchases through certain accounts over which the Investment
Adviser or an affiliate exercises investment discretion
[- Certain institutional investors]
If you redeem Class I shares and within 30 days buy new shares of the same
class, you will not pay a sales charge on the new purchase amount. The amount
eligible for this "Reinstatement Privilege" may not exceed the amount of your
redemption proceeds. To exercise the privilege, contact your financial
consultant, selected securities dealer or other financial intermediary or the
Fund's Transfer Agent at 1-800-236-4479.
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
--------------------------------------------------------------------------------
The chart below summarizes how to buy, sell, transfer and exchange shares
through your financial consultant, selected securities dealer, broker,
investment adviser, service provider or other financial intermediary. You may
also buy shares through the Transfer Agent. To learn more about buying shares
through the Transfer Agent, call 1-800-236-4479. Because the selection of a
mutual fund involves many considerations, your financial consultant, selected
securities dealer or other financial intermediary may help you with this
decision. The Fund does not issue share certificates.
Because of the high cost of maintaining smaller shareholder accounts, the Fund
may redeem the shares in your account (without charging any deferred sales
charge) if the net asset value of your account falls below $500 due to
redemptions you have made. You will be notified that the value of your account
is less than $500 before the Fund makes an involuntary redemption. You will then
have 60 days to make an additional investment to bring the value of your account
to at least $500 before the Fund takes any action. This involuntary redemption
does not apply to retirement plans or Uniform Gifts or Transfers to Minors Act
accounts.
14
MERCURY HW GLOBAL VALUE FUND
<PAGE> 123
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BUY SHARES Determine the amount of your The minimum initial investment for the Fund is $1,000 for
investment all accounts except:
- $500 for certain fee-based programs
- $100 for retirement plans
(The minimums for initial investments may be waived under
certain circumstances.)
-------------------------------------------------------------------------------------------------
Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. Purchase orders
other financial intermediary placed prior to the close of regular trading on the New York
submit your purchase order Stock Exchange (generally, 4:00 p.m. Eastern time) are
priced at the net asset value determined that day. Certain
selected securities dealers or other financial
intermediaries, however, may require submission of orders
prior to that time.
Purchase orders placed after that time are priced at the net
asset value determined on the next business day. The Fund
may reject any order to buy shares and may suspend the sale
of shares at any time. Certain financial intermediaries may
charge a fee to process a purchase. For example, Merrill
Lynch, Pierce, Fenner & Smith Incorporated currently charges
a $5.35 processing fee. The fees charged by other financial
intermediaries may be higher or lower.
-------------------------------------------------------------------------------------------------
Or contact the Transfer Agent To purchase shares directly, call the Transfer Agent at
1-800-236-4479 and request a purchase application. Mail the
completed purchase application to the Transfer Agent at the
address on the back cover of this prospectus.
------------------------------------------------------------------------------------------------------------------------
ADD TO YOUR Purchase additional shares The minimum investment for additional purchases is generally
INVESTMENT $100 for all accounts except:
- $50 for certain fee-based programs
- $1 for retirement plans
(The minimums for additional purchases may be waived under
certain circumstances.)
-------------------------------------------------------------------------------------------------
Acquire additional shares All dividends are automatically reinvested without a sales
through the automatic dividend charge.
reinvestment plan
-------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan your selected securities dealer or other financial
intermediary.
The current minimum for such automatic reinvestments is $100.
The minimum may be waived or revised under certain circumstances.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY HW GLOBAL VALUE FUND 15
<PAGE> 124
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
TRANSFER SHARES TO Transfer to a participating You may transfer your Fund shares to another selected
ANOTHER SECURITIES securities dealer or other securities dealer or other financial intermediary if
DEALER OR OTHER financial intermediary authorized dealer agreements are in place between the
FINANCIAL Distributor and the transferring intermediary and the
INTERMEDIARY Distributor and the receiving intermediary. Certain
shareholder services may not be available for all
transferred shares. You may only purchase additional shares
of funds previously owned before the transfer. All future
trading of these shares must be coordinated by the receiving
intermediary.
-------------------------------------------------------------------------------------------------
Transfer to a non-participating You must either:
securities dealer or other - Transfer your shares to an account with the Transfer Agent; or
financial intermediary - Sell your shares, paying any applicable deferred sales charge.
------------------------------------------------------------------------------------------------------------------------
SELL YOUR SHARES Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. For your
other financial intermediary redemption request to be priced at the net asset value on
submit your sales order the day of your request, you must submit your request to
your selected securities dealer or other financial
intermediary prior to that day's close of regular trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern
time). Certain financial intermediaries, however, may
require submission of orders prior to that time. Redemption
requests placed after that time are priced at the net asset
value at the close of regular trading on the next business
day.
Certain or financial intermediaries may charge a fee to
process a sale of shares. For example, Merrill Lynch,
Pierce, Fenner & Smith Incorporated currently charges a
$5.35 processing fee. No processing fee is charged if you
redeem the shares directly through the Transfer Agent. The
fees charged by other financial intermediaries may be higher
or lower.
The Fund may reject an order to sell shares under certain
circumstances.
-------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by writing to
the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter. A signature guarantee will generally be
required but may be waived in certain limited circumstances.
You can obtain a signature guarantee from a bank, securities
dealer, securities broker, credit union, savings
association, national securities exchange and registered
securities association. A notary public seal will not be
acceptable. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
16 MERCURY HW GLOBAL VALUE FUND
<PAGE> 125
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SELL SHARES Participate in the Fund's You can choose to receive systematic payments from your Fund
SYSTEMATICALLY Systematic Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. You can
generally arrange through your selected securities dealer or
other financial intermediary for systematic sales of shares
of a fixed dollar amount on a monthly, bi-monthly,
quarterly, semi-annual or annual basis, subject to certain
conditions. Under either method, you must have dividends
automatically reinvested. Ask your financial intermediary
for details.
------------------------------------------------------------------------------------------------------------------------
EXCHANGE YOUR Select the fund into which you You can exchange your shares of the Fund for shares of other
SHARES want to exchange. Be sure to Mercury mutual funds or for shares of the Summit Cash
read that fund's prospectus Reserves Fund. You must have held the shares used in the
exchange for at least 15 calendar days before you can
exchange to another fund.
If you wish to exchange into a fund in which you have no
Class I shares (and are not eligible to buy Class I shares),
you will exchange into Class A shares. If you wish to
exchange into Summit, you will exchange into Class A shares
of Summit.
Some of the Mercury mutual funds may impose a different
initial or deferred sales charge schedule. If you exchange
Class I shares for shares of a fund with a higher initial
sales charge than you originally paid, you may be charged
the difference at the time of exchange.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY HW GLOBAL VALUE FUND 17
<PAGE> 126
[CHECKMARK ICON] Account Choices
NET ASSET VALUE -- the market value in U.S. dollars of the Fund's total assets
after deducting liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
--------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open as of the close of regular trading on the Exchange based on
prices at the time of closing. Regular trading on the Exchange generally closes
at 4:00 p.m. Eastern time. The net asset value used in determining your price is
the next one calculated after your purchase or redemption order is placed.
Foreign securities owned by the Fund may trade on weekends or other days when
the Fund does not price its shares. As a result, the Fund's net asset value may
change on days when you will not be able to purchase or redeem the Fund's
shares.
The Fund may accept orders from certain authorized financial intermediaries or
their designees. The Fund will be deemed to receive an order when accepted by
the intermediary or designee and the order will receive the net asset value next
computed by the Fund after such acceptance. If the payment for a purchase order
is not made by a designated later time, the order will be canceled and the
financial intermediary could be held liable for any losses.
FEE-BASED PROGRAMS
--------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by the Investment
Adviser or an affiliate of the Investment Adviser, or by selected securities
dealers or other financial intermediaries that have an agreement with the
Distributor, you may be able to buy Class I shares at net asset value, including
by exchanges from other share classes. Sales charges on the shares being
exchanged may be reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. [Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.]
18
MERCURY HW GLOBAL VALUE FUND
<PAGE> 127
[CHECKMARK ICON] Account Choices
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed ordinary income or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
[If you leave one of these programs, your shares may be redeemed or
automatically exchanged into another class of the Fund's shares or into the
Summit fund. The class you receive may be the class you originally owned when
you entered the program, or in certain cases, a different class.] Any redemption
or exchange will be at net asset value. However, if you participate in the
program for less than a specified period, you may be charged a fee in accordance
with the terms of the program.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your financial
consultant, selected securities dealer or other financial intermediary.
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
The Fund will distribute any net investment income and any net realized long-
term or short-term capital gains at least annually. The Fund may also pay a
special distribution at the end of the calendar year to comply with Federal tax
requirements. DIVIDENDS may be reinvested automatically in shares of the Fund at
net asset value without a sales charge or may be taken in cash. If your account
is with a selected securities dealer or other financial intermediary that has an
agreement with the Fund, contact your dealer or intermediary about which option
you would like. If your account is with the Transfer Agent and you would like to
receive dividends in cash, contact the Transfer Agent. The Fund anticipates that
the majority of its dividends, if any, will consist of ordinary income. Capital
gains, if any, may be taxable to you at different rates, depending, in part, on
how long the Fund has held the assets sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your shares and any
gain on the transaction may be subject to tax. Capital gain dividends are
generally taxed at different rates than ordinary income dividends.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax treaties between certain countries
and the U.S. may reduce or eliminate such taxes.
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
MERCURY HW GLOBAL VALUE FUND 19
<PAGE> 128
[CHECKMARK ICON] Account Choices
By law, the Fund must withhold 31% of your dividends and redemption proceeds if
you have not provided a taxpayer identification number or social security number
or if the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
20
MERCURY HW GLOBAL VALUE FUND
<PAGE> 129
[MANAGEMENT TEAM ICON] The Management Team
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
Mercury Advisors, the Fund's Investment Adviser, manages the Fund's investments
under the overall supervision of the Board of Trustees. The Investment Adviser
has the responsibility for making all investment decisions for the Fund. For the
fiscal year ended June 30, 2000, the Fund paid the Investment Adviser a fee at
the annual rate of 0.75% of the average daily net assets of the Fund.
The Investment Adviser was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
The Investment Adviser and its affiliates had approximately $558 billion in
investment company and other portfolio assets under management as of June 30,
2000.
Although not required to do so, the Investment Adviser has agreed to make
reimbursements so that the regular annual operating expenses of the Fund will be
limited as shown in the table on page 5. The Investment Adviser has agreed to
these expense limits through June 2001, and will thereafter give shareholders at
least 30 days' notice if this reimbursement policy will change.
The Investment Adviser has entered into subadvisory agreements with Merrill
Lynch Investment Managers International Limited, 33 King William Street, London,
England EC4R 9AS, and Merrill Lynch Asset Management U.K. Limited, Ropemaker
Place, 25 Ropemaker Street, London, England E2Y 9LY, affiliated investment
advisers that are indirect wholly-owned subsidiaries of Merrill Lynch & Co.,
Inc. The subadvisory arrangements are for investment research, recommendations
and other investment-related services. There is no increase in the aggregate
fees paid by the Fund for these services.
The Investment Adviser is allowed to allocate brokerage based on sales of shares
of funds managed by the Investment Adviser.
MERCURY HW GLOBAL VALUE FUND 21
<PAGE> 130
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned on an investment in the
Fund (assuming reinvestment of all dividends and distributions). These financial
highlights were audited by PricewaterhouseCoopers LLP. The accountants' report
and the Fund's financial statements are included in the Fund's annual report,
which is available upon request. Further performance information is contained in
the annual report.
<TABLE>
<CAPTION>
CLASS I(1)
-------------------------------------------
FOR THE YEAR ENDED JUNE 30,
INCREASE (DECREASE) IN -------------------------------------------
NET ASSET VALUE: 2000 1999 1998 1997(2)
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
---------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $11.38 $11.09 $10.00
---------------------------------------------------------------------------------------------------------
Investment income -- net 0.35 0.28 0.14
---------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss) on investments -- net 0.24 0.51 1.09
---------------------------------------------------------------------------------------------------------
Total from investment operations 0.59 0.79 1.23
---------------------------------------------------------------------------------------------------------
Less dividends and distributions
Investment income -- net (0.11) (0.32) (0.14)
Realized gain on investments -- net (0.02) (0.18) --
---------------------------------------------------------------------------------------------------------
Total dividends and distributions (0.13) (0.50) (0.14)
---------------------------------------------------------------------------------------------------------
Net asset value, end of year $11.84 $11.38 $11.09
---------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
---------------------------------------------------------------------------------------------------------
Based on net asset value per share 5.40% 7.61% 12.32%++
---------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
---------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement 1.09% 1.00% 1.00%+
---------------------------------------------------------------------------------------------------------
Expenses 2.07% 2.88% 4.43%+
---------------------------------------------------------------------------------------------------------
Investment income -- net 2.76% 1.88% 3.50%+
---------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
---------------------------------------------------------------------------------------------------------
Net assets, end of year (in millions) $7.60 $7.30 $3.70
---------------------------------------------------------------------------------------------------------
Portfolio turnover 40% 54% 18%++
---------------------------------------------------------------------------------------------------------
</TABLE>
(1) As of October , 2000, Investor Class shares were redesignated Class I
shares.
No sales loads were charged prior to this time.
(2) The Fund commenced operations on January 2, 1997.
* Total investment return excludes the effects of sales charges.
+ Annualized.
++ Not annualized.
22 MERCURY HW GLOBAL VALUE FUND
<PAGE> 131
<TABLE>
<S> <C>
FUND
Mercury HW Global Value Fund
of Mercury HW Funds
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(800-236-4479)
INVESTMENT ADVISER
Administrative Offices:
Mercury Advisors
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
725 South Figueroa Street,
Suite 4000
Los Angeles, California 90017-5400
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 44062
Jacksonville, Florida 32232-4062
(800-236-4479)
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
100 E. Wisconsin Ave., Suite 1500
Milwaukee, Wisconsin 53202
DISTRIBUTOR
FAM Distributors, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109-3661
COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610-4795
</TABLE>
<PAGE> 132
[TELEPHONE ICON] To Learn More
SHAREHOLDER REPORTS
Additional information about the Fund's investments will be available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report you will find a discussion of the relevant market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling
1-800-236-4479.
The Fund will send you one copy of each shareholder report and certain other
mailings regardless of the number of Fund accounts you have. To receive separate
shareholder reports for each account, call your financial consultant or other
financial intermediary or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and brokerage or mutual
fund account number. If you have any questions, please call your financial
consultant or other financial intermediary or the Transfer Agent at
1-800-236-4479.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at Financial Data Services, Inc., P.O. Box 41621, Jacksonville, Florida
32232-1621 or by calling 1-800-236-4479.
Contact your financial consultant or other financial intermediary or the Fund at
the telephone number or address indicated on the inside back cover of this
prospectus if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet Site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION IN THIS PROSPECTUS.
Investment Company Act File #811-4182.
CODE #MHW-1020-1000
(C) Mercury Advisors
Mercury HW
Global Value Fund
OF MERCURY HW FUNDS
ARTWORK
PROSPECTUS - October , 2000
<PAGE> 133
PROSPECTUS - October , 2000
MERCURY HW BALANCED FUND
OF MERCURY HW FUNDS
[GRAPHIC]
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING INFORMATION
ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST
AND KEEP IT FOR FUTURE REFERENCE.
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.
<PAGE> 134
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
[FUND FACTS ICON]
FUND FACTS
-----------------------------------------------------------------
About the Mercury HW Balanced Fund.......................... 2
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[ABOUT THE DETAILS ICON]
ABOUT THE DETAILS
-----------------------------------------------------------------
How the Fund Invests........................................ 7
Investment Risks............................................ 9
Statement of Additional Information......................... 15
[ACCOUNT CHOICES ICON]
ACCOUNT CHOICES
-----------------------------------------------------------------
Pricing of Shares........................................... 16
How to Buy, Sell, Transfer and Exchange Shares.............. 19
How Shares are Priced....................................... 24
Fee-Based Programs.......................................... 24
Dividends and Taxes......................................... 25
[THE MANAGEMENT TEAM ICON]
THE MANAGEMENT TEAM
-----------------------------------------------------------------
Management of the Fund...................................... 27
Financial Highlights........................................ 28
[TO LEARN MORE ICON]
TO LEARN MORE
-----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERCURY HW BALANCED FUND
<PAGE> 135
[FUND FACTS ICON] FUND FACTS
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
COMMON STOCK -- units of ownership of a corporation.
U.S. GOVERNMENT SECURITIES -- include direct obligations issued by the U.S.
Treasury and securities issued or guaranteed by U.S. government agencies and
instrumentalities.
CORPORATE BONDS -- bonds issued by corporations, as distinct from bonds issued
by a government or its agencies or instrumentalities.
ASSET-BACKED SECURITIES -- bonds or notes backed by loan paper or accounts
receivable originated by banks, credit card companies, or other providers of
credit.
MORTGAGE-BACKED SECURITIES -- securities that give the holder the right to
receive a portion of principal and/or interest payments made on a pool of
residential or commercial mortgage loans, which in some cases are guaranteed by
government agencies.
PRICE-TO-EARNINGS RATIO -- price of a stock divided by its earnings per share.
YIELD -- percentage rate of return paid on a stock in dividends and share
repurchases.
PRICE-TO-BOOK VALUE RATIO -- price of a stock divided by its book value per
share.
ABOUT THE MERCURY HW BALANCED FUND
--------------------------------------------------------------------------------
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to preserve capital while producing a high
total return.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests primarily in COMMON STOCKS of U.S. companies and investment
grade bonds, including U.S. GOVERNMENT SECURITIES, CORPORATE BONDS, ASSET-BACKED
SECURITIES and MORTGAGE-BACKED SECURITIES. The Fund's assets are allocated among
stocks and bonds.
In investing the Fund's assets in stocks, Mercury Advisors (the "Investment
Adviser") follows a value style. This means that the Investment Adviser buys
stocks that it believes are currently undervalued by the market and thus have a
lower price than their true worth. Typical value characteristics include:
- low PRICE-TO-EARNINGS RATIO relative to the market
- high YIELD relative to the market
- low PRICE-TO-BOOK VALUE RATIO relative to the market
- financial strength
Stocks may be "undervalued" because they are part of an industry that is out of
favor with investors generally. Even in those industries, though, individual
companies may have high rates of growth of earnings and be financially sound. At
the same time, the price of their common stock may be depressed because
investors associate the companies with their industries.
This value discipline sometimes prevents or limits investments in stocks that
are in well-known indexes, like the S&P 500 Index. Also, the return of the Fund
will not necessarily be similar to the return of the S&P 500 Index.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of Fund shares, may go up and down. These changes may occur because the
stock market is rising or falling or because there are specific factors that may
affect the value of a specific investment. The Fund is also subject to the risk
that the stocks the Fund's Investment Adviser selects will underperform the
stock markets or other funds with similar investment objectives and investment
strategies. These changes also may occur in response to interest rate changes or
other factors that may affect a particular issuer or obligation. Generally, when
interest rates go up, the value of bonds goes down. The value
2 MERCURY HW BALANCED FUND
<PAGE> 136
[FUND FACTS ICON] FUND FACTS
PREPAYMENT RISK -- the risk that certain obligations will be paid off by the
obligor more quickly than anticipated and the value of these securities will
fall.
EXTENSION RISK -- the risk that certain obligations will be paid off more slowly
by the obligor than anticipated and the value of these securities will fall.
VOLATILITY -- the amount and frequency of changes in a security's value.
of the Fund's bonds also may be affected by market conditions and economic and
political developments. If the value of the Fund's investments goes down, you
may lose money.
In addition, because the Fund invests some of its assets in foreign securities,
the Fund is subject to additional risks. For example, the Fund's securities may
go up or down in value depending on foreign exchange rates, political and
economic developments and U.S. and foreign laws relating to foreign investment.
Foreign securities may also be less liquid, more volatile and harder to value
than U.S. securities. These risks are heightened when the issuer of the
securities is in a country with an emerging capital market.
The Fund invests in mortgage-backed and asset-backed securities. In addition to
normal bond risks, these securities are subject to PREPAYMENT RISK and EXTENSION
RISK, and may involve more VOLATILITY than other bonds of similar maturities.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
See "Investment Risks" for more information about the risks associated with the
Fund.
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are investing with long-term goals in mind, such as retirement or
funding a child's education.
- Want a professionally managed and diversified portfolio.
- Are willing to accept the risk that the value of your investment
may decline in order to seek long-term capital appreciation and as
a result of interest rate movements in order to seek high current
return.
- Are seeking a diversified portfolio including stocks and bonds.
- Are looking for an investment that provides income.
- Are prepared to receive taxable distributions.
MERCURY HW BALANCED FUND 3
<PAGE> 137
[FUND FACTS ICON] FUND FACTS
RISK/RETURN BAR CHART
--------------------------------------------------------------------------------
The bar charts and tables below provide some indication of the risks of
investing in the Fund by showing changes in the year to year performance of the
Class I shares of the Fund and by showing how the Fund's average annual total
returns for 1, 5 and 10 years and for the life of the Class compare with those
of a broad measure of market performance. How the Fund has performed in the past
is not necessarily an indication of how the Fund will perform in the future.
[GRAPH]
<TABLE>
<S> <C>
1990 -0.45
---- -----
1991 20.53
1992 9.41
1993 12.59
1994 0.82
1995 24.80
1996 11.71
1997 16.75
1998 5.20
1999 -2.30
</TABLE>
Total return for the six months ended June 30, 2000: -3.46%.
During the period shown in the bar chart, the highest return for a quarter was
10.28% (quarter ended March 31, 1991) and the lowest return for a quarter was
-8.32% (quarter ended September 30, 1990).
<TABLE>
<CAPTION>
PAST PAST PAST
AVERAGE ANNUAL TOTAL RETURNS ONE FIVE TEN SINCE
(FOR THE PERIODS ENDED DECEMBER 31, 1999) YEAR YEARS YEARS INCEPTION
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CLASS I*+ -2.30% 10.84% 9.57% 10.84%(1)
S&P 500 Index 21.14% 28.66% 18.25% 18.55%
Lehman Brothers Government/Credit Intermediate Bond 0.39% (7.10)% 7.26% 8.52%
Index
----------------------------------------------------------------------------------------------------
CLASS A*++ N/A N/A N/A -0.03%(2)
S&P 500 Index N/A N/A N/A 18.55%
Lehman Brothers Government/Credit Intermediate Bond N/A N/A N/A 0.45%
Index
----------------------------------------------------------------------------------------------------
</TABLE>
The S&P 500 Index is a capital weighted, unmanaged index representing the
aggregate market value of the common equity of 500 stocks primarily traded
on the New York Stock Exchange.
The Lehman Brothers Government/Credit Intermediate Bond Index is a weighted
index comprised of publicly-traded intermediate-term government and
corporate debt with maturities between 1 and 9.99 years.
* Includes the effect of sales charges, which were not imposed until October
, 2000.
+ As of October , 2000, Investor Class shares were redesignated Class I
shares.
++ As of October , 2000, Distributor Class shares were redesignated Class A
shares.
(1) Inception date is August 13, 1985.
(2) Inception date is October 12, 1999.
4 MERCURY HW BALANCED FUND
<PAGE> 138
[FUND FACTS ICON] FUND FACTS
UNDERSTANDING EXPENSES
Fund investors pay various expenses, either directly or indirectly. Listed below
are some of the main types of expenses, which all mutual funds may charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
INVESTMENT ADVISORY FEE -- a fee paid to the Investment Adviser for managing the
Fund.
SERVICE (ACCOUNT MAINTENANCE) FEES -- fees used to compensate securities dealers
or other financial intermediaries for account maintenance activities.
FEES AND EXPENSES
--------------------------------------------------------------------------------
The Fund offers two different classes of shares. Although your money will be
invested the same way no matter which class of shares you buy, there are
differences among the fees and expenses associated with each class. Not everyone
is eligible to buy every class. Your financial consultant, selected securities
dealer or other financial intermediary can help you determine which classes of
shares you are eligible to buy.
THIS TABLE SHOWS THE DIFFERENT FEES AND EXPENSES THAT YOU MAY PAY IF YOU BUY AND
HOLD THE DIFFERENT CLASSES OF SHARES OF THE FUND. FUTURE EXPENSES MAY BE GREATER
OR LESS THAN THOSE INDICATED BELOW.
<TABLE>
<CAPTION>
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)(a): CLASS I* CLASS A*
------------------------------------------------------------------------------------
<S> <C> <C>
Maximum Sales Charge (Load) imposed on purchases (as a
percentage of offering price) 5.25%(b) 5.25%(b)
------------------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a percentage of
original purchase price or redemption proceeds, whichever is
lower) None(c) None(c)
------------------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend Reinvestments None None
------------------------------------------------------------------------------------
Redemption Fee None None
------------------------------------------------------------------------------------
Exchange Fee None None
------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED
FROM THE FUND'S TOTAL ASSETS):
------------------------------------------------------------------------------------
INVESTMENT ADVISORY FEE(d) 0.75% 0.75%
------------------------------------------------------------------------------------
DISTRIBUTION AND/OR SERVICE (12b-1) FEES(e) None 0.25%
------------------------------------------------------------------------------------
Other Expenses (including transfer agency fees) 0.40% 0.40%
------------------------------------------------------------------------------------
TOTAL ANNUAL OPERATING EXPENSES 1.15% 1.40%
------------------------------------------------------------------------------------
Expense Reimbursement(d) 0.20% 0.20%
------------------------------------------------------------------------------------
NET ANNUAL FUND OPERATING EXPENSES 0.95% 1.20%
------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C>
( *) As of October , 2000, Investor Class shares were
redesignated Class I shares and Distributor Class shares
were redesignated Class A shares.
(a) Certain securities dealers or other financial intermediaries
may charge a fee to process a purchase or sale of shares.
See "How to Buy, Sell, Transfer and Exchange Shares."
(b) Some investors may qualify for reductions in the sales
charge (load).
(c) You may pay a deferred sales charge if you purchase $1
million or more and you redeem within one year.
(d) The Investment Adviser has contractually agreed to waive
management fees and/or reimburse expenses through June 30,
2001, as shown in the table.
(e) The Fund calls the "Service Fee" an "Account Maintenance
Fee." Account Maintenance Fee is the term used elsewhere in
this prospectus and in all other Fund materials.
</TABLE>
MERCURY HW BALANCED FUND 5
<PAGE> 139
[FUND FACTS ICON] FUND FACTS
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, if any, that apply to the particular class and that the Fund's
operating expenses remain the same except for the expense reimbursement in
effect for the first year. This assumption is not meant to indicate you will
receive a 5% annual rate of return. Your annual return may be more or less than
the 5% used in these examples. Although your actual costs may be higher or
lower, based on these assumptions, your costs would be:
<TABLE>
<CAPTION>
CLASS I CLASS A
-----------------------------------------------------------------------------------
<S> <C> <C>
ONE YEAR $617 $641
-----------------------------------------------------------------------------------
THREE YEARS $852 $926
-----------------------------------------------------------------------------------
FIVE YEARS $1,106 $1,233
-----------------------------------------------------------------------------------
TEN YEARS $1,832 $2,100
-----------------------------------------------------------------------------------
</TABLE>
6 MERCURY HW BALANCED FUND
<PAGE> 140
[ABOUT THE DETAILS ICON] ABOUT THE DETAILS
ABOUT THE PORTFOLIO MANAGERS -- Michael Sanchez has served as a portfolio
manager of the Fund since joining the Investment Adviser in 1996. Mr. Sanchez is
the portfolio manager with responsibility for the day-to-day management of the
bond portion of the Fund's portfolio. Before joining the Investment Adviser, Mr.
Sanchez was with Provident Investment Counsel as senior vice president and
portfolio manager from 1991 to 1995 and with ARCO Investment Management Company
as Director of Fixed Income Investments from 1988 to 1991.
Sheldon Lieberman is responsible for the day-to-day management of the equity
portion of the Fund's portfolio and the asset allocation strategy. Mr. Lieberman
joined the Investment Adviser in 1994 and became a portfolio manager of the Fund
in July 2000. Before joining the Investment Adviser, Mr. Lieberman was the Chief
Investment Officer for the Los Angeles County Employees Retirement Association.
ABOUT THE INVESTMENT ADVISER -- Mercury Advisors manages the Fund.
HOW THE FUND INVESTS
--------------------------------------------------------------------------------
The Fund's investment objective is to preserve capital while producing a high
total return.
TYPES OF INVESTMENTS
The Fund's assets are allocated among stocks and bonds. The Investment Adviser
uses a proprietary model to set the amount invested in each category. Generally
stocks will be at least 20% of the Fund's total assets and bonds at least 25%.
Historically, the Fund's allocation to stocks has ranged from 27% to 59%, and to
bonds from 41% to 73%.
The Fund seeks to achieve growth of capital through its investment in stocks. It
may purchase common stocks or securities with common stock characteristics (like
convertible preferred stocks, convertible bonds or warrants).
The Fund seeks to earn income and reduce fluctuation in the value of its shares
through its investments in bonds and preferred stocks. The Fund invests in bonds
with a portfolio duration of two to five years. The Fund purchases investment
grade bonds and preferred stocks as follows:
- U.S. Government securities
- preferred stocks
- mortgage-backed and other asset-backed securities
- corporate bonds
- bonds that are convertible into stocks
- bank certificates of deposit, fixed time deposits and bankers'
acceptances
- repurchase agreements, reverse repurchase agreements and dollar
rolls
- obligations of foreign governments or their subdivisions, agencies
and instrumentalities
- obligations of international agencies or supra-national entities
- municipal bonds
After the Fund buys a security, it may be given a lower rating or stop being
rated. This will not require the Fund to sell it, but the Investment Adviser
will consider the change in rating in deciding whether to keep the security. It
is expected that the average credit quality of the Fund's bonds will be AA/Aa or
higher.
Because the Fund allocates its assets among stocks and bonds, it may not be able
to achieve a total return as high as a fund with complete freedom to invest its
assets in any one type of security. Likewise, because at least 25% of the
MERCURY HW BALANCED FUND 7
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[ABOUT THE DETAILS ICON] ABOUT THE DETAILS
Fund's portfolio will normally consist of bonds, the Fund may not achieve as
much capital appreciation as a portfolio investing only in stocks. Although the
Fund intends to invest in bonds to keep the price of the Fund's shares more
stable, it can invest in intermediate- and long-term bonds, which fluctuate in
price more than money market obligations.
The Fund can invest up to 20% of its total assets in foreign securities.
MATURITY AND DURATION REQUIREMENTS
Maturity. The EFFECTIVE MATURITY of a bond is the weighted average period over
which principal is expected to be repaid. STATED MATURITY is the date when the
issuer is scheduled to make the final payment of principal. Effective maturity
is different than stated maturity because it estimates the effect of expected
principal prepayments and call provisions.
Duration. Duration measures the potential volatility of the price of a bond or
a portfolio of bonds prior to maturity. Duration is the magnitude of the change
in price of a bond relative to a given change in the market interest rate.
Duration incorporates a bond's yield, coupon interest payments, final maturity,
call and put features and prepayment exposure into one measure.
For any bond with interest payments occurring before principal is repaid,
duration is ordinarily less than maturity. Generally, the lower the stated or
coupon rate of interest of a bond, the longer the duration. The higher the
stated or coupon rate of interest of a bond, the shorter the duration. The
calculation of duration is based on estimates.
Duration is a tool to measure interest rate risk.
Other factors such as changes in credit quality, prepayments, the shape of the
yield curve and liquidity can affect the price of the Fund and may correlate
with changes in interest rates. These factors can increase swings in the Fund's
share price during periods of volatile interest rate changes.
MONEY MARKET INVESTMENTS
To meet redemptions and when waiting to invest cash receipts, the Fund may
invest in short-term, investment grade bonds, money market mutual funds and
other money market instruments. Also, the Fund temporarily can invest up to 100%
of its assets in short-term, investment grade bonds and other money market
instruments in response to adverse market, economic or political conditions. The
Fund may not achieve its objective using this type of investing.
8 MERCURY HW BALANCED FUND
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[ABOUT THE DETAILS ICON] ABOUT THE DETAILS
PORTFOLIO TURNOVER
As a result of the strategies described above, the Fund may have an annual
portfolio turnover rate above 100%. Portfolio turnover is generally the
percentage found by dividing the lesser of portfolio purchases or sales by the
monthly average value of the portfolio. High portfolio turnover (100% or more)
results in higher mark ups and other transaction costs and can affect the Fund's
performance. It also can result in a greater amount of distributions as ordinary
income rather than long-term capital gains.
INVESTMENT RISKS
--------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK
Market risk is the risk that the stock or bond market will go down in value,
including the possibility that the market will go down sharply and
unpredictably. Selection risk is the risk that the investments that Fund
management selects will underperform the market or other funds with similar
investment objectives and investment strategies.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities are the right to receive a portion of principal
and/or interest payments made on a pool of residential or commercial mortgage
loans. When interest rates fall, borrowers may refinance or otherwise repay
principal on their mortgages earlier than scheduled. When this happens, certain
types of mortgage-backed securities will be paid off more quickly than
originally anticipated. Prepayment reduces the yield to maturity and average
life of the mortgage-backed securities. In addition, when the Fund reinvests the
proceeds of a prepayment, it may receive a lower interest rate than the rate on
the security that was prepaid. This risk is known as "prepayment risk." When
interest rates rise, certain types of mortgage-backed securities will be paid
off more slowly than originally anticipated and the value of these securities
will fall. This risk is known as extension risk.
Because of prepayment risk and extension risk, mortgage-backed securities react
differently to changes in interest rates than other bonds. Small movements in
interest rates (both up and down) may quickly and significantly reduce the value
of certain mortgage-backed securities.
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[ABOUT THE DETAILS ICON] ABOUT THE DETAILS
Mortgage-backed securities are issued by Federal government agencies like the
Government National Mortgage Association ("Ginnie Mae"), the Federal Home Loan
Mortgage Association ("Freddie Mac") or the Federal National Mortgage
Association ("Fannie Mae"). Principal and interest payments on mortgage-backed
securities issued by Federal government agencies are guaranteed by either the
Federal government or the government agency. This means that such securities
have very little credit risk. Other mortgage-backed securities are issued by
private corporations rather than Federal agencies. Private mortgage-backed
securities have credit risk as well as prepayment risk and extension risk.
Mortgage-backed securities may be either pass-through securities or
collateralized mortgage obligations (CMOs). Pass-through securities represent a
right to receive principal and interest payments collected on a pool of
mortgages, which are passed through to security holders (less servicing costs).
CMOs are created by dividing the principal and interest payments collected on a
pool of mortgages into several revenue streams (tranches) with different
priority rights to portions of the underlying mortgage payments. Certain CMO
tranches may represent a right to receive interest only (IOs), principal only
(POs) or an amount that remains after other floating-rate tranches are paid (an
inverse floater). These securities are frequently referred to as "mortgage
derivatives" and may be extremely sensitive to changes in interest rates. If a
Fund invests in CMO tranches (including CMO tranches issued by government
agencies) and interest rates move in a manner not anticipated by Fund
management, it is possible that the Fund could lose all or substantially all of
its investment.
ASSET-BACKED SECURITIES
Like traditional bonds, the value of asset-backed securities typically increases
when interest rates fall and decreases when interest rates rise. Certain asset-
backed securities may also be subject to the risk of prepayment. In a period of
declining interest rates, borrowers may pay what they owe on the underlying
assets more quickly than anticipated. Prepayment reduces the yield to maturity
and the average life of the asset-backed securities. In addition, when the Fund
reinvests the proceeds of a prepayment, it may receive a lower interest rate
than the rate on the security that was prepaid. In a period of rising interest
rates, prepayments may occur at a slower rate than expected. As a result, the
average maturity of the Fund's portfolio will increase. The value of long-term
securities changes more widely in response to changes in interest rates than
shorter-term securities.
10 MERCURY HW BALANCED FUND
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[ABOUT THE DETAILS ICON] ABOUT THE DETAILS
CREDIT RISK
Credit risk is the risk that the issuer of bonds will be unable to pay the
interest or principal when due. The degree of credit risk depends on both the
financial condition of the issuer and on the terms of the specific bonds.
INTEREST RATE RISK
Interest rate risk is the risk that prices of bonds generally increase when
interest rates decline and decrease when interest rates increase. Prices of
longer term securities generally change more in response to interest rate
changes than do prices of shorter term securities.
CALL AND REDEMPTION RISK
Investments in bonds carry the risk that a bond's issuer will call the bond for
redemption prior to the bond's maturity. If there is an early call of a bond,
the Fund may lose income and may have to invest the proceeds of the redemption
in bonds with lower yields than the called bond.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD COMMITMENTS
These types of securities involve the risk that the security the Fund buys will
lose value prior to its delivery to the Fund. There also is the risk that the
security will not be issued or that the other party will not meet its
obligation, in which case the Fund loses the investment opportunity of the
assets it has set aside to pay for the security and any gain in the security's
price.
VARIABLE RATE DEMAND OBLIGATIONS
These are floating rate securities that consist of an interest in a long-term
bond and the conditional right to demand payment prior to the bond's maturity
from a bank or other financial institution. If the bank or other financial
institution is unable to pay on demand, the Fund may be adversely affected. In
addition, these securities are subject to credit risk.
CORPORATE LOANS
Corporate loans are subject to the risk of loss of principal and income.
Borrowers do not always provide collateral for corporate loans and the value of
the collateral may not completely cover the borrower's obligations at the time
of a default. If a borrower files for protection from its creditors under the
U.S. bankruptcy laws, these laws may limit the Fund's rights to its collateral.
In addition, the value of collateral may erode during a bankruptcy case. In the
event of a bankruptcy, the holder of a corporate loan may not recover its
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[ABOUT THE DETAILS ICON] ABOUT THE DETAILS
principal, may experience a long delay in recovering its investment and may not
receive interest during the delay.
RISKS OF CONVERTIBLE SECURITIES
Convertibles are generally bonds or preferred stocks that may be converted into
common stock. Convertibles typically pay current income, as either interest
(bond convertibles) or dividends (preferred stocks). A convertible's value
usually reflects both the stream of current income payments and the value of the
underlying common stock. The market value of a convertible performs like regular
bonds; that is, if market interest rates rise, the value of a convertible
usually falls. Since it is convertible into common stock, the convertible also
has the same types of market and issuer risk as the underlying common stock.
FOREIGN MARKET RISK
The Fund may invest a portion of its assets in foreign securities. Such
investments involve special risks not present in U.S. investments that can
increase the chances that the Fund will lose money. In particular, investments
in foreign securities involve the following risks, which are generally greater
for investments in emerging markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair the Fund's
ability to purchase or sell foreign securities or transfer its
assets or income back into the U.S., or otherwise adversely affect
the Fund's operations.
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[ABOUT THE DETAILS ICON] ABOUT THE DETAILS
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal
remedies available to investors in some foreign countries may be
less extensive than those available to investors in the U.S.
- Because there are generally fewer investors on foreign exchanges
and a smaller number of shares traded each day, it may be
difficult for a Fund to buy and sell securities on those
exchanges. In addition, prices of foreign securities may go up and
down more than prices of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and a Fund's assets may be uninvested
and not earning returns. The Fund also may miss investment
opportunities or be unable to sell an investment because of these
delays.
- The value of the Fund's foreign holdings (and hedging transactions
in foreign currencies) will be affected by changes in currency
exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- If the Fund purchases a bond issued by a foreign government, the
government may be unwilling or unable to make payments when due.
There may be no formal bankruptcy proceeding by which the Fund
would be able to collect amounts owed by a foreign government.
EUROPEAN ECONOMIC AND MONETARY UNION (EMU)
A number of European countries have entered into EMU in an effort to reduce
trade barriers between themselves and eliminate fluctuations in their
currencies. EMU establishes a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These securities trade and make dividend and other payments only in euros. Like
other investment companies and business organizations, including the companies
MERCURY HW BALANCED FUND 13
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[ABOUT THE DETAILS ICON] ABOUT THE DETAILS
in which the Fund invests, the Fund could be adversely affected if the
transition to euro, or EMU as a whole, does not take effect as planned or if a
participating country withdraws from EMU.
DERIVATIVES
Derivatives involve the following risks:
- CREDIT RISK -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Fund.
- CURRENCY RISK -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
- LEVERAGE RISK -- Leverage risk is the risk associated with certain
types of investments or trading strategies that relatively small
market movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- LIQUIDITY RISK -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time that
the seller would like or at the price that the seller believes the
security is currently worth.
- INDEX RISK -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
STATEMENT OF ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
14 MERCURY HW BALANCED FUND
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[ACCOUNT CHOICES ICON] ACCOUNT CHOICES
PRICING OF SHARES
--------------------------------------------------------------------------------
The Fund offers two classes of shares, each with its own sales charge and
expense structure. Each share class represents an ownership interest in the same
investment portfolio.
The Fund's shares are distributed by FAM Distributors, Inc. (the "Distributor").
Holders of Class I or A shares generally pay the Distributor a sales charge at
the time of purchase. If you buy Class A shares, you also pay out of Fund assets
an ongoing account maintenance fee of 0.25%. You may be eligible for a sales
charge reduction or waiver.
Certain financial institutions may charge you additional fees in connection with
transactions in Fund shares. The Investment Adviser, the Distributor or their
affiliates may make payments out of their own resources to selected securities
dealers and other financial intermediaries for providing services intended to
result in the sale of Fund shares or for shareholder servicing activities.
MERCURY HW BALANCED FUND 15
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[ACCOUNT CHOICES ICON] ACCOUNT CHOICES
To better understand the pricing of each class of the Fund's shares, we have
summarized the information below:
<TABLE>
<CAPTION>
CLASS I*
------------------------------------------------------------------------------
<S> <C>
Availability LIMITED TO CERTAIN INVESTORS INCLUDING:
- Investor Class and current Class I shareholders.
- Certain retirement plans.
- Participants in certain sponsored programs.
- Certain affiliates or customers of selected
securities dealers and other financial
intermediaries.
------------------------------------------------------------------------------
Initial Sales Charge? YES. PAYABLE AT TIME OF PURCHASE. LOWER SALES
CHARGES AVAILABLE FOR LARGER INVESTMENTS.
------------------------------------------------------------------------------
Deferred Sales NO. (MAY BE CHARGED FOR PURCHASES OVER $1 MILLION
Charge? THAT ARE REDEEMED WITHIN ONE YEAR.)
------------------------------------------------------------------------------
Account Maintenance NO.
and Distribution
Fees?
------------------------------------------------------------------------------
<CAPTION>
CLASS A*
<S> <C>
Availability GENERALLY AVAILABLE THROUGH SELECTED SECURITIES
DEALERS AND OTHER FINANCIAL INTERMEDIARIES.
DISTRIBUTOR CLASS SHAREHOLDERS.
------------------------------------------------------------------------------
Initial Sales Charge? YES. PAYABLE AT TIME OF PURCHASE. LOWER SALES
CHARGES AVAILABLE FOR LARGER INVESTMENTS.
------------------------------------------------------------------------------
Deferred Sales NO. (MAY BE CHARGED FOR PURCHASES OVER $1 MILLION
Charge? THAT ARE REDEEMED WITHIN ONE YEAR.)
------------------------------------------------------------------------------
Account Maintenance 0.25% ACCOUNT MAINTENANCE FEE
and Distribution NO DISTRIBUTION FEE.
Fees?
------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I shares
and Distributor Class shares were redesignated Class A shares.
16 MERCURY HW BALANCED FUND
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[ACCOUNT CHOICES ICON] ACCOUNT CHOICES
RIGHT OF ACCUMULATION -- permits you to pay the sales charge applicable to the
cost or value (whichever is higher) of all shares you own in the Mercury mutual
funds.
LETTER OF INTENT -- permits you to pay the sales charge that would be applicable
if you add up all shares of Mercury mutual funds that you agree to buy within a
13 month period. Certain restrictions apply.
CLASS I AND A SHARES* -- INITIAL SALES CHARGE OPTION
If you select Class I or A shares, you will pay a sales charge at the time of
purchase as shown in the following table. Securities dealers' compensation will
be as shown in the last column.
<TABLE>
<CAPTION>
DEALER
AS A % OF COMPENSATION
AS A % OF YOUR AS A % OF
YOUR INVESTMENT OFFERING PRICE INVESTMENT** OFFERING PRICE
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
LESS THAN $25,000 5.25% 5.54% 5.00%
---------------------------------------------------------------------------------------
$25,000 BUT LESS THAN
$50,000 4.75% 4.99% 4.50%
---------------------------------------------------------------------------------------
$50,000 BUT LESS THAN
$100,000 4.00% 4.17% 3.75%
---------------------------------------------------------------------------------------
$100,000 BUT LESS THAN
$250,000 3.00% 3.09% 2.75%
---------------------------------------------------------------------------------------
$250,000 BUT LESS THAN
$1,000,000 2.00% 2.04% 1.80%
---------------------------------------------------------------------------------------
$1,000,000 AND OVER*** 0.00% 0.00% 0.00%
---------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares and Distributor Class shares were redesignated Class A shares.
** Rounded to the nearest one-hundredth percent.
*** If you invest $1,000,000 or more in Class I or A shares, you may not pay an
initial sales charge. In that case, the Investment Adviser compensates the
selling dealer or other financial intermediary from its own resources. If
you redeem your shares within one year after purchase, you may be charged a
deferred sales charge. This charge is 1% of the lesser of the original cost
of the shares being redeemed or your redemption proceeds. A sales charge of
0.75% will be charged on purchases of $1,000,000 or more of Class I and A
shares by certain employer sponsored retirement or savings plans.
No initial sales charge applies to Class I or Class A shares that you buy
through reinvestment of dividends.
A reduced or waived sales charge on a purchase of Class I or A shares may apply
for:
- Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT
- Certain trusts managed by banks, thrifts or trust companies
including those affiliated with the Investment Adviser or its
affiliates
- Certain employer-sponsored retirement or savings plans
- Certain investors, including directors or trustees of mutual funds
sponsored by the Investment Adviser or its affiliates, employees
MERCURY HW BALANCED FUND 17
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[ACCOUNT CHOICES ICON] ACCOUNT CHOICES
of the Investment Adviser and its affiliates and employees or
customers of selected securities dealers
- Certain fee-based programs managed by the Investment Adviser or
its affiliates
- Certain fee-based programs managed by selected securities dealers
that have an agreement with the Distributor
- Purchases through certain financial advisers, selected securities
dealers, brokers, investment advisers, service providers and other
financial intermediaries
- Purchases through certain accounts over which the Investment
Adviser or an affiliate exercises investment discretion
Only certain investors are eligible to buy Class I shares, including former
Investor Class shareholders of the Fund, existing Class I shareholders of the
Fund, certain retirement plans and participants in certain programs sponsored by
the Investment Adviser or its affiliates. Your financial consultant, selected
securities dealer or other financial intermediary can help you determine whether
you are eligible to buy Class I shares or to participate in any of these
programs.
If you decide to buy shares under the initial sales charge alternative and you
are eligible to buy both Class I and Class A shares, you should buy Class I
since Class A shares are subject to a 0.25% account maintenance fee, while Class
I shares are not.
If you redeem Class I or Class A shares and within 30 days buy new shares of the
same class, you will not pay a sales charge on the new purchase amount. The
amount eligible for this "Reinstatement Privilege" may not exceed the amount of
your redemption proceeds. To exercise the privilege, contact your financial
consultant, selected securities dealer, other financial intermediary or the
Fund's Transfer Agent at 1-800-236-4479.
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
--------------------------------------------------------------------------------
The chart below summarizes how to buy, sell, transfer and exchange shares
through your financial consultant, selected securities dealer, broker,
investment adviser, service provider or other financial intermediary. You may
also buy shares through the Transfer Agent. To learn more about buying shares
through the Transfer Agent, call 1-800-236-4479. Because the selection of a
mutual fund involves many considerations, your financial consultant, selected
securities dealer or other financial intermediary may help you with this
decision. The Fund does not issue share certificates.
18 MERCURY HW BALANCED VALUE FUND
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[ACCOUNT CHOICES ICON] ACCOUNT CHOICES
Because of the high cost of maintaining smaller shareholder accounts, the Fund
may redeem the shares in your account (without charging any deferred sales
charge) if the net asset value of your account falls below $500 due to
redemptions you have made. You will be notified that the value of your account
is less than $500 before the Fund makes an involuntary redemption. You will then
have 60 days to make an additional investment to bring the value of your account
to at least $500 before the Fund takes any action. This involuntary redemption
does not apply to retirement plans or Uniform Gifts or Transfers to Minors Act
accounts.
MERCURY HW BALANCED FUND 19
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[ACCOUNT CHOICES ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BUY SHARES First, select the share class Refer to the pricing of shares table on page 17. Be sure to
appropriate for you read this prospectus carefully.
-------------------------------------------------------------------------------------------------
Next, determine the amount of The minimum initial investment for the Fund is $1,000 for
your investment all accounts except:
- $500 for certain fee-based programs
- $100 for retirement plans
(The minimums for initial investments may be waived under
certain circumstances.)
-------------------------------------------------------------------------------------------------
Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer, or net asset value after your order is placed. Purchase orders
other financial intermediary placed prior to the close of regular trading on the New York
submit your purchase order Stock Exchange (generally, 4:00 p.m. Eastern time) are
priced at the net asset value determined that day. Certain
financial intermediaries, however, may require submission of
orders prior to that time.
Purchase orders placed after that time are priced at the net
asset value determined on the next business day. The Fund
may reject any order to buy shares and may suspend the sale
of shares at any time. Certain financial intermediaries may
charge a fee to process a purchase. For example, Merrill
Lynch, Pierce, Fenner & Smith Incorporated currently charges
a $5.35 processing fee. The fees charged by other financial
intermediaries may be higher or lower.
-------------------------------------------------------------------------------------------------
Or contact the Transfer Agent To purchase shares directly, call the Transfer Agent at
1-800-236-4479 and request a purchase application. Mail the
completed purchase application to the Transfer Agent at the
address on the back cover of this prospectus.
------------------------------------------------------------------------------------------------------------------------
ADD TO YOUR Purchase additional shares The minimum investment for additional purchases is generally
INVESTMENT $100 for all accounts except:
- $50 for certain fee-based programs
- $1 for retirement plans
(The minimums for additional purchases may be waived under
certain circumstances.)
-------------------------------------------------------------------------------------------------
Acquire additional shares All dividends are automatically reinvested without a sales
through the automatic dividend charge.
reinvestment plan
-------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan your selected securities dealer or other financial
intermediary.
The current minimum for such automatic reinvestments is $100.
The minimum may be waived or revised under certain
circumstances.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
20 MERCURY HW BALANCED FUND
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[ACCOUNT CHOICES ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
TRANSFER SHARES TO Transfer to a participating You may transfer your Fund shares to another selected
ANOTHER SELECTED securities dealer or other securities dealer or other financial intermediary if
SECURITIES DEALER financial intermediary authorized dealer agreements are in place between the
OR OTHER FINANCIAL Distributor and the transferring intermediary and the
INTERMEDIARY Distributor and the receiving intermediary. Certain
shareholder services may not be available for all
transferred shares. You may only purchase additional shares
of funds previously owned before the transfer. All future
trading of these shares must be coordinated by the receiving
financial intermediary.
-------------------------------------------------------------------------------------------------
Transfer to a non-participating You must either:
securities dealer or other - Transfer your shares to an account with the Transfer Agent; or
financial intermediary - Sell your shares, paying any applicable deferred sales charge.
------------------------------------------------------------------------------------------------------------------------
SELL YOUR SHARES Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. For your
other financial intermediary redemption request to be priced at the net asset value on
submit your sales order the day of your request, you must submit your request to
your selected securities dealer or other financial
intermediary prior to that day's close of regular trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern
time). Certain financial intermediaries, however, may
require submission of orders prior to that time. Redemption
requests placed after that time are priced at the net asset
value at the close of regular trading on the next business
day.
Certain financial intermediaries may charge a fee to process
a sale of shares. For example, Merrill Lynch, Pierce, Fenner
& Smith Incorporated currently charges a $5.35 processing
fee. No processing fee is charged if you redeem the shares
directly through the Transfer Agent. The fees charged by
other financial intermediaries may be higher or lower.
The Fund may reject an order to sell shares under certain
circumstances.
-------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by writing to
the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter. A signature guarantee will generally be
required but may be waived in certain limited circumstances.
You can obtain a signature guarantee from a bank, securities
dealer, securities broker, credit union, savings
association, national securities exchange and registered
securities association. A notary public seal will not be
acceptable. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY HW BALANCED FUND 21
<PAGE> 155
[ACCOUNT CHOICES ICON] ACCOUNT CHOICES
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SELL SHARES Participate in the Fund's You can choose to receive systematic payments from your Fund
SYSTEMATICALLY Systematic Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. You can
generally arrange through your selected securities dealer or
other financial intermediary for systematic sales of shares
of a fixed dollar amount on a monthly, bi-monthly,
quarterly, semi-annual or annual basis, subject to certain
conditions. Under either method, you must have dividends
automatically reinvested. Ask your financial intermediary
for details.
------------------------------------------------------------------------------------------------------------------------
EXCHANGE YOUR Select the fund into which you You can exchange your shares of the Fund for shares of other
SHARES want to exchange. Be sure to Mercury mutual funds or for shares of the Summit Cash
read that fund's prospectus Reserves Fund. You must have held the shares used in the
exchange for at least 15 calendar days before you can
exchange to another fund.
Each class of Fund shares is generally exchangeable for
shares of the same class of another Mercury fund. If you own
Class I shares and wish to exchange into a fund in which you
have no Class I shares (and are not eligible to buy Class I
shares), you will exchange into Class A shares. If you own
Class I or Class A shares and wish to exchange into Summit,
you will exchange into Class A shares of Summit.
Some of the Mercury mutual funds may impose a different
initial or deferred sales charge schedule. If you exchange
Class I or A shares for shares of a fund with a higher
initial sales charge than you originally paid, you may be
charged the difference at the time of exchange.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
22 MERCURY HW BALANCED FUND
<PAGE> 156
[ACCOUNT CHOICES ICON] ACCOUNT CHOICES
NET ASSET VALUE -- the market value in U.S. dollars of the Fund's total assets
after deducting liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
--------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open as of the close of regular trading on the Exchange based on
prices at the time of closing. Regular trading on the Exchange generally closes
at 4:00 p.m. Eastern time. The net asset value used in determining your price is
the next one calculated after your purchase or redemption order is placed.
Foreign securities owned by the Fund may trade on weekends or other days when
the Fund does not price its shares. As a result, the Fund's net asset value may
change on days when you will not be able to purchase or redeem the Fund's
shares.
The Fund may accept orders from certain authorized financial intermediaries or
their designees. The Fund will be deemed to receive an order when accepted by
the intermediary or designee and the order will receive the net asset value next
computed by the Fund after such acceptance. If the payment for a purchase order
is not made by a designated later time, the order will be canceled and the
financial intermediary could be held liable for any losses.
Generally, Class I shares will have the higher net asset value because that
class has lower expenses.
FEE-BASED PROGRAMS
--------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by the Investment
Adviser or an affiliate of the Investment Adviser, or by selected securities
dealers or other financial intermediaries that have an agreement with the
Distributor, you may be able to buy Class I shares at net asset value, including
by exchanges from other share classes. Sales charges on the shares being
exchanged may be reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
MERCURY HW BALANCED FUND 23
<PAGE> 157
[ACCOUNT CHOICES ICON] ACCOUNT CHOICES
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed ordinary income or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
If you leave one of these programs, your shares may be redeemed or automatically
exchanged into another class of the Fund's shares or into the Summit fund. The
class you receive may be the class you originally owned when you entered the
program, or in certain cases, a different class. Any redemption or exchange will
be at net asset value. However, if you participate in the program for less than
a specified period, you may be charged a fee in accordance with the terms of the
program.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your financial
consultant, selected securities dealer or other financial intermediary.
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
The Fund will distribute any net investment income quarterly and any net
realized long-term or short-term capital gains at least annually. The Fund may
also pay a special distribution at the end of the calendar year to comply with
Federal tax requirements. DIVIDENDS may be reinvested automatically in shares of
the Fund at net asset value without a sales charge or may be taken in cash. If
your account is with a selected securities dealer or other financial
intermediary that has an agreement with the Fund, contact your dealer or
intermediary about which option you would like. If your account is with the
Transfer Agent and you would like to receive dividends in cash, contact the
Transfer Agent. The Fund anticipates that the majority of its dividends, if any,
will consist of ordinary income. Capital gains, if any, may be taxable to you at
different rates, depending, in part, on how long the Fund has held the assets
sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your shares and any
gain on the transaction may be subject to tax. Capital gain dividends are
generally taxed at different rates than ordinary income dividends.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax treaties between certain countries
and the U.S. may reduce or eliminate such taxes.
24 MERCURY HW BALANCED FUND
<PAGE> 158
[ACCOUNT CHOICES ICON] ACCOUNT CHOICES
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
By law, the Fund must withhold 31% of your dividends and redemption proceeds if
you have not provided a taxpayer identification number or social security number
or if the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
MERCURY HW BALANCED FUND 25
<PAGE> 159
[MANAGEMENT TEAM ICON] THE MANAGEMENT TEAM
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
Mercury Advisors, the Fund's Investment Adviser, manages the Fund's investments
under the overall supervision of the Board of Trustees. The Investment Adviser
has the responsibility for making all investment decisions for the Fund.
The Investment Adviser was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
The Investment Adviser and its affiliates had approximately $555 billion in
investment company and other portfolio assets under management as of June 30,
2000.
For the fiscal year ended June 30, 2000, the Fund paid to the Investment Adviser
fees of 0.75% of the Fund's average net assets. Although not required to do so,
the Investment Adviser has agreed to make reimbursements so that the regular
annual operating expenses of the Fund will be limited as shown in the table on
page 5. The Investment Adviser has agreed to these expense limits through June
2001, and will thereafter give shareholders at least 30 days' notice if this
reimbursement policy will change.
The Investment Adviser is allowed to allocate brokerage based on sales of shares
of funds managed by the Investment Adviser.
26 MERCURY HW BALANCED FUND
<PAGE> 160
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned on an investment in the
Fund (assuming reinvestment of all dividends and distributions). These financial
highlights were audited by PricewaterhouseCoopers LLP. The accountants' report
and the Fund's financial statements are included in the Fund's annual report,
which is available upon request. Further performance information is contained in
the annual report.
<TABLE>
<CAPTION>
CLASS I(1) CLASS A(1)
------------------------------------------------------- -----------------------------
FOR THE YEAR ENDED JUNE 30, FOR THE PERIOD ENDED JUNE 30,
INCREASE (DECREASE) IN ------------------------------------------------------- -----------------------------
NET ASSET VALUE: 2000 1999 1998 1997 1996 2000(2)
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $19.84 $ 19.38 $18.27 $16.74
---------------------------------------------------------------------------------------------------------------------------------
Investment income -- net 0.77 0.89 0.90(3) 0.94
---------------------------------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss)
on investments -- net (0.04) 1.58 1.86 1.53
---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations 0.73 2.47 2.76 2.47
---------------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions
---------------------------------------------------------------------------------------------------------------------------------
Investment income -- net (0.75) (0.90) (0.99) (0.92)
---------------------------------------------------------------------------------------------------------------------------------
Realized gain on investments -- net (0.82) (1.11) (0.66) (0.02)
---------------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions (1.57) (2.01) (1.65) (0.94)
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $19.00 $ 19.84 $19.38 $18.27
---------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
---------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share 4.04% 13.29% 15.75% 15.04%
---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
---------------------------------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement 0.95% 0.93% 0.98% 1.00%
---------------------------------------------------------------------------------------------------------------------------------
Expenses 0.98% 0.93% 0.98% 1.06%
---------------------------------------------------------------------------------------------------------------------------------
Investment income -- net 4.02% 4.49% 4.77% 5.26%
---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
---------------------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in millions) $97.90 $104.60 $90.20 $70.60
---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover 135% 121% 117% 92%
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) As of October , 2000, Investor Class shares were redesignated Class I
shares and Distributor Class shares were redesignated Class A shares.
No sales loads were charged prior to this time.
(2) The Class commenced operations on October 12, 1999.
(3) Net investment income per share is calculated using ending balances prior to
consideration of adjustments for permanent book and tax differences.
(*) Total investment return excludes the effects of sales charges.
MERCURY HW BALANCED FUND 27
<PAGE> 161
<TABLE>
<S> <C>
FUND
Mercury HW Balanced Fund
of Mercury HW Funds
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(800-236-4479)
INVESTMENT ADVISER
Administrative Offices:
Mercury Advisors
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 41621
Jacksonville, Florida 32232-1621
(800-236-4479)
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
100 E. Wisconsin Ave., Suite 1500
Milwaukee, Wisconsin 53202
DISTRIBUTOR
FAM Distributors, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109-3661
COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610-4795
</TABLE>
<PAGE> 162
[TO LEARN MORE ICON] To Learn More
SHAREHOLDER REPORTS
Additional information about the Fund's investments will be available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report you will find a discussion of the relevant market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling
1-800-236-4479.
The Fund will send you one copy of each shareholder report and certain other
mailings regardless of the number of Fund accounts you have. To receive separate
shareholder reports for each account, call your financial consultant or other
financial intermediary or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and brokerage or mutual
fund account number. If you have any questions, please call your financial
consultant or other financial intermediary or the Transfer Agent at
1-800-236-4479.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at Financial Data Services, Inc., P.O. Box 41621, Jacksonville, Florida
32232-1621 or by calling 1-800-236-4479.
Contact your financial consultant or other financial intermediary or the Fund at
the telephone number or address indicated on the inside back cover of this
prospectus if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet Site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION IN THIS PROSPECTUS.
Investment Company Act File #811-4182.
CODE #MHW-1000-1000
(C) Mercury Advisors
MERCURY HW
BALANCED FUND
OF MERCURY HW FUNDS
[GRAPH]
PROSPECTUS - October , 2000
<PAGE> 163
Mercury Total Return Bond Fund
OF MERCURY HW FUNDS
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING INFORMATION
ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST
AND KEEP IT FOR FUTURE REFERENCE.
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.
PROSPECTUS - October , 2000
<PAGE> 164
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
[GLOBE ICON]
FUND FACTS
-----------------------------------------------------------------
About the Mercury Total Return Bond Fund.................... 2
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[MAGNIFYING GLASS ICON]
ABOUT THE DETAILS
-----------------------------------------------------------------
How the Fund Invests........................................ 8
Investment Risks............................................ 10
Statement of Additional Information......................... 17
[CHECKMARK ICON]
ACCOUNT CHOICES
-----------------------------------------------------------------
Pricing of Shares........................................... 18
How to Buy, Sell, Transfer and Exchange Shares.............. 24
How Shares are Priced....................................... 28
Fee-Based Programs.......................................... 28
Dividends and Taxes......................................... 29
[MANAGEMENT TEAM ICON]
THE MANAGEMENT TEAM
-----------------------------------------------------------------
Management of the Fund...................................... 31
Master/Feeder Structure..................................... 31
Financial Highlights........................................ 33
[TELEPHONE ICON]
TO LEARN MORE
-----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERCURY TOTAL RETURN BOND FUND
<PAGE> 165
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
U.S. GOVERNMENT SECURITIES -- include direct obligations issued by the U.S.
Treasury and securities issued or guaranteed by U.S. government agencies and
instrumentalities.
CORPORATE BONDS -- bonds issued by corporations, as distinct from bonds issued
by a government or its agencies or instrumentalities.
ASSET-BACKED SECURITIES -- bonds backed by loan paper or accounts receivable
originated by banks, credit card companies or other providers of credit.
MORTGAGE-BACKED SECURITIES -- securities that give the holder the right to
receive a portion of principal and/or interest payments made on a pool of
residential or commercial mortgage loans, which in some cases are guaranteed by
government agencies.
[GLOBE ICON] Fund Facts
ABOUT THE MERCURY TOTAL RETURN BOND FUND
--------------------------------------------------------------------------------
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to maximize long-term total return.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests in a diversified portfolio of bonds of different maturities,
including U.S. GOVERNMENT SECURITIES, CORPORATE BONDS, ASSET-BACKED SECURITIES
and MORTGAGE-BACKED SECURITIES. At least 85% of its investments may be
investment grade. Up to 15% of its investments may be rated below investment
grade (none below B). The Fund's DURATION will be from two to eight years.
The Fund is a "feeder" fund that invests all of its assets in a corresponding
"master" portfolio (the "Total Return Bond Master Portfolio") of the Fund Asset
Management Master Trust (the "Trust") which has the same objective as the Fund.
All investments will be made at the Trust level. This structure is sometimes
called a "master/feeder" structure. The Fund's investment results will
correspond directly to the investment results of the Total Return Bond Master
Portfolio in which it invests. For simplicity, this prospectus uses the term
"Fund" to include the Total Return Bond Master Portfolio of the Trust.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of Fund shares, may go up or down. These changes may occur in response to
interest rate changes or other factors that may affect a particular issuer or
obligation. Generally, when interest rates go up, the value of bonds goes down.
The value of the Fund's shares also may be affected by market conditions and
economic or political developments. The longer the duration of the Fund, the
more the Fund's price will go down if interest rates go up. If the value of the
Fund's investments goes down, you may lose money.
The Fund invests in mortgage-backed and asset-backed securities. In addition to
normal bond risks, these securities are subject to PREPAYMENT RISK and EXTENSION
RISK, and may involve more VOLATILITY than other bonds of similar maturities.
The Fund also may invest in "JUNK" BONDS, which have more credit risk and tend
to be less liquid than higher-rated securities.
2
MERCURY TOTAL RETURN BOND FUND
<PAGE> 166
[GLOBE ICON] Fund Facts
DURATION -- a measure of how much the price of a bond would change compared to a
change in market interest rates.
PREPAYMENT RISK -- the risk that certain obligations will be paid off by the
obligor more quickly than anticipated and the value of these securities will
fall.
EXTENSION RISK -- the risk that certain obligations will be paid off more slowly
by the obligor than anticipated and the value of these securities will fall.
VOLATILITY -- the amount and frequency of changes in a security's value.
"JUNK" BOND -- bond with a credit rating of BB/Ba or lower by rating agencies.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
See "Investment Risks" for more information about the risks associated with the
Fund.
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are looking for an investment that provides income.
- Want a professionally managed and diversified portfolio.
- Are willing to accept the risk that the value of your investment
may decline as a result of interest rate movements in order to
seek high current return.
- Are prepared to receive taxable distributions.
MERCURY TOTAL RETURN BOND FUND 3
<PAGE> 167
[GLOBE ICON] Fund Facts
RISK/RETURN BAR CHART
--------------------------------------------------------------------------------
The bar charts and tables below provide some indication of the risks of
investing in the Fund by showing changes in the year to year performance of the
Class I shares of the Fund and by showing how the Fund's average annual total
returns for 1 and 5 years and for the life of the Class compare with those of a
broad measure of market performance. How the Fund has performed in the past is
not necessarily an indication of how the Fund will perform in the future.
<TABLE>
<CAPTION>
1995 21.32%
---- -----
<S> <C>
1996 4.34%
1997 10.76%
1998 8.79%
1999 -1.66%
</TABLE>
Total return for the six months ended June 30, 2000: 2.42%.
During the period shown in the bar chart, the highest return for a quarter was
6.57% (quarter ended June 30, 1995) and the lowest return for a quarter was
-2.38% (quarter ended March 31, 1996).
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS PAST PAST SINCE
(FOR THE PERIODS ENDED DECEMBER 31, 1999) ONE YEAR FIVE YEARS INCEPTION
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
CLASS I*+ -1.66% 8.45% 8.40%(1)
Lehman Brothers Aggregate Bond Index -0.82% 7.73% 7.63%
---------------------------------------------------------------------------------------
CLASS A*++ N/A N/A 0.29%(2)
Lehman Brothers Aggregate Bond Index N/A N/A 0.83%
---------------------------------------------------------------------------------------
CLASS B N/A N/A N/A
Lehman Brothers Aggregate Bond Index N/A N/A N/A
---------------------------------------------------------------------------------------
CLASS C N/A N/A N/A
Lehman Brothers Aggregate Bond Index N/A N/A N/A
---------------------------------------------------------------------------------------
</TABLE>
The Lehman Brothers Aggregate Bond Index is an unmanaged market-weighted Index
comprised of investment-grade corporate bonds (rated BBB or better), mortgages
and U.S. Treasury and Government agency issues with at least one year to
maturity.
* Includes the effect of sales charges, which were not imposed until October
, 2000.
+ As of October , 2000, Investor Class shares were redesignated Class I
shares.
++ As of October , 2000, Distributor Class shares were redesignated Class A
shares.
(1) Inception date is December 6, 1994.
(2) Inception date is June 2, 1999.
4
MERCURY TOTAL RETURN BOND FUND
<PAGE> 168
[GLOBE ICON] Fund Facts
UNDERSTANDING EXPENSES
Fund investors pay various expenses, either directly or indirectly. Listed below
are some of the main types of expenses, which all mutual funds may charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
INVESTMENT ADVISORY FEE -- a fee paid to the Investment Adviser for managing the
Trust.
DISTRIBUTION FEES -- fees used to support the Fund's marketing and distribution
efforts, such as compensating financial consultants and other financial
intermediaries, advertising and promotion.
SERVICE (ACCOUNT MAINTENANCE) FEES -- fees used to compensate securities dealers
or other financial intermediaries for account maintenance activities.
FEES AND EXPENSES
--------------------------------------------------------------------------------
The Fund offers four different classes of shares. Although your money will be
invested the same way no matter which class of shares you buy, there are
differences among the fees and expenses associated with each class. Not everyone
is eligible to buy every class. After determining which classes you are eligible
to buy, decide which class best suits your needs. Your financial consultant,
selected securities dealer or other financial intermediary can help you with
this decision.
THIS TABLE SHOWS THE DIFFERENT FEES AND EXPENSES THAT YOU MAY PAY IF YOU BUY AND
HOLD THE DIFFERENT CLASSES OF SHARES OF THE FUND. FUTURE EXPENSES MAY BE GREATER
OR LESS THAN THOSE INDICATED BELOW.
<TABLE>
<CAPTION>
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR
INVESTMENT)(A): CLASS I* CLASS A* CLASS B(B) CLASS C
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Maximum Sales Charge (Load) imposed on purchases
(as a percentage of offering price)
---------------------------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a
percentage of original purchase price or redemption
proceeds, whichever is lower)
---------------------------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend
Reinvestments None None None None
---------------------------------------------------------------------------------------------
Redemption Fee None None None None
---------------------------------------------------------------------------------------------
Exchange Fee None None None None
---------------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE
DEDUCTED FROM THE FUND'S TOTAL ASSETS)(e):
---------------------------------------------------------------------------------------------
INVESTMENT ADVISORY FEE(f)
---------------------------------------------------------------------------------------------
DISTRIBUTION AND/OR SERVICE (12b-1) FEES(g)
---------------------------------------------------------------------------------------------
Other Expenses (including transfer agency and
administrative fees)(h)
---------------------------------------------------------------------------------------------
TOTAL ANNUAL OPERATING EXPENSES
---------------------------------------------------------------------------------------------
Expense Reimbursement(i)
---------------------------------------------------------------------------------------------
NET ANNUAL FUND OPERATING EXPENSES
---------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C>
( *) As of October , 2000, Investor Class shares were
redesignated Class I shares and Distributor Class shares
were redesignated Class A shares.
(a) Certain selected securities dealers or other financial
intermediaries may charge a fee to process a purchase or
sale of shares. See "How to Buy, Sell, Transfer and Exchange
Shares."
(b) Class B shares automatically convert to Class A shares about
ten years after you buy them and will no longer be subject
to distribution fees.
(c) Some investors may qualify for reductions in the sales
charge (load).
(d) You may pay a deferred sales charge if you purchase $1
million or more and you redeem within one year.
(e) For the Fund, the fees and expenses include both the Fund
and the Trust.
(f) Paid by the Total Return Bond Master Portfolio.
(g) The Fund calls the "Service Fee" an "Account Maintenance
Fee." Account Maintenance Fee is the term used elsewhere in
this prospectus and in all other Fund materials. If you hold
Class B or C shares for a long time, it may cost you more in
distribution (12b-1) fees than the maximum sales charge that
you would have paid if you had bought one of the other
classes.
(h) Includes administrative fees, which are payable to the
Investment Adviser by the Fund at the annual rate of %.
(i) The Investment Adviser has contractually agreed to waive
management fees and/or reimburse expenses through June 30,
2001, as shown in the table.
</TABLE>
MERCURY TOTAL RETURN BOND FUND 5
<PAGE> 169
[GLOBE ICON] Fund Facts
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, if any, that apply to the particular class and that the Fund's
operating expenses remain the same except for the expense reimbursement in
effect for the first year. This assumption is not meant to indicate you will
receive a 5% annual rate of return. Your annual return may be more or less than
the 5% used in these examples. Although your actual costs may be higher or
lower, based on these assumptions, your costs would be:
Expenses if you did redeem your shares:
<TABLE>
<CAPTION>
CLASS I CLASS A CLASS B CLASS C
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ONE YEAR $ $ $ $
------------------------------------------------------------------------------------------
THREE YEARS $ $ $ $
------------------------------------------------------------------------------------------
FIVE YEARS $ $ $ $
------------------------------------------------------------------------------------------
TEN YEARS $ $ $ $
------------------------------------------------------------------------------------------
</TABLE>
Expenses if you did not redeem your shares:
<TABLE>
<CAPTION>
CLASS I CLASS A CLASS B CLASS C
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ONE YEAR $ $ $ $
------------------------------------------------------------------------------------------
THREE YEARS $ $ $ $
------------------------------------------------------------------------------------------
FIVE YEARS $ $ $ $
------------------------------------------------------------------------------------------
TEN YEARS $ $ $ $
------------------------------------------------------------------------------------------
</TABLE>
6
MERCURY TOTAL RETURN BOND FUND
<PAGE> 170
ABOUT THE PORTFOLIO MANAGERS -- Michael Sanchez has been a co-Portfolio Manager
of the Fund since joining the Investment Adviser in 1996. Before joining the
Investment Adviser, Mr. Sanchez was with Provident Investment Counsel as senior
vice president and portfolio manager from 1991 to 1995 and with ARCO Investment
Management Company as Director of Fixed Income Investments from 1988 to 1991.
John Queen has been a co-Portfolio Manager of the Fund since 1997. Prior to
joining the Investment Adviser in 1997, Mr. Queen was associated with The
Capital Group as a member of an analyst team responsible for $8 billion in
fixed-income assets.
ABOUT THE INVESTMENT ADVISER -- Mercury Advisors manages the Fund.
[MAGNIFYING GLASS ICON] About the Details
HOW THE FUND INVESTS
--------------------------------------------------------------------------------
The Fund's investment objective is to maximize long-term total return. The Fund
invests in bonds with a portfolio duration of two to eight years. Investments
are concentrated in areas of the bond market (based on quality, sector, coupon
or maturity) that the Investment Adviser believes are relatively undervalued.
TYPES OF INVESTMENTS
The Fund seeks to achieve its objective by investing mainly in investment grade,
interest-bearing securities of varying maturities. These include:
- U.S. Government securities
- preferred stocks
- mortgage-backed and other asset-backed securities
- corporate bonds
- bonds that are convertible into stocks
- bank certificates of deposit, fixed time deposits and bankers'
acceptances
- repurchase agreements, reverse repurchase agreements and dollar
rolls
- obligations of foreign governments or their subdivisions, agencies
and instrumentalities
- obligations of international agencies or supra-national entities
- municipal bonds
RATINGS LIMITATIONS
- at least 85% of total assets rated at least investment grade or,
if short-term, the second highest quality grade, by a major rating
agency such as Moody's Investors Service ("Moody's") or Standard &
Poor's Ratings Group ("S&P")
- up to 15% of total assets rated below investment grade (below Baa
by Moody's or below BBB by S&P), but none below B
The Investment Adviser can invest in unrated securities and will assign them the
rating of a rated security of comparable quality. After the Fund buys a
security, it may be given a lower rating or stop being rated. This will not
require the Fund to sell it, but the Investment Adviser will consider the change
in rating in deciding whether to keep the security.
MERCURY TOTAL RETURN BOND FUND 7
<PAGE> 171
[MAGNIFYING GLASS ICON] About the Details
MATURITY AND DURATION REQUIREMENTS
Maturity. The EFFECTIVE MATURITY of a bond is the weighted average period over
which principal is expected to be repaid. STATED MATURITY is the date when the
issuer is scheduled to make the final payment of principal. Effective maturity
is different than stated maturity because it estimates the effect of expected
principal prepayments and call provisions.
Duration. Duration measures the potential volatility of the price of a bond or
a portfolio of bonds prior to maturity. Duration is the magnitude of the change
in price of a bond relative to a given change in the market interest rate.
Duration incorporates a bond's yield, coupon interest payments, final maturity,
call and put features and prepayment exposure into one measure.
For any bond with interest payments occurring before principal is repaid,
duration is ordinarily less than maturity. Generally, the lower the stated or
coupon rate of interest of a bond, the longer the duration. The higher the
stated or coupon rate of interest of a bond, the shorter the duration. The
calculation of duration is based on estimates.
Duration is a tool to measure interest rate risk. Assuming a 1% change in
interest rates and the durations shown below, the Fund's price would change as
follows:
<TABLE>
<CAPTION>
DURATION CHANGE IN INTEREST RATES
---------------------------------------------------------
<C> <S>
4.5 yrs. 1% decline W 4.5% gain in Fund price
---------------------------------------------------------
1% rise W 4.5% decline in Fund price
---------------------------------------------------------
</TABLE>
Other factors such as changes in credit quality, prepayments, the shape of the
yield curve and liquidity affect the price of the Fund and may correlate with
changes in interest rates. These factors can increase swings in the Fund's share
price during periods of volatile interest rate changes.
FOREIGN BONDS
The Fund may invest in foreign bonds as follows:
- up to 25% of total assets in foreign bonds that are denominated in
U.S. dollars
- up to 15% of total assets in foreign bonds that are not
denominated in U.S. dollars
- up to 15% of total assets in emerging market foreign bonds
8
MERCURY TOTAL RETURN BOND FUND
<PAGE> 172
[MAGNIFYING GLASS ICON] About the Details
MONEY MARKET INVESTMENTS
To meet redemptions and when waiting to invest cash receipts, the Fund may
invest in short-term, investment grade bonds, money market mutual funds and
other money market instruments. Also, the Fund temporarily can invest up to 100%
of its assets in short-term, investment grade bonds and other money market
instruments in response to adverse market, economic or political conditions. The
Fund may not achieve its objectives using this type of investing.
PORTFOLIO TURNOVER
As a result of the strategies described above, the Fund may have an annual
portfolio turnover rate above 100%. Portfolio turnover is generally the
percentage found by dividing the lesser of portfolio purchases or sales by the
monthly average value of the portfolio. High portfolio turnover (100% or more)
results in higher mark ups and other transaction costs and can affect the Fund's
performance. It also can result in a greater amount of distributions as ordinary
income rather than long-term capital gains.
INVESTMENT RISKS
--------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK
Market risk is the risk that the market will go down in value, including the
possibility that the market will go down sharply and unpredictably. Selection
risk is the risk that the investments that Fund management selects will
underperform the market or other funds with similar investment objectives and
investment strategies.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities are the right to receive a portion of principal
and/or interest payments made on a pool of residential or commercial mortgage
loans. When interest rates fall, borrowers may refinance or otherwise repay
principal on their mortgages earlier than scheduled. When this happens, certain
types of mortgage-backed securities will be paid off more quickly than
originally anticipated. Prepayment reduces the yield to maturity and average
life of the mortgage-backed securities. In addition, when the Fund reinvests the
proceeds of a prepayment, it may receive a lower interest rate than the rate on
the
MERCURY TOTAL RETURN BOND FUND 9
<PAGE> 173
[MAGNIFYING GLASS ICON] About the Details
security that was prepaid. This risk is known as "prepayment risk." When
interest rates rise, certain types of mortgage-backed securities will be paid
off more slowly than originally anticipated and the value of these securities
will fall. This risk is known as extension risk.
Because of prepayment risk and extension risk, mortgage-backed securities react
differently to changes in interest rates than other bonds. Small movements in
interest rates (both up and down) may quickly and significantly reduce the value
of certain mortgage-backed securities.
Mortgage-backed securities are issued by Federal government agencies like the
Government National Mortgage Association ("Ginnie Mae") the Federal National
Mortgage Association ("Fannie Mae") or the Federal Home Loan Mortgage
Association ("Freddie Mac"). Principal and interest payments on mortgage-backed
securities issued by Federal government agencies are guaranteed by either the
Federal government or the government agency. This means that such securities
have very little credit risk. Other mortgage-backed securities are issued by
private corporations rather than Federal agencies. Private mortgage-backed
securities have credit risk as well as prepayment risk and extension risk.
Mortgage-backed securities may be either pass-through securities or
collateralized mortgage obligations (CMOs). Pass-through securities represent a
right to receive principal and interest payments collected on a pool of
mortgages, which are passed through to security holders (less servicing costs).
CMOs are created by dividing the principal and interest payments collected on a
pool of mortgages into several revenue streams (tranches) with different
priority rights to portions of the underlying mortgage payments. Certain CMO
tranches may represent a right to receive interest only (IOs), principal only
(POs) or an amount that remains after other floating-rate tranches are paid (an
inverse floater). These securities are frequently referred to as "mortgage
derivatives" and may be extremely sensitive to changes in interest rates. If the
Fund invests in CMO tranches (including CMO tranches issued by government
agencies) and interest rates move in a manner not anticipated by the Investment
Adviser, it is possible that the Fund could lose all or substantially all of its
investment.
ASSET-BACKED SECURITIES
Like traditional bonds, the value of asset-backed securities typically increases
when interest rates fall and decreases when interest rates rise. Certain asset-
backed securities may also be subject to the risk of prepayment. In a period of
declining interest rates, borrowers may pay what they owe on the underlying
assets more quickly than anticipated. Prepayment reduces the yield to maturity
and the average life of the asset-backed securities. In addition, when the Fund
reinvests the proceeds of a prepayment, it may receive a lower interest rate
10
MERCURY TOTAL RETURN BOND FUND
<PAGE> 174
[MAGNIFYING GLASS ICON] About the Details
than the rate on the security that was prepaid. In a period of rising interest
rates, prepayments may occur at a slower rate than expected. As a result, the
average maturity of the Fund's portfolio will increase. The value of long-term
securities changes more widely in response to changes in interest rates than
shorter-term securities.
CREDIT RISK
Credit risk is the risk that the issuer of bonds will be unable to pay the
interest or principal when due. The degree of credit risk depends on both the
financial condition of the issuer and on the terms of the specific bonds.
INTEREST RATE RISK
Interest rate risk is the risk that prices of bonds generally increase when
interest rates decline and decrease when interest rates increase. Prices of
longer term securities generally change more in response to interest rate
changes than do prices of shorter term securities.
CALL AND REDEMPTION RISK
Investments in bonds carry the risk that a bond's issuer will call the bond for
redemption prior to the bond's maturity. If there is an early call of a bond,
the Fund may lose income and may have to invest the proceeds of the redemption
in bonds with lower yields than the called bond.
JUNK BONDS
Junk bonds are bonds that are rated below investment grade by the major rating
agencies or are unrated securities that the Fund's Investment Adviser believes
are of comparable quality. Although junk bonds generally pay higher rates of
interest than investment grade bonds, they are high risk investments that may
cause income and principal losses for the Fund. Junk bonds generally are less
liquid and experience more price volatility than higher rated bonds. The issuers
of junk bonds may have a larger amount of outstanding debt relative to their
assets than issuers of investment grade bonds. In the event of an issuer's
bankruptcy, claims of other creditors may have priority over the claims of junk
bond holders, leaving few or no assets available to repay junk bond holders.
Junk bonds may be subject to greater call and redemption risk than higher rated
debt securities.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD COMMITMENTS
These types of investments involve the risk that the security the Fund buys will
lose value prior to its delivery to the Fund. There also is the risk that the
MERCURY TOTAL RETURN BOND FUND 11
<PAGE> 175
[MAGNIFYING GLASS ICON] About the Details
security will not be issued or that the other party will not meet its
obligation, in which case the Fund loses the investment opportunity of the
assets it has set aside to pay for the security and any gain in the security's
price.
VARIABLE RATE DEMAND OBLIGATIONS
These are floating rate securities that consist of an interest in a long-term
bond and the conditional right to demand payment prior to the bond's maturity
from a bank or other financial institution. If the bank or other financial
institution is unable to pay on demand, the Fund may be adversely affected. In
addition, these securities are subject to credit risk.
INDEXED AND INVERSE FLOATING RATE SECURITIES
The Fund may invest in securities whose potential returns are directly related
to changes in an underlying index or interest rate, known as indexed securities.
The return on indexed securities will rise when the underlying index or interest
rate rises and fall when the index or interest rate falls. The Fund may also
invest in securities whose return is inversely related to changes in an interest
rate (inverse floaters). In general, inverse floaters change in value in a
manner that is opposite to most bonds -- that is, interest rates on inverse
floaters will decrease when short-term rates increase and increase when
short-term rates decrease. Investments in indexed securities and inverse
floaters may subject the Fund to the risk of reduced or eliminated interest
payments. Investments in indexed securities also may subject the Fund to loss of
principal. In addition, certain indexed securities and inverse floaters may
increase or decrease in value at a greater rate than the underlying interest
rate, which effectively leverages the Fund's investment. As a result, the market
value of such securities will generally be more volatile than that of fixed rate
securities. Both indexed securities and inverse floaters can be derivative
securities and can be considered speculative.
SOVEREIGN DEBT
The Fund may invest in sovereign debt securities. These securities are issued or
guaranteed by foreign government entities. Investments in sovereign debt subject
the Fund to the risk that a government entity may delay or refuse to pay
interest or repayment of principal on its sovereign debt. Some of these reasons
may include cash flow problems, insufficient foreign currency reserves,
political considerations, the relative size of its debt position to its economy
or its failure to put in place economic reforms required by the International
Monetary Fund or other multilateral agencies. If a government entity defaults,
it may ask for more time in which to pay or for further loans. There is no legal
process for collecting sovereign debts that a government does not pay.
12
MERCURY TOTAL RETURN BOND FUND
<PAGE> 176
[MAGNIFYING GLASS ICON] About the Details
CORPORATE LOANS
Corporate loans are subject to the risk of loss of principal and income.
Borrowers do not always provide collateral for corporate loans and the value of
the collateral may not completely cover the borrower's obligations at the time
of a default. If a borrower files for protection from its creditors under the
U.S. bankruptcy laws, these laws may limit the Fund's rights to its collateral.
In addition, the value of collateral may erode during a bankruptcy case. In the
event of a bankruptcy, the holder of a corporate loan may not recover its
principal, may experience a long delay in recovering its investment and may not
receive interest during the delay.
RISKS OF CONVERTIBLE SECURITIES
Convertibles are generally bonds or preferred stocks that may be converted into
common stock. Convertibles typically pay current income, as either interest
(bond convertibles) or dividends (preferred stocks). A convertible's value
usually reflects both the stream of current income payments and the value of the
underlying common stock. The market value of a convertible performs like regular
bonds; that is, if market interest rates rise, the value of a convertible
usually falls. Since it is convertible into common stock, the convertible also
has the same types of market and issuer risk as the underlying common stock.
FOREIGN MARKET RISK
The Fund may invest a portion of its assets in foreign securities. Such
investments involve special risks not present in U.S. investments that can
increase the chances that the Fund will lose money. In particular, investments
in foreign securities involve the following risks, which are generally greater
for investments in emerging markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
MERCURY TOTAL RETURN BOND FUND 13
<PAGE> 177
[MAGNIFYING GLASS ICON] About the Details
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair the Fund's
ability to purchase or sell foreign securities or transfer its
assets or income back into the U.S., or otherwise adversely affect
the Fund's operations.
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal
remedies available to investors in some foreign countries may be
less extensive than those available to investors in the U.S.
- Prices of foreign securities may go up and down more than prices
of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and a Fund's assets may be uninvested
and not earning returns. The Fund also may miss investment
opportunities or be unable to sell an investment because of these
delays.
- The value of the Fund's foreign holdings (and hedging transactions
in foreign currencies) will be affected by changes in currency
exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- If the Fund purchases a bond issued by a foreign government, the
government may be unwilling or unable to make payments when due.
There may be no formal bankruptcy proceeding to collect amounts
owed by a foreign government.
14
MERCURY TOTAL RETURN BOND FUND
<PAGE> 178
[MAGNIFYING GLASS ICON] About the Details
EUROPEAN ECONOMIC AND MONETARY UNION (EMU)
A number of European countries have entered into EMU in an effort to reduce
trade barriers between themselves and eliminate fluctuations in their
currencies. EMU establishes a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These securities trade and make dividend and other payments only in euros. Like
other investment companies and business organizations, including the companies
in which the Fund invests, the Fund could be adversely affected the transition
to euro, or EMU as a whole, does not take effect as planned or if a
participating country withdraws from EMU.
DERIVATIVES
Derivatives involve the following risks:
- CREDIT RISK -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Fund.
- CURRENCY RISK -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
- LEVERAGE RISK -- Leverage risk is the risk associated with certain
types of investments or trading strategies that relatively small
market movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- LIQUIDITY RISK -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time that
the seller would like or at the price that the seller believes the
security is currently worth.
- INDEX RISK -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
MERCURY TOTAL RETURN BOND FUND 15
<PAGE> 179
[MAGNIFYING GLASS ICON] About the Details
STATEMENT OF ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
16
MERCURY TOTAL RETURN BOND FUND
<PAGE> 180
[CHECKMARK ICON] Account Choices
PRICING OF SHARES
--------------------------------------------------------------------------------
The Fund offers four classes of shares, each with its own sales charge and
expense structure, allowing you to invest in the way that best suits your needs.
Each share class represents an ownership interest in the same investment
portfolio. When you choose your class of shares, you should consider the size of
your investment and how long you plan to hold your shares. Your financial
consultant or other financial intermediary can help you determine which share
class is best suited to your personal financial goals.
The Fund's shares are distributed by FAM Distributors, Inc. (the "Distributor").
For example, if you select Class I or A shares, you generally pay the
Distributor a sales charge at the time of purchase. If you buy Class A shares,
you also pay out of Fund assets an ongoing account maintenance fee of %. You
may be eligible for a sales charge reduction or waiver.
If you select Class B or C shares, you will invest the full amount of your
purchase price, but you will be subject to a distribution fee of % for Class
B shares or % for Class C shares and an account maintenance fee of %.
Because these fees are paid out of the Fund's assets on an ongoing basis, over
time these fees increase the cost of your investment and may cost you more than
paying an initial sales charge. In addition, you may be subject to a deferred
sales charge when you sell Class B or C shares.
Certain financial institutions may charge you additional fees in connection with
transactions in Fund shares. The Investment Adviser, the Distributor or their
affiliates may make payments out of their own resources to securities dealers
and other financial intermediaries for providing services intended to result in
the sale of Fund shares or for shareholder servicing activities.
MERCURY TOTAL RETURN BOND FUND 17
<PAGE> 181
[CHECKMARK ICON] Account Choices
To better understand the pricing of each class of the Fund's shares, we have
summarized the information below:
<TABLE>
<CAPTION>
CLASS I* CLASS A* CLASS B
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Availability LIMITED TO CERTAIN GENERALLY AVAILABLE GENERALLY AVAILABLE
INVESTORS INCLUDING: THROUGH SELECTED THROUGH SELECTED
- Investor Class and SECURITIES DEALERS AND SECURITIES DEALERS AND
Current Class I OTHER FINANCIAL OTHER FINANCIAL
shareholders. INTERMEDIARIES. INTERMEDIARIES.
- Certain retirement DISTRIBUTOR CLASS
plans. SHAREHOLDERS.
- Participants in
certain sponsored
programs.
- Certain affiliates or
customers of selected
securities dealers and
other financial
intermediaries.
---------------------------------------------------------------------------------------------------------------
Initial Sales Charge? YES. PAYABLE AT TIME OF YES. PAYABLE AT TIME OF NO. ENTIRE PURCHASE
PURCHASE. LOWER SALES PURCHASE. LOWER SALES PRICE IS INVESTED IN
CHARGES AVAILABLE FOR CHARGES AVAILABLE FOR SHARES OF THE FUND.
LARGER INVESTMENTS. LARGER INVESTMENTS.
---------------------------------------------------------------------------------------------------------------
Deferred Sales NO. (MAY BE CHARGED FOR NO. (MAY BE CHARGED FOR YES. PAYABLE IF YOU
Charge? PURCHASES OVER $1 PURCHASES OVER $1 REDEEM WITHIN SIX YEARS
MILLION THAT ARE MILLION THAT ARE OF PURCHASE.
REDEEMED WITHIN ONE REDEEMED WITHIN ONE
YEAR.) YEAR.)
---------------------------------------------------------------------------------------------------------------
Account Maintenance NO. % ACCOUNT MAINTENANCE % ACCOUNT MAINTENANCE
and Distribution FEE NO DISTRIBUTION FEE. FEE % DISTRIBUTION
Fees? FEE.
---------------------------------------------------------------------------------------------------------------
Conversion to Class A NO. NO. YES, AUTOMATICALLY AFTER
shares? APPROXIMATELY TEN YEARS.
---------------------------------------------------------------------------------------------------------------
<CAPTION>
CLASS C
<S> <C>
Availability GENERALLY AVAILABLE
THROUGH SELECTED
SECURITIES DEALERS AND
OTHER FINANCIAL
INTERMEDIARIES.
------------------------------------------------------------------------
Initial Sales Charge? NO. ENTIRE PURCHASE
PRICE IS INVESTED IN
SHARES OF THE FUND.
-------------------------------------------------------------------------------------------------
Deferred Sales YES. PAYABLE IF YOU
Charge? REDEEM WITHIN ONE YEAR
OF PURCHASE.
---------------------------------------------------------------------------------------------------------------
Account Maintenance % ACCOUNT MAINTENANCE
and Distribution FEE % DISTRIBUTION
Fees? FEE.
---------------------------------------------------------------------------------------------------------------
Conversion to Class A NO.
shares?
---------------------------------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I shares
and Distributor Class shares were redesignated Class A shares.
18 MERCURY TOTAL RETURN BOND FUND
<PAGE> 182
[CHECKMARK ICON] Account Choices
RIGHT OF ACCUMULATION -- permits you to pay the sales charge applicable to the
cost or value (whichever is higher) of all shares you own in the Mercury mutual
funds.
LETTER OF INTENT -- permits you to pay the sales charge that would be applicable
if you add up all shares of Mercury mutual funds that you agree to buy within a
13 month period. Certain restrictions apply.
CLASS I AND A SHARES* -- INITIAL SALES CHARGE OPTIONS
If you select Class I or A shares, you will pay a sales charge at the time of
purchase as shown in the following table. Securities dealers' compensation will
be as shown in the last column.
<TABLE>
<CAPTION>
DEALER
AS A % OF COMPENSATION
AS A % OF YOUR AS A % OF
YOUR INVESTMENT OFFERING PRICE INVESTMENT** OFFERING PRICE
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
LESS THAN $25,000
---------------------------------------------------------------------------------------
$25,000 BUT LESS THAN
$50,000
---------------------------------------------------------------------------------------
$50,000 BUT LESS THAN
$100,000
---------------------------------------------------------------------------------------
$100,000 BUT LESS THAN
$250,000
---------------------------------------------------------------------------------------
$250,000 BUT LESS THAN
$1,000,000
---------------------------------------------------------------------------------------
$1,000,000 AND OVER***
---------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares and Distributor Class shares were redesignated Class A shares.
** Rounded to the nearest one-hundredth percent.
*** If you invest $1,000,000 or more in Class I or A shares, you may not pay an
initial sales charge. In that case, the Investment Adviser compensates the
selling dealer or other financial intermediary from its own resources. If
you redeem your shares within one year after purchase, you may be charged a
deferred sales charge. This charge is % of the lesser of the original cost
of the shares being redeemed or your redemption proceeds. A sales charge of
% will be charged on purchases of $1,000,000 or more of Class I and A
shares by certain employer sponsored retirement or savings plans.
No initial sales charge applies to Class I or Class A shares that you buy
through reinvestment of dividends.
A reduced or waived sales charge on a purchase of Class I or A shares may apply
for:
- Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT
- Certain trusts managed by banks, thrifts or trust companies
including those affiliated with the Investment Adviser or its
affiliates
- Certain employer-sponsored retirement or savings plans
- Certain investors, including directors or trustees of mutual funds
sponsored by the Investment Adviser or its affiliates, employees
MERCURY TOTAL RETURN BOND FUND 19
<PAGE> 183
[CHECKMARK ICON] Account Choices
of the Investment Adviser and its affiliates and employees or
customers of selected securities dealers
- Certain fee-based programs managed by the Investment Adviser or
its affiliates
- Certain fee-based programs managed by selected securities dealers
that have an agreement with the Distributor
- Purchases through certain financial advisers, selected securities
dealers, brokers, investment advisers, service providers and other
financial intermediaries
- Purchases through certain accounts over which the Investment
Adviser or an affiliate exercises investment discretion
Only certain investors are eligible to buy Class I shares, including former
Investor Class shareholders of the Fund, existing Class I shareholders of the
Fund, certain retirement plans and participants in certain programs sponsored by
the Investment Adviser or its affiliates. Your financial consultant, selected
securities dealer or other financial intermediary can help you determine whether
you are eligible to buy Class I shares or to participate in any of these
programs.
If you decide to buy shares under the initial sales charge alternative and you
are eligible to buy both Class I and Class A shares, you should buy Class I
since Class A shares are subject to a % account maintenance fee, while Class I
shares are not.
If you redeem Class I or Class A shares and within 30 days buy new shares of the
same class, you will not pay a sales charge on the new purchase amount. The
amount eligible for this "Reinstatement Privilege" may not exceed the amount of
your redemption proceeds. To exercise the privilege, contact your financial
consultant, selected securities dealer, other financial intermediary or the
Fund's Transfer Agent at 1-800-236-4479.
CLASS B AND C SHARES -- DEFERRED SALES CHARGE OPTIONS
If you select Class B or Class C shares, you do not pay an initial sales charge
at the time of purchase. However, if you redeem your Class B shares within six
years after purchase or Class C shares within one year after purchase, you may
be required to pay a deferred sales charge. You will also pay distribution fees
of % for Class B shares or % for Class C shares and account maintenance
fees of % each year under a distribution plan that the Fund has adopted under
Rule 12b-1. Because these fees are paid out of the Fund's assets on an ongoing
basis, over time these fees increase the cost of your investment and may cost
you more than paying an initial sales charge. The Distributor uses the
20
MERCURY TOTAL RETURN BOND FUND
<PAGE> 184
[CHECKMARK ICON] Account Choices
money that it receives from the deferred sales charge and the distribution fees
to cover the costs of marketing, advertising and compensating the financial
consultant, selected securities dealer or other financial intermediary who
assists you in purchasing Fund shares.
CLASS B SHARES
If you redeem Class B shares within six years after purchase, you may be charged
a deferred sales charge. The amount of the charge gradually decreases as you
hold your shares over time, according to the following schedule:
<TABLE>
<CAPTION>
YEAR SINCE PURCHASE SALES CHARGE*
------------------------------------------
<S> <C>
0 - 1 %
------------------------------------------
1 - 2 %
------------------------------------------
2 - 3 %
------------------------------------------
3 - 4 %
------------------------------------------
4 - 5 %
------------------------------------------
5 - 6 %
------------------------------------------
6 AND THEREAFTER %
------------------------------------------
</TABLE>
* The percentage charge will apply to the lesser of the original cost of the
shares being redeemed or the proceeds of your redemption. Shares acquired
through reinvestment of dividends are not subject to a deferred sales charge.
Not all Mercury funds have identical deferred sales charge schedules. If you
exchange your shares for shares of another Mercury fund, the higher charge
will apply, if any would apply.
The deferred sales charge relating to Class B shares may be reduced or waived in
certain circumstances, such as:
- Certain post-retirement withdrawals from an IRA or other
retirement plan if you are over 59 1/2 years old
- Redemption by certain eligible 401(a) and 401(k) plans and certain
retirement plan rollovers
- Redemption in connection with participation in certain fee-based
programs managed by the Investment Adviser or its affiliates
- Redemption in connection with participation in certain fee-based
programs managed by selected securities dealers or other financial
intermediaries that have agreements with the Distributor or its
affiliates
- Withdrawals resulting from shareholder death or disability as long
as the waiver request is made within one year after death or
disability or, if later, reasonably promptly following comple-
MERCURY TOTAL RETURN BOND FUND 21
<PAGE> 185
[CHECKMARK ICON] Account Choices
tion of probate, or in connection with involuntary termination of
an account in which Fund shares are held
- Withdrawal through the Systematic Withdrawal Plan of up to 10% per
year of your Class B account value at the time the plan is
established
Your Class B shares convert automatically into Class A shares approximately ten
years after purchase. Any Class B shares received through reinvestment of
dividends paid on converting shares will also convert at that time. Class A
shares are subject to lower annual expenses than Class B shares. The conversion
of Class B shares to Class A shares is not a taxable event for Federal income
tax purposes.
Different conversion schedules may apply to Class B shares of different Mercury
mutual funds. If you acquire your Class B shares in an exchange from another
fund with a longer conversion schedule, the other fund's conversion schedule
will apply. If you exchange your Class B shares in the Fund for Class B shares
of a fund with a longer conversion schedule, the other fund's conversion
schedule will apply. The length of time that you hold both the original and
exchanged Class B shares in both funds will count toward the conversion
schedule. The conversion schedule may be modified in certain other cases as
well.
CLASS C SHARES
If you redeem Class C shares within one year after purchase, you may be charged
a deferred sales charge of %. The charge will apply to the lesser of the
original cost of the shares being redeemed or the proceeds of your redemption.
You will not be charged a deferred sales charge when you redeem shares that you
acquire through reinvestment of Fund dividends. The deferred sales charge
relating to Class C shares may be reduced or waived in connection with
involuntary termination of an account in which Fund shares are held and
withdrawals through the Systematic Withdrawal Plan.
Class C shares do not offer a conversion privilege.
22
MERCURY TOTAL RETURN BOND FUND
<PAGE> 186
[CHECKMARK ICON] Account Choices
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
--------------------------------------------------------------------------------
The chart below summarizes how to buy, sell, transfer and exchange shares
through your financial consultant, selected securities dealer, broker,
investment adviser, service provider or other financial intermediary. You may
also buy shares through the Transfer Agent. To learn more about buying shares
through the Transfer Agent, call 1-800-236-4479. Because the selection of a
mutual fund involves many considerations, your financial consultant, selected
securities dealer or other financial intermediary may help you with this
decision. The Fund does not issue share certificates.
Because of the high cost of maintaining smaller shareholder accounts, the Fund
may redeem the shares in your account (without charging any deferred sales
charge) if the net asset value of your account falls below $500 due to
redemptions you have made. You will be notified that the value of your account
is less than $500 before the Fund makes an involuntary redemption. You will then
have 60 days to make an additional investment to bring the value of your account
to at least $500 before the Fund takes any action. This involuntary redemption
does not apply to retirement plans or Uniform Gifts or Transfers to Minors Act
accounts.
MERCURY TOTAL RETURN BOND FUND 23
<PAGE> 187
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BUY SHARES First, select the share class Refer to the pricing of shares table on page 18. Be sure to
appropriate for you read this prospectus carefully.
-------------------------------------------------------------------------------------------------
Next, determine the amount of The minimum initial investment for the Fund is $1,000 for
your investment all accounts except:
- $500 for certain fee-based programs
- $100 for retirement plans
(The minimums for initial investments may be waived under
certain circumstances.)
-------------------------------------------------------------------------------------------------
Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. Purchase orders
other financial intermediary placed prior to the close of regular trading on the New York
submit your purchase order Stock Exchange (generally, 4:00 p.m. Eastern time) are
priced at the net asset value determined that day. Certain
financial intermediaries, however, may require submission of
orders prior to that time.
Purchase orders placed after that time are priced at the net
asset value determined on the next business day. The Fund
may reject any order to buy shares and may suspend the sale
of shares at any time. Certain financial intermediaries may
charge a fee to process a purchase. For example, Merrill
Lynch, Pierce, Fenner & Smith Incorporated currently charges
a $5.35 processing fee. The fees charged by other financial
intermediaries may be higher or lower.
-------------------------------------------------------------------------------------------------
Or contact the Transfer Agent To purchase shares directly, call the Transfer Agent at
1-800-236-4479 and request a purchase application. Mail the
completed purchase application to the Transfer Agent at the
address on the back cover of this prospectus.
------------------------------------------------------------------------------------------------------------------------
ADD TO YOUR Purchase additional shares The minimum investment for additional purchases is generally
INVESTMENT $100 for all accounts except:
- $50 for certain fee-based programs
- $1 for retirement plans
(The minimums for additional purchases may be waived under
certain circumstances.)
-------------------------------------------------------------------------------------------------
Acquire additional shares All dividends are automatically reinvested without a sales
through the automatic dividend charge.
reinvestment plan
-------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan your selected securities dealer or other financial
intermediary. The current minimum for such automatic
reinvestments is $100. The minimum may be waived or revised
under certain circumstances.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
24 MERCURY TOTAL RETURN BOND FUND
<PAGE> 188
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
TRANSFER SHARES TO Transfer to a participating You may transfer your Fund shares to another selected
ANOTHER SELECTED securities dealer or other securities dealer or other financial intermediary if
SECURITIES DEALER financial intermediary authorized dealer agreements are in place between the
OR OTHER FINANCIAL Distributor and the transferring intermediary and the
INTERMEDIARY Distributor and the receiving intermediary. Certain
shareholder services may not be available for all
transferred shares. You may only purchase additional shares
of funds previously owned before the transfer. All future
trading of these shares must be coordinated by the receiving
intermediary.
-------------------------------------------------------------------------------------------------
Transfer to a non-participating You must either:
securities dealer or other - Transfer your shares to an account with the Transfer
financial intermediary Agent; or
- Sell your shares, paying any applicable deferred sales
charge.
------------------------------------------------------------------------------------------------------------------------
SELL YOUR SHARES Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. For your
other financial intermediary redemption request to be priced at the net asset value on
submit your sales order the day of your request, you must submit your request to
your selected securities dealer or other financial
intermediary prior to that day's close of regular trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern
time). Certain financial intermediaries, however, may
require submission of orders prior to that time. Any
redemption request placed after that time are priced at the
net asset value at the close of regular trading on the next
business day.
Certain financial intermediaries may charge a fee to process
a sale of shares. For example, Merrill Lynch, Pierce, Fenner
& Smith Incorporated currently charges a $5.35 processing
fee. No processing fee is charged if you redeem the shares
directly through the Transfer Agent. The fees charged by
other financial intermediaries may be higher or lower.
The Fund may reject an order to sell shares under certain
circumstances.
-------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by writing to
the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter. A signature guarantee will generally be
required but may be waived in certain limited circumstances.
You can obtain a signature guarantee from a bank, securities
dealer, securities broker, credit union, savings
association, national securities exchange and registered
securities association. A notary public seal will not be
acceptable. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY TOTAL RETURN BOND FUND 25
<PAGE> 189
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SELL SHARES Participate in the Fund's You can choose to receive systematic payments from your Fund
SYSTEMATICALLY Systematic Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. You can
generally arrange through your selected securities dealer or
other financial intermediary for systematic sales of shares
of a fixed dollar amount on a monthly, bi-monthly,
quarterly, semi-annual or annual basis, subject to certain
conditions. Under either method, you must have dividends
automatically reinvested.
For Class B and C shares, your total annual withdrawals
cannot be more than 10% per year of the value of your shares
at the time your plan is established. The deferred sales
charge is waived for systematic redemptions. Ask your
financial intermediary for details.
------------------------------------------------------------------------------------------------------------------------
EXCHANGE YOUR Select the fund into which you You can exchange your shares of the Fund for shares of other
SHARES want to exchange. Be sure to Mercury mutual funds or for shares of the Summit Cash
read that fund's prospectus Reserves Fund. You must have held the shares used in the
exchange for at least 15 calendar days before you can
exchange to another fund.
Each class of Fund shares is generally exchangeable for
shares of the same class of another Mercury fund. If you own
Class I shares and wish to exchange into a fund in which you
have no Class I shares (and are not eligible to buy Class I
shares), you will exchange into Class A shares. If you own
Class I or Class A shares and wish to exchange into Summit,
you will exchange into Class A shares of Summit. Class B or
Class C shares can be exchanged for Class B shares of
Summit.
Some of the Mercury mutual funds may impose a different
initial or deferred sales charge schedule. If you exchange
Class I or A shares for shares of a fund with a higher
initial sales charge than you originally paid, you may be
charged the difference at the time of exchange. If you
exchange Class B or Class C shares for shares of a fund with
a different deferred sales charge schedule, the higher
schedule will apply. The time you hold Class B or C shares
in both funds will count when determining your holding
period for calculating a deferred sales charge at
redemption. Your time in both funds will also count when
determining the holding period for a conversion from Class B
to Class A shares.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
26 MERCURY TOTAL RETURN BOND FUND
<PAGE> 190
[CHECKMARK ICON] Account Choices
NET ASSET VALUE -- the market value in U.S. dollars of the Fund's total assets
after deducting liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
--------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open as of the close of regular trading on the Exchange based on
prices at the time of closing. Regular trading on the Exchange generally closes
at 4:00 p.m. Eastern time. The net asset value used in determining your price is
the next one calculated after your purchase or redemption order is placed.
Foreign securities owned by the Fund may trade on weekends or other days when
the Fund does not price its shares. As a result, the Fund's net asset value may
change on days when you will not be able to purchase or redeem the Fund's
shares.
The Fund may accept orders from certain authorized financial intermediaries or
their designees. The Fund will be deemed to receive an order when accepted by
the intermediary or designee and the order will receive the net asset value next
computed by the Fund after such acceptance. If the payment for a purchase order
is not made by a designated later time, the order will be canceled and the
financial intermediary could be held liable for any losses.
Generally, Class I shares will have the highest net asset value because that
class has the lowest expenses, and Class A shares will have a higher net asset
value than Class B or Class C shares. Also dividends paid on Class I and Class A
shares will generally be higher than dividends paid on Class B and Class C
shares because Class I and Class A shares have lower expenses.
FEE-BASED PROGRAMS
--------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by the Investment
Adviser or an affiliate of the Investment Adviser, or by selected securities
dealers or other financial intermediaries that have an agreement with the
Distributor, you may be able to buy Class I shares at net asset value, including
by exchanges from other share classes. Sales charges on the shares being
exchanged may be reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
MERCURY TOTAL RETURN BOND FUND 27
<PAGE> 191
[CHECKMARK ICON] Account Choices
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed ordinary income or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
If you leave one of these programs, your shares may be redeemed or automatically
exchanged into another class of the Fund's shares or into the Summit fund. The
class you receive may be the class you originally owned when you entered the
program, or in certain cases, a different class. If the exchange is into Class B
shares, the period before conversion to Class A shares may be modified. Any
redemption or exchange will be at net asset value. However, if you participate
in the program for less than a specified period, you may be charged a fee in
accordance with the terms of the program.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your financial
consultant, selected securities dealer or other financial intermediary.
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
The Fund will distribute any net investment income monthly and any net realized
long-term or short-term capital gains at least annually. The Fund may also pay a
special distribution at the end of the calendar year to comply with Federal tax
requirements. DIVIDENDS may be reinvested automatically in shares of the Fund at
net asset value without a sales charge or may be taken in cash. If your account
is with a securities dealer or other financial intermediary that has an
agreement with the Fund, contact your dealer or intermediary about which option
you would like. If your account is with the Transfer Agent and you would like to
receive dividends in cash, contact the Transfer Agent. The Fund anticipates that
the majority of its dividends, if any, will consist of ordinary income. Capital
gains, if any, may be taxable to you at different rates, depending, in part, on
how long the Fund has held the assets sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your shares and any
gain on the transaction may be subject to tax. Capital gain dividends are
generally taxed at different rates than ordinary income dividends.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax treaties between certain countries
and the U.S. may reduce or eliminate such taxes.
28 MERCURY TOTAL RETURN BOND FUND
<PAGE> 192
[CHECKMARK ICON] Account Choices
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
By law, the Fund must withhold 31% of your dividends and redemption proceeds if
you have not provided a taxpayer identification number or social security number
or if the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
MERCURY TOTAL RETURN BOND FUND 29
<PAGE> 193
[MANAGEMENT TEAM ICON] The Management Team
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
Mercury Advisors, the Fund's Investment Adviser, manages the Fund's investments
under the overall supervision of the Board of Trustees of the Trust. The
Investment Adviser has the responsibility for making all investment decisions
for the Fund. The Trust pays the Investment Adviser a fee at the annual rate of
0.30% of the average daily net assets of the Total Return Bond Master Portfolio
of the Trust. The Fund pays the Investment Adviser an administrative fee at the
annual rate of 0.25% of the average daily net assets of the Fund.
The Investment Adviser was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
The Investment Adviser and its affiliates had approximately $555 billion in
investment company and other portfolio assets under management as of June 30,
2000.
For the fiscal year ended June 30, 2000, the Fund paid to the Investment Adviser
fees for advisory and administrative services of 0.55% of the Fund's average net
assets. Although not required to do so, the Investment Adviser has agreed to
make reimbursements so that the regular annual operating expenses of the Fund
will be limited as shown in the table on page 5. The Investment Adviser has
agreed to these expense limits through June 2001, and will thereafter give
shareholders at least 30 days' notice if this reimbursement policy will change.
Prior to the date of this prospectus, the Investment Adviser provided portfolio
management directly to the Fund.
The Investment Adviser is allowed to allocate brokerage based on sales of shares
of funds managed by the Investment Adviser.
MASTER/FEEDER STRUCTURE
--------------------------------------------------------------------------------
Unlike many other mutual funds, which directly buy and manage their own
portfolio securities, the Fund seeks to achieve its investment objective by
investing all its assets in the corresponding Total Return Bond Master Portfolio
of the Trust. Investors in the Fund will acquire an indirect interest in the
underlying Portfolio.
Other "feeder" funds may also invest in the "master" Portfolio. This structure
may enable the Fund to reduce costs through economies of scale. A larger
investment portfolio may also reduce certain transaction costs to the extent
that
30 MERCURY TOTAL RETURN BOND FUND
<PAGE> 194
[MANAGEMENT TEAM ICON] The Management Team
contributions to and redemptions from the master from different feeders may
offset each other and produce a lower net cash flow.
The Fund may withdraw from the Total Return Bond Master Portfolio at any time
and may invest all of its assets in another pooled investment vehicle or retain
an investment adviser to manage the Fund's assets directly.
Smaller feeder funds may be harmed by the actions of larger feeder funds. For
example, a larger feeder fund could have more voting power than the Fund over
the operations of the Total Return Bond Master Portfolio.
Whenever the Total Return Bond Master Portfolio holds a vote of its feeder
funds, the Fund will pass the vote through to its own shareholders.
MERCURY TOTAL RETURN BOND FUND 31
<PAGE> 195
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned on an investment in the
Fund (assuming reinvestment of all dividends and distributions). These financial
highlights were audited by PricewaterhouseCoopers LLP. The accountants' report
and the Fund's financial statements are included in the Fund's annual report,
which is available upon request. Further performance information is contained in
the annual report.
<TABLE>
<CAPTION>
CLASS I(1) CLASS A(1)
------------------------------------------------------- ------------------------------
FOR THE YEAR ENDED JUNE 30, FOR THE PERIOD ENDED JUNE 30,
INCREASE (DECREASE) IN ------------------------------------------------------- ------------------------------
NET ASSET VALUE: 2000 1999 1998 1997 1996 2000 1999(2)
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $ 13.46 $13.04 $12.78 $12.94 $12.88
---------------------------------------------------------------------------------------------------------------------------------
Investment income -- net 0.81 0.89 0.99 0.83 0.06
---------------------------------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss)
on investments -- net (0.49) 0.50 0.30 0.06 (0.03)
---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations 0.32 1.39 1.29 0.90 0.03
---------------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions
Investment income -- net (0.83) (0.97) (0.92) (0.93) (0.06)
Realized gain on investments -- net (0.10) -- (0.11) (0.13)
---------------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions (0.93) (0.97) (1.03) (1.06) (0.06)
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $ 12.85 $13.46 $13.04 $12.78 $12.85
---------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
---------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share 2.30% 11.04% 10.48% 7.05% 0.23%()++
---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
---------------------------------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement 0.65% 0.65% 0.65% 0.68% 0.90%()+
---------------------------------------------------------------------------------------------------------------------------------
Expenses 0.79% 1.02% 0.95% 0.98% 1.18%()+
---------------------------------------------------------------------------------------------------------------------------------
Investment income -- net 5.78% 6.65% 7.08% 7.16% 6.26%()+
---------------------------------------------------------------------------------------------------------------------------------
Supplemental Data:
---------------------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in
millions) $124.30 $45.20 $14.30 $43.40 $ 0.40
---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover 233% 195% 173% 51% 233%
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) As of October , 2000, Investor Class shares were redesignated Class I
shares and Distributor Class shares were redesignated Class A shares.
No sales loads were charged prior to this time.
(2) The Class commenced operations on June 2, 1999.
(3) Net investment income per share is calculated using ending balances prior
to consideration of adjustments for permanent book and tax differences.
(*) Total investment return excludes the effects of sales charges.
(+) Annualized.
(++) Not annualized.
32 MERCURY TOTAL RETURN BOND FUND
<PAGE> 196
<TABLE>
<S> <C>
FUND
Mercury Total Return Bond Fund
of Mercury HW Funds
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(800-236-4479)
INVESTMENT ADVISER
Administrative Offices:
Mercury Advisors
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 41621
Jacksonville, Florida 32232-1621
(800-236-4479)
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
100 E. Wisconsin Ave., Suite 1500
Milwaukee, Wisconsin 53202
DISTRIBUTOR
FAM Distributors, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109-3661
COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610-4795
</TABLE>
<PAGE> 197
SHAREHOLDER REPORTS
Additional information about the Fund's investments will be available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report you will find a discussion of the relevant market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling
1-800-236-4479.
The Fund will send you one copy of each shareholder report and certain other
mailings regardless of the number of Fund accounts you have. To receive separate
shareholder reports for each account, call your financial consultant or other
financial intermediary or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and brokerage or mutual
fund account number. If you have any questions, please call your financial
consultant or other financial intermediary or the Transfer Agent at
1-800-236-4479.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at Financial Data Services, Inc., P.O. Box 41621, Jacksonville, Florida
32232-1621 or by calling 1-800-236-4479.
Contact your financial consultant or other financial intermediary or the Fund at
the telephone number or address indicated on the inside back cover of this
prospectus if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet Site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION IN THIS PROSPECTUS.
Investment Company Act File #811-4182.
CODE #MHW-1090-1000
(C) Mercury Advisors
[TELEPHONE ICON] To Learn More
Mercury Total
Return Bond Fund
OF MERCURY HW FUNDS
PROSPECTUS - October , 2000
<PAGE> 198
Mercury Low Duration Fund
OF MERCURY HW FUNDS
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING INFORMATION
ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST
AND KEEP IT FOR FUTURE REFERENCE.
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.
PROSPECTUS - October , 2000
<PAGE> 199
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
[GLOBE ICON]
FUND FACTS
-----------------------------------------------------------------
About the Mercury Low Duration Fund......................... 2
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[MAGNIFYING GLASS ICON]
ABOUT THE DETAILS
-----------------------------------------------------------------
How the Fund Invests........................................ 7
Investment Risks............................................ 9
Statement of Additional Information......................... 16
[CHECKMARK ICON]
ACCOUNT CHOICES
-----------------------------------------------------------------
Pricing of Shares........................................... 17
How to Buy, Sell, Transfer and Exchange Shares.............. 23
How Shares are Priced....................................... 27
Fee-Based Programs.......................................... 27
Dividends and Taxes......................................... 28
[MANAGEMENT TEAM ICON]
THE MANAGEMENT TEAM
-----------------------------------------------------------------
Management of the Fund...................................... 30
Master/Feeder Structure..................................... 30
Financial Highlights........................................ 32
[TELEPHONE ICON]
TO LEARN MORE
-----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERCURY LOW DURATION FUND
<PAGE> 200
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
U.S. GOVERNMENT SECURITIES -- include direct obligations issued by the U.S.
Treasury and securities issued or guaranteed by U.S. government agencies and
instrumentalities.
CORPORATE BONDS -- bonds debt securities issued by corporations, as distinct
from bonds issued by a government or its agencies or instrumentalities.
ASSET-BACKED SECURITIES -- bonds or note backed by loan paper or accounts
receivable originated by banks, credit card companies, or other providers of
credit.
MORTGAGE-BACKED SECURITIES -- securities that give the holder the right to
receive a portion of principal and/or interest payments made on a pool of
residential or commercial mortgage loans, which in some cases are guaranteed by
government agencies.
DURATION -- a measure of how much the price of a bond would change compared to a
change in market interest rates.
PREPAYMENT RISK -- the risk that certain obligations will be paid off by the
obligor more quickly than anticipated and the value of these securities will
fall.
EXTENSION RISK -- the risk that certain obligations will be paid off more slowly
by the obligor than anticipated and the value of these securities will fall.
[GLOBE ICON] Fund Facts
ABOUT THE MERCURY LOW DURATION FUND
--------------------------------------------------------------------------------
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to maximize total return, consistent with
capital preservation.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests in a diversified portfolio of bonds of different maturities,
including U.S. GOVERNMENT SECURITIES, CORPORATE BONDS, ASSET-BACKED SECURITIES
and MORTGAGE-BACKED SECURITIES. At least 70% of its investments will be in
securities rated A or better. Up to 30% of its investments in securities rated
BBB/Baa and up to 10% of its investments may be in securities rated below
investment grade (none below B). The Fund's DURATION will be from one to three
years.
The Fund is a "feeder" fund that invests all of its assets in a corresponding
"master" portfolio (the "Low Duration Master Portfolio") of the Fund Asset
Management Master Trust (the "Trust") which has the same objective as the Fund.
All investments will be made at the Trust level. This structure is sometimes
called a "master/feeder" structure. The Fund's investment results will
correspond directly to the investment results of the Low Duration Master
Portfolio in which it invests. For simplicity, this prospectus uses the term
"Fund" to include the Low Duration Master Portfolio of the Trust.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of Fund shares, may go up or down. These changes may occur in response to
interest rate changes or other factors that may affect a particular issuer or
obligation. Generally, when interest rates go up, the value of bonds goes down.
The value of the Fund's shares also may be affected by market conditions and
economic or political developments. The longer the duration of the Fund, the
more the Fund's price will go down if interest rates go up. If the value of the
Fund's investments goes down, you may lose money.
The Fund invests in mortgage-backed and asset-backed securities. In addition to
normal bond risks, these securities are subject to PREPAYMENT RISK and EXTENSION
RISK, and may involve more VOLATILITY than other bonds of similar maturities.
The Fund also may invest in "JUNK" BONDS, which have more credit risk and tend
to be less liquid than higher-rated securities.
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MERCURY LOW DURATION FUND
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[GLOBE ICON] Fund Facts
VOLATILITY -- the amount and frequency of changes in a security's value.
"JUNK" BOND -- bond with a credit rating of BB/Ba or lower by rating agencies.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
See "Investment Risks" for more information about the risks associated with the
Fund.
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are looking for an investment that provides income.
- Are investing with long-term goals in mind, such as retirement or
funding a child's education.
- Want a professionally managed and diversified portfolio.
- Are willing to accept the risk that the value of your investment
may decline as the result of interest rate movements in order to
seek high current return.
- Are not looking for a significant amount of current income.
- Are prepared to receive taxable distributions.
MERCURY LOW DURATION FUND 3
<PAGE> 202
[GLOBE ICON] Fund Facts
RISK/RETURN BAR CHART
--------------------------------------------------------------------------------
The bar chart and table below provide some indication of the risks of investing
in the Fund by showing changes in the year to year performance of the Class I
shares of the Fund and by showing how the Fund's average annual total returns
for 1 and 5 years and for the life of the Class compare with those of a broad
measure of market performance. How the Fund has performed in the past is not
necessarily an indication of how the Fund will perform in the future.
<TABLE>
<CAPTION>
1994 5.23
---- ----
<S> <C>
1995 12.75
1996 6.23
1997 7.59
1998 5.65
1999 3.19
</TABLE>
Total return for the six months ended June 30, 2000: 3.01%.
During the period shown in the bar chart, the highest return for a quarter was
4.02% (quarter ended June 30, 1995) and the lowest return for a quarter was
-0.09% (quarter ended December 31, 1998).
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS PAST PAST SINCE
(FOR THE PERIODS ENDED DECEMBER 31, 1999) ONE YEAR FIVE YEARS INCEPTION
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
CLASS I*+ 3.19% 7.04% 7.19%(1)
Merrill Lynch 1-3 Year U.S. Treasury Note Index 3.06% 6.51% 5.37%
---------------------------------------------------------------------------------------
CLASS A*++ N/A N/A 0.80%(2)
Merrill Lynch 1-3 Year U.S. Treasury Note Index N/A N/A 0.71%
---------------------------------------------------------------------------------------
CLASS B N/A N/A N/A
Merrill Lynch 1-3 Year U.S. Treasury Note Index N/A N/A N/A
---------------------------------------------------------------------------------------
CLASS C N/A N/A N/A
Merrill Lynch 1-3 Year U.S. Treasury Note Index N/A N/A N/A
---------------------------------------------------------------------------------------
</TABLE>
The Merrill Lynch 1-3 year U.S. Treasury Note Index is an unmanaged Index
comprised of U.S. Treasury securities with maturities ranging from one to three
years, which are guaranteed as to the timely payment of principal and interest
by the U.S. government. The Fund invests in securities that are not reflected in
the Index or guaranteed.
* Includes the effect of sales charges, which were not imposed until October
, 2000.
+ As of October , 2000, Investor Class shares were redesignated Class I
shares.
++ As of October , 2000, Distributor Class shares were redesignated Class A
shares.
(1) Inception date is May 18, 1993.
(2) Inception date is September 24, 1999.
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<PAGE> 203
[GLOBE ICON] Fund Facts
UNDERSTANDING EXPENSES
Fund investors pay various expenses, either directly or indirectly. Listed below
are some of the main types of expenses, which all mutual funds may charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
INVESTMENT ADVISORY FEE -- a fee paid to the Investment Adviser for managing the
Trust.
DISTRIBUTION FEES -- fees used to support the Fund's marketing and distribution
efforts, such as compensating financial consultants, other financial
intermediaries, advertising and promotion.
SERVICE (ACCOUNT MAINTENANCE) FEES -- fees used to compensate selected
securities dealers or other financial intermediaries for account maintenance
activities.
FEES AND EXPENSES
--------------------------------------------------------------------------------
The Fund offers four different classes of shares. Although your money will be
invested the same way no matter which class of shares you buy, there are
differences among the fees and expenses associated with each class. Not everyone
is eligible to buy every class. After determining which classes you are eligible
to buy, decide which class best suits your needs. Your financial consultant,
selected securities dealer or other financial intermediary can help you with
this decision.
THIS TABLE SHOWS THE DIFFERENT FEES AND EXPENSES THAT YOU MAY PAY IF YOU BUY AND
HOLD THE DIFFERENT CLASSES OF SHARES OF THE FUND. FUTURE EXPENSES MAY BE GREATER
OR LESS THAN THOSE INDICATED BELOW.
<TABLE>
<CAPTION>
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR
INVESTMENT)(A): CLASS I* CLASS A* CLASS B(B) CLASS C
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Maximum Sales Charge (Load) imposed on purchases
(as a percentage of offering price)
---------------------------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a
percentage of original purchase price or redemption
proceeds, whichever is lower)
---------------------------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend
Reinvestments None None None None
---------------------------------------------------------------------------------------------
Redemption Fee None None None None
---------------------------------------------------------------------------------------------
Exchange Fee None None None None
---------------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE
DEDUCTED FROM THE FUND'S TOTAL ASSETS)(e):
---------------------------------------------------------------------------------------------
INVESTMENT ADVISORY FEE(f)
---------------------------------------------------------------------------------------------
DISTRIBUTION AND/OR SERVICE (12b-1) FEES(g)
---------------------------------------------------------------------------------------------
Other Expenses (including transfer agency and
administrative fees)(h)
---------------------------------------------------------------------------------------------
TOTAL ANNUAL OPERATING EXPENSES
---------------------------------------------------------------------------------------------
Expense Reimbursement(i)
---------------------------------------------------------------------------------------------
NET ANNUAL FUND OPERATING EXPENSES
---------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C>
* As of October , 2000, Investor Class shares were
redesignated Class I shares and Distributor Class shares
were redesignated Class A shares.
(a) Certain securities dealers or other financial intermediaries
may charge a fee to process a purchase or sale of shares.
See "How to Buy, Sell, Transfer and Exchange Shares."
(b) Class B shares automatically convert to Class A shares about
ten years after you buy them and will no longer be subject
to distribution fees.
(c) Some investors may qualify for reductions in the sales
charge (load).
(d) You may pay a deferred sales charge if you purchase $1
million or more and you redeem within one year.
(e) For the Fund, the fees and expenses include both the Fund
and the Trust.
(f) Paid by the Low Duration Master Portfolio.
(g) The Fund calls the "Service Fee" an "Account Maintenance
Fee." Account Maintenance Fee is the term used elsewhere in
this prospectus and in all other Fund materials. If you hold
Class B or C shares for a long time, it may cost you more in
distribution (12b-1) fees than the maximum sales charge that
you would have paid if you had bought one of the other
classes.
(h) Includes administrative fees, which are payable to the
Investment Adviser by the Fund at the annual rate of 0. %.
(i) The Investment Adviser has contractually agreed to waive
management fees and/or reimburse expenses through June 30,
2001, as shown in the table.
</TABLE>
MERCURY LOW DURATION FUND 5
<PAGE> 204
[GLOBE ICON] Fund Facts
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, if any, that apply to the particular class and that the Fund's
operating expenses remain the same except for the expense reimbursement in
effect for the first year. This assumption is not meant to indicate you will
receive a 5% annual rate of return. Your annual return may be more or less than
the 5% used in these examples. Although your actual costs may be higher or
lower, based on these assumptions, your costs would be:
Expenses if you did redeem your shares:
<TABLE>
<CAPTION>
CLASS I CLASS A CLASS B CLASS C
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ONE YEAR $ $ $ $
------------------------------------------------------------------------------------------
THREE YEARS $ $ $ $
------------------------------------------------------------------------------------------
FIVE YEARS $ $ $ $
------------------------------------------------------------------------------------------
TEN YEARS $ $ $ $
------------------------------------------------------------------------------------------
</TABLE>
Expenses if you did not redeem your shares:
<TABLE>
<CAPTION>
CLASS I CLASS A CLASS B CLASS C
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ONE YEAR $ $ $ $
------------------------------------------------------------------------------------------
THREE YEARS $ $ $ $
------------------------------------------------------------------------------------------
FIVE YEARS $ $ $ $
------------------------------------------------------------------------------------------
TEN YEARS $ $ $ $
------------------------------------------------------------------------------------------
</TABLE>
6
MERCURY LOW DURATION FUND
<PAGE> 205
ABOUT THE PORTFOLIO MANAGERS -- Michael Sanchez has been a co-Portfolio Manager
of the Fund since joining the Investment Adviser in 1996. Before joining the
Investment Adviser, Mr. Sanchez was with Provident Investment Counsel as senior
vice president and portfolio manager from 1991 to 1995 and with ARCO Investment
Management Company as Director of Fixed Income Investments from 1988 to 1991.
John Queen has been a co-Portfolio Manager of the Fund since 1997. Prior to
joining the Investment Adviser in 1997, Mr. Queen was associated with The
Capital Group as a member of an analyst team responsible for $8 billion in
fixed-income assets.
ABOUT THE INVESTMENT ADVISER -- Mercury Advisors manages the Fund.
[MAGNIFYING GLASS ICON] About the Details
HOW THE FUND INVESTS
--------------------------------------------------------------------------------
The Fund's investment objective is to maximize total return, consistent with
capital preservation. The Fund invests in bonds with a portfolio duration of one
to three years. The total rate of return for the Fund is expected to rise and
fall less than a longer duration bond fund.
TYPES OF INVESTMENTS
The Fund seeks to achieve its objective by investing mainly in investment grade,
interest-bearing securities of varying maturities. These include:
- U.S. Government securities
- preferred stocks
- mortgage-backed and other asset-backed securities
- corporate bonds
- bonds that are convertible into stocks
- bank certificates of deposit, fixed time deposits and bankers'
acceptances
- repurchase agreements, reverse repurchase agreements and dollar
rolls
- obligations of foreign governments or their subdivisions, agencies
and instrumentalities
- obligations of international agencies or supra-national entities
- municipal bonds
RATINGS LIMITATIONS
- at least 70% of total assets rated at least A or, if short-term,
the second highest quality grade, by a major rating agency
- up to 30% of total assets rated Baa by Moody's or BBB by S&P
- up to 10% of total assets rated below investment grade, but none
below B
The Investment Advisor can invest in unrated securities and will assign them the
rating of a voted security of comparable quality. After the Fund buys a
security, it may be given a lower rating or stop being rated. This will not
require the Fund to sell it, but the Investment Adviser will consider the change
in rating in deciding whether to keep the security.
MATURITY AND DURATION REQUIREMENTS
Maturity. The EFFECTIVE MATURITY of a bond is the weighted average period over
which principal is expected to be repaid. STATED MATURITY is the date when the
issuer is scheduled to make the final payment of principal. Effective
MERCURY LOW DURATION FUND 7
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[MAGNIFYING GLASS ICON] About the Details
maturity is different than stated maturity because it estimates the effect of
expected principal prepayments and call provisions.
Duration. Duration measures the potential volatility of the price of a bond or
a portfolio of bonds prior to maturity. Duration is the magnitude of the change
in price of a bond relative to a given change in the market interest rate.
Duration incorporates a bond's yield, coupon interest payments, final maturity,
call and put features and prepayment exposure into one measure.
For any bond with interest payments occurring before principal is repaid,
duration is ordinarily less than maturity. Generally, the lower the stated or
coupon rate of interest of a bond, the longer the duration. The higher the
stated or coupon rate of interest of a bond, the shorter the duration. The
calculation of duration is based on estimates.
Duration is a tool to measure interest rate risk. Assuming a 1% change in
interest rates and the durations shown below, the Fund's price would change as
follows:
<TABLE>
<CAPTION>
DURATION CHANGE IN INTEREST RATES
---------------------------------------------------------------
<C> <S>
2 yrs. 1% decline W 2% gain in Fund price
---------------------------------------------------------------
1% rise W 2% decline in Fund price
---------------------------------------------------------------
</TABLE>
Other factors such as changes in credit quality, prepayments, the shape of the
yield curve and liquidity affect the price of the Fund and may correlate with
changes in interest rates. These factors can increase swings in the Fund's share
price during periods of volatile interest rate changes.
FOREIGN BONDS
The Fund may invest in foreign bonds as follows:
- up to 25% of total assets in foreign bonds that are denominated in
U.S. dollars
- up to 15% of total assets in foreign bonds that are not
denominated in U.S. dollars
- up to 15% of total assets in emerging market foreign bonds
MONEY MARKET INVESTMENTS
To meet redemptions and when waiting to invest cash receipts, the Fund may
invest in short-term, investment grade bonds, money market mutual funds and
other money market instruments. Also, the Fund temporarily can invest up to 100%
of its assets in short-term, investment grade bonds and other money
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[MAGNIFYING GLASS ICON] About the Details
market instruments in response to adverse market, economic or political
conditions. The Fund may not achieve its objective using this type of investing.
PORTFOLIO TURNOVER
As a result of the strategies described above, the Fund may have an annual
portfolio turnover rate above 100%. Portfolio turnover is generally the
percentage found by dividing the lesser of portfolio purchases or sales by the
monthly average value of the portfolio. High portfolio turnover (100% or more)
results in higher mark ups and other transaction costs and can affect the Fund's
performance. It also can result in a greater amount of distributions as ordinary
income rather than long-term capital gains.
INVESTMENT RISKS
--------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK
Market risk is the risk that the market will go down in value, including the
possibility that the market will go down sharply and unpredictably. Selection
risk is the risk that the investments that Fund management selects will
underperform the market or other funds with similar investment objectives and
investment strategies.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities are the right to receive a portion of principal
and/or interest payments made on a pool of residential or commercial mortgage
loans. When interest rates fall, borrowers may refinance or otherwise repay
principal on their mortgages earlier than scheduled. When this happens, certain
types of mortgage-backed securities will be paid off more quickly than
originally anticipated. Prepayment reduces the yield to maturity and average
life of mortgage-backed securities. In addition, when the Fund reinvests the
proceeds of a prepayment, it may receive a lower interest rate than the rate on
the security that was prepaid. This risk is known as "prepayment risk." When
interest rates rise, certain types of mortgage-backed securities will be paid
off more slowly than originally anticipated and the value of these securities
will fall. This risk is known as extension risk.
MERCURY LOW DURATION FUND 9
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[MAGNIFYING GLASS ICON] About the Details
Because of prepayment risk and extension risk, mortgage-backed securities react
differently to changes in interest rates than other bonds. Small movements in
interest rates (both up and down) may quickly and significantly reduce the value
of certain mortgage-backed securities.
Mortgage-backed securities are issued by Federal government agencies like the
Government National Mortgage Association ("Ginnie Mae"), the Federal Home Loan
Mortgage Association ("Freddie Mac") or the Federal National Mortgage
Association ("Fannie Mae"). Principal and interest payments on mortgage-backed
securities issued by Federal government agencies are guaranteed by either the
Federal government or the government agency. This means that such securities
have very little credit risk. Other mortgage-backed securities are issued by
private corporations rather than Federal agencies. Private mortgage-backed
securities have credit risk as well as prepayment risk and extension risk.
Mortgage-backed securities may be either pass-through securities or
collateralized mortgage obligations (CMOs). Pass-through securities represent a
right to receive principal and interest payments collected on a pool of
mortgages, which are passed through to security holders (less servicing costs).
CMOs are created by dividing the principal and interest payments collected on a
pool of mortgages into several revenue streams (tranches) with different
priority rights to portions of the underlying mortgage payments. Certain CMO
tranches may represent a right to receive interest only (IOs), principal only
(POs) or an amount that remains after other floating-rate tranches are paid (an
inverse floater). These securities are frequently referred to as "mortgage
derivatives" and may be extremely sensitive to changes in interest rates. If the
Fund invests in CMO tranches (including CMO tranches issued by government
agencies) and interest rates move in a manner not anticipated by the Investment
Adviser, it is possible that the Fund could lose all or substantially all of its
investment.
ASSET-BACKED SECURITIES
Like traditional bonds, the value of asset-backed securities typically increases
when interest rates fall and decreases when interest rates rise. Certain asset-
backed securities may also be subject to the risk of prepayment. In a period of
declining interest rates, borrowers may pay what they owe on the underlying
assets more quickly than anticipated. Prepayment reduces the yield to maturity
and the average life of the asset-backed securities. In addition, when the Fund
reinvests the proceeds of a prepayment, it may receive a lower interest rate
than the rate on the security that was prepaid. In a period of rising interest
rates, prepayments may occur at a slower rate than expected. As a result, the
average maturity of the Fund's portfolio will increase. The value of long-term
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[MAGNIFYING GLASS ICON] About the Details
securities changes more widely in response to changes in interest rates than
shorter-term securities.
CREDIT RISK
Credit risk is the risk that the issuer of bonds will be unable to pay the
interest or principal when due. The degree of credit risk depends on both the
financial condition of the issuer and on the terms of the specific bonds.
INTEREST RATE RISK
Interest rate risk is the risk that prices of bonds generally increase when
interest rates decline and decrease when interest rates increase. Prices of
longer term securities generally change more in response to interest rate
changes than do prices of shorter term securities.
CALL AND REDEMPTION RISK
Investments in bonds carry the risk that a bond's issuer will call the bond for
redemption prior to the bond's maturity. If there is an early call of a bond,
the Fund may lose income and may have to invest the proceeds of the redemption
in bonds with lower yields than the called bond.
JUNK BONDS
Junk bonds are bonds that are rated below investment grade by the major rating
agencies or are unrated securities that the Fund's Investment Adviser believes
are of comparable quality to bonds rated below investment grade. Although junk
bonds generally pay higher rates of interest than investment grade bonds, they
are high risk investments that may cause income and principal losses for the
Fund. Junk bonds generally are less liquid and experience more price volatility
than higher rated bonds. The issuers of junk bonds may have a larger amount of
outstanding debt relative to their assets than issuers of investment grade
bonds. In the event of an issuer's bankruptcy, claims of other creditors may
have priority over the claims of junk bond holders, leaving few or no assets
available to repay junk bond holders. Junk bonds may be subject to greater call
and redemption risk than higher rated debt securities.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD COMMITMENTS
These types of investments involve the risk that the security the Fund buys will
lose value prior to its delivery to the Fund. There also is the risk that the
security will not be issued or that the other party will not meet its
obligation, in
MERCURY LOW DURATION FUND 11
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[MAGNIFYING GLASS ICON] About the Details
which case the Fund loses the investment opportunity of the assets it has set
aside to pay for the security and any gain in the security's price.
VARIABLE RATE DEMAND OBLIGATIONS
These are floating rate securities that consist of an interest in a long-term
bond and the conditional right to demand payment prior to the bond's maturity
from a bank or other financial institution. If the bank or other financial
institution is unable to pay on demand, the Fund may be adversely affected. In
addition, these securities are subject to credit risk.
INDEXED AND INVERSE FLOATING RATE SECURITIES
The Fund may invest in securities whose potential returns are directly related
to changes in an underlying index or interest rate, known as indexed securities.
The return on indexed securities will rise when the underlying index or interest
rate rises and fall when the index or interest rate falls. The Fund may also
invest in securities whose return is inversely related to changes in an interest
rate (inverse floaters). In general, inverse floaters change in value in a
manner that is opposite to most bonds -- that is, interest rates on inverse
floaters will decrease when short-term rates increase and increase when
short-term rates decrease. Investments in indexed securities and inverse
floaters may subject the Fund to the risk of reduced or eliminated interest
payments. Investments in indexed securities also may subject the Fund to loss of
principal. In addition, certain indexed securities and inverse floaters may
increase or decrease in value at a greater rate than the underlying interest
rate, which effectively leverages the Fund's investment. As a result, the market
value of such securities will generally be more volatile than that of fixed rate
securities. Both indexed securities and inverse floaters can be derivative
securities and can be considered speculative.
SOVEREIGN DEBT
The Fund may invest in sovereign debt securities. These securities are issued or
guaranteed by foreign government entities. Investments in sovereign debt subject
the Fund to the risk that a government entity may delay or refuse to pay
interest or repayment of principal on its sovereign debt. Some of these reasons
may include cash flow problems, insufficient foreign currency reserves,
political considerations, the relative size of its debt position to its economy
or its failure to put in place economic reforms required by the International
Monetary Fund or other multilateral agencies. If a government entity defaults,
it may ask for more time in which to pay or for further loans. There is no legal
process for collecting sovereign debts that a government does not pay.
12
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[MAGNIFYING GLASS ICON] About the Details
CORPORATE LOANS
Corporate loans are subject to the risk of loss of principal and income.
Borrowers do not always provide collateral for corporate loans and the value of
the collateral may not completely cover the borrower's obligations at the time
of a default. If a borrower files for protection from its creditors under the
U.S. bankruptcy laws, these laws may limit the Fund's rights to its collateral.
In addition, the value of collateral may erode during a bankruptcy case. In the
event of a bankruptcy, the holder of a corporate loan may not recover its
principal, may experience a long delay in recovering its investment and may not
receive interest during the delay.
RISKS OF CONVERTIBLE SECURITIES
Convertibles are generally bonds or preferred stocks that may be converted into
common stock. Convertibles typically pay current income, as either interest
(bond convertibles) or dividends (preferred stocks). A convertible's value
usually reflects both the stream of current income payments and the value of the
underlying common stock. The market value of a convertible performs like regular
bonds; that is, if market interest rates rise, the value of a convertible
usually falls. Since it is convertible into common stock, the convertible also
has the same types of market and issuer risk as the underlying common stock.
FOREIGN MARKET RISK
Since the Fund may invest in foreign securities, it offers the potential for
more diversification than an investment only in the U.S. This is because bonds
traded in foreign markets have often (though not always) performed differently
than bonds in the U.S. However, such investments involve special risks not
present in U.S. investments that can increase the chances that the Fund will
lose money. In particular, investments in foreign securities involve the
following risks, which are generally greater for investments in emerging
markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
MERCURY LOW DURATION FUND 13
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[MAGNIFYING GLASS ICON] About the Details
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair the Fund's
ability to purchase or sell foreign securities or transfer its
assets or income back into the U.S., or otherwise adversely affect
the Fund's operations.
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal
remedies available to investors in some foreign countries may be
less extensive than those available to investors in the U.S.
- Prices of foreign securities may go up and down more than prices
of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and a Fund's assets may be uninvested
and not earning returns. The Fund also may miss investment
opportunities or be unable to sell an investment because of these
delays.
- The value of the Fund's foreign holdings (and hedging transactions
in foreign currencies) will be affected by changes in currency
exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- If the Fund purchases a bond issued by a foreign government, the
government may be unwilling or unable to make payments when due.
There may be no formal bankruptcy proceeding to collect amounts
owed by a foreign government.
14
MERCURY LOW DURATION FUND
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[MAGNIFYING GLASS ICON] About the Details
EUROPEAN ECONOMIC AND MONETARY UNION (EMU)
A number of European countries have entered into EMU in an effort to reduce
trade barriers between themselves and eliminate fluctuations in their
currencies. EMU establishes a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These securities trade and make dividend and other payments only in euros. Like
other investment companies and business organizations, including the companies
in which the Fund invests, the Fund could be adversely affected if the
transition to euro, or EMU as a whole, does not take effect as planned or if a
participating country withdraws from EMU.
DERIVATIVES
Derivatives involve the following risks:
- CREDIT RISK -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Fund.
- CURRENCY RISK -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
- LEVERAGE RISK -- Leverage risk is the risk associated with certain
types of investments or trading strategies that relatively small
market movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- LIQUIDITY RISK -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time that
the seller would like or at the price that the seller believes the
security is currently worth.
- INDEX RISK -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
MERCURY LOW DURATION FUND 15
<PAGE> 214
[MAGNIFYING GLASS ICON] About the Details
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
STATEMENT OF ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
16
MERCURY LOW DURATION FUND
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[CHECKMARK ICON] Account Choices
PRICING OF SHARES
--------------------------------------------------------------------------------
The Fund offers four classes of shares, each with its own sales charge and
expense structure, allowing you to invest in the way that best suits your needs.
Each share class represents an ownership interest in the same investment
portfolio. When you choose your class of shares, you should consider the size of
your investment and how long you plan to hold your shares. Your financial
consultant or other financial intermediary can help you determine which share
class is best suited to your personal financial goals.
The Fund's shares are distributed by FAM Distributors, Inc. (the "Distributor").
For example, if you select Class I or A shares, you generally pay the
Distributor a sales charge at the time of purchase. If you buy Class A shares,
you also pay out of Fund assets an ongoing account maintenance fee of %. You
may be eligible for a sales charge reduction or waiver.
If you select Class B or C shares, you will invest the full amount of your
purchase price, but you will be subject to a distribution fee of % for Class
B shares or % for Class C shares and an account maintenance fee of %.
Because these fees are paid out of the Fund's assets on an ongoing basis, over
time these fees increase the cost of your investment and may cost you more than
paying an initial sales charge. In addition, you may be subject to a deferred
sales charge when you sell Class B or C shares.
Certain financial institutions may charge you additional fees in connection with
transactions in Fund shares. The Investment Adviser, the Distributor or their
affiliates may make payments out of their own resources to securities dealers
and other financial intermediaries for providing services intended to result in
the sale of Fund shares or for shareholder servicing activities.
MERCURY LOW DURATION FUND 17
<PAGE> 216
[CHECKMARK ICON] Account Choices
To better understand the pricing of each class of the Fund's shares, we have
summarized the information below:
<TABLE>
<CAPTION>
CLASS I* CLASS A* CLASS B
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Availability LIMITED TO CERTAIN GENERALLY AVAILABLE GENERALLY AVAILABLE
INVESTORS INCLUDING: THROUGH SELECTED THROUGH SELECTED
- Investor Class and SECURITIES DEALERS AND SECURITIES DEALERS AND
current Class I OTHER FINANCIAL OTHER FINANCIAL
shareholders. INTERMEDIARIES. INTERMEDIARIES.
- Certain retirement DISTRIBUTOR CLASS
plans. SHAREHOLDERS.
- Participants in
certain sponsored
programs.
- Certain affiliates or
customers of selected
securities dealers and
other financial
intermediaries.
---------------------------------------------------------------------------------------------------------------
Initial Sales Charge? YES. PAYABLE AT TIME OF YES. PAYABLE AT TIME OF NO. ENTIRE PURCHASE
PURCHASE. LOWER SALES PURCHASE. LOWER SALES PRICE IS INVESTED IN
CHARGES AVAILABLE FOR CHARGES AVAILABLE FOR SHARES OF THE FUND.
LARGER INVESTMENTS. LARGER INVESTMENTS.
---------------------------------------------------------------------------------------------------------------
Deferred Sales NO. (MAY BE CHARGED FOR NO. (MAY BE CHARGED FOR YES. PAYABLE IF YOU
Charge? PURCHASES OVER $1 PURCHASES OVER $1 REDEEM WITHIN FOUR YEARS
MILLION THAT ARE MILLION THAT ARE OF PURCHASE.
REDEEMED WITHIN ONE REDEEMED WITHIN ONE
YEAR.) YEAR.)
---------------------------------------------------------------------------------------------------------------
Account Maintenance NO. % ACCOUNT MAINTENANCE % ACCOUNT MAINTENANCE
and Distribution FEE NO DISTRIBUTION FEE. FEE % DISTRIBUTION
Fees? FEE.
---------------------------------------------------------------------------------------------------------------
Conversion to Class A NO. NO. YES, AUTOMATICALLY AFTER
shares? APPROXIMATELY TEN YEARS.
---------------------------------------------------------------------------------------------------------------
<CAPTION>
CLASS C
<S> <C>
Availability GENERALLY AVAILABLE
THROUGH SELECTED
SECURITIES DEALERS AND
OTHER FINANCIAL
INTERMEDIARIES.
------------------------------------------------------------------------
Initial Sales Charge? NO. ENTIRE PURCHASE
PRICE IS INVESTED IN
SHARES OF THE FUND.
-------------------------------------------------------------------------------------------------
Deferred Sales YES. PAYABLE IF YOU
Charge? REDEEM WITHIN ONE YEAR
OF PURCHASE.
---------------------------------------------------------------------------------------------------------------
Account Maintenance % ACCOUNT MAINTENANCE
and Distribution FEE % DISTRIBUTION
Fees? FEE.
---------------------------------------------------------------------------------------------------------------
Conversion to Class A NO.
shares?
---------------------------------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I shares
and Distributor Class shares were redesignated Class A shares.
18 MERCURY LOW DURATION FUND
<PAGE> 217
[CHECKMARK ICON] Account Choices
RIGHT OF ACCUMULATION -- permits you to pay the sales charge applicable to the
cost or value (whichever is higher) of all shares you own in the Mercury mutual
funds.
LETTER OF INTENT -- permits you to pay the sales charge that would be applicable
if you add up all shares of Mercury mutual funds that you agree to buy within a
13 month period. Certain restrictions apply.
CLASS I AND A SHARES* -- INITIAL SALES CHARGE OPTIONS
If you select Class I or A shares, you will pay a sales charge at the time of
purchase as shown in the following table. Securities dealers' compensation will
be as shown in the last column.
<TABLE>
<CAPTION>
DEALER
AS A % OF COMPENSATION
AS A % OF YOUR AS A % OF
YOUR INVESTMENT OFFERING PRICE INVESTMENT** OFFERING PRICE
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
LESS THAN $25,000 % % %
---------------------------------------------------------------------------------------
$25,000 BUT LESS THAN
$50,000 % % %
---------------------------------------------------------------------------------------
$50,000 BUT LESS THAN
$100,000 % % %
---------------------------------------------------------------------------------------
$100,000 BUT LESS THAN
$250,000 % % %
---------------------------------------------------------------------------------------
$250,000 BUT LESS THAN
$1,000,000 % % %
---------------------------------------------------------------------------------------
$1,000,000 AND OVER*** % % %
---------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares and Distributor Class shares were redesignated Class A shares.
** Rounded to the nearest one-hundredth percent.
*** If you invest $1,000,000 or more in Class I or A shares, you may not pay an
initial sales charge. In that case, the Investment Adviser compensates the
selling dealer or other financial intermediary from its own resources. If
you redeem your shares within one year after purchase, you may be charged a
deferred sales charge. This charge is % of the lesser of the original cost
of the shares being redeemed or your redemption proceeds. A sales charge of
% will be charged on purchases of $1,000,000 or more of Class I and A
shares by certain employer sponsored retirement or savings plans.
No initial sales charge applies to Class I or Class A shares that you buy
through reinvestment of dividends.
A reduced or waived sales charge on a purchase of Class I or A shares may apply
for:
- Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT
- Certain trusts managed by banks, thrifts or trust companies
including those affiliated with the Investment Adviser or its
affiliates
- Certain employer-sponsored retirement or savings plans
- Certain investors, including directors or trustees of mutual funds
sponsored by the Investment Adviser or its affiliates, employees
MERCURY LOW DURATION FUND 19
<PAGE> 218
[CHECKMARK ICON] Account Choices
of the Investment Adviser and its affiliates and employees or
customers of selected securities dealers
- Certain fee-based programs managed by the Investment Adviser or
its affiliates
- Certain fee-based programs managed by selected securities dealers
that have an agreement with the Distributor
- Purchases through certain financial advisers, selected securities
dealers, brokers, investment advisers, service providers and other
financial intermediaries
- Purchases through certain accounts over which the Investment
Adviser or an affiliate exercises investment discretion
Only certain investors are eligible to buy Class I shares, including former
Investor Class shareholders of the Fund, existing Class I shareholders of the
Fund, certain retirement plans and participants in certain programs sponsored by
the Investment Adviser or its affiliates. Your financial consultant, selected
securities dealer or other financial intermediary can help you determine whether
you are eligible to buy Class I shares or to participate in any of these
programs.
If you decide to buy shares under the initial sales charge alternative and you
are eligible to buy both Class I and Class A shares, you should buy Class I
since Class A shares are subject to a % account maintenance fee, while Class
I shares are not.
If you redeem Class I or Class A shares and within 30 days buy new shares of the
same class, you will not pay a sales charge on the new purchase amount. The
amount eligible for this "Reinstatement Privilege" may not exceed the amount of
your redemption proceeds. To exercise the privilege, contact your financial
consultant, selected securities dealer, other financial intermediary or the
Fund's Transfer Agent at 1-800-236-4479.
CLASS B AND C SHARES -- DEFERRED SALES CHARGE OPTIONS
If you select Class B or Class C shares, you do not pay an initial sales charge
at the time of purchase. However, if you redeem your Class B shares within four
years after purchase or Class C shares within one year after purchase, you may
be required to pay a deferred sales charge. You will also pay distribution fees
of % for Class B shares or % for Class C shares and account maintenance fees
of % each year under a distribution plan that the Fund has adopted under Rule
12b-1. Because these fees are paid out of the Fund's assets on an ongoing basis,
over time these fees increase the cost of your investment and may cost you more
than paying an initial sales charge. The Distributor uses the
20
MERCURY LOW DURATION FUND
<PAGE> 219
[CHECKMARK ICON] Account Choices
money that it receives from the deferred sales charge and the distribution fees
to cover the costs of marketing, advertising and compensating the financial
consultant, selected securities dealer or other financial intermediary who
assists you in purchasing Fund shares.
CLASS B SHARES
If you redeem Class B shares within four years after purchase, you may be
charged a deferred sales charge. The amount of the charge gradually decreases as
you hold your shares over time, according to the following schedule:
<TABLE>
<CAPTION>
YEAR SINCE PURCHASE SALES CHARGE*
------------------------------------------
<S> <C>
0 - 1
------------------------------------------
1 - 2
------------------------------------------
2 - 3
------------------------------------------
3 - 4
------------------------------------------
4 AND THEREAFTER
------------------------------------------
</TABLE>
* The percentage charge will apply to the lesser of the original cost of the
shares being redeemed or the proceeds of your redemption. Shares acquired
through reinvestment of dividends are not subject to a deferred sales charge.
Not all Mercury funds have identical deferred sales charge schedules. If you
exchange your shares for shares of another Mercury fund, the higher charge
will apply, if any would apply.
The deferred sales charge relating to Class B shares may be reduced or waived in
certain circumstances, such as:
- Certain post-retirement withdrawals from an IRA or other
retirement plan if you are over 59 1/2 years old
- Redemption by certain eligible 401(a) and 401(k) plans and certain
retirement plan rollovers
- Redemption in connection with participation in certain fee-based
programs managed by the Investment Adviser or its affiliates
- Redemption in connection with participation in certain fee-based
programs managed by selected securities dealers or other financial
intermediaries that have agreements with the Distributor or its
affiliates
- Withdrawals resulting from shareholder death or disability as long
as the waiver request is made within one year after death or
disability or, if later, reasonably promptly following completion
of probate, or in connection with involuntary termination of an
account in which Fund shares are held
MERCURY LOW DURATION FUND 21
<PAGE> 220
[CHECKMARK ICON] Account Choices
- Withdrawal through the Systematic Withdrawal Plan of up to 10% per
year of your Class B account value at the time the plan is
established
Your Class B shares convert automatically into Class A shares approximately ten
years after purchase. Any Class B shares received through reinvestment of
dividends paid on converting shares will also convert at that time. Class A
shares are subject to lower annual expenses than Class B shares. The conversion
of Class B shares to Class A shares is not a taxable event for Federal income
tax purposes.
Different conversion schedules may apply to Class B shares of different Mercury
mutual funds. If you acquire your Class B shares in an exchange from another
fund with a longer conversion schedule, the other fund's conversion schedule
will apply. If you exchange your Class B shares in the Fund for Class B shares
of a fund with a longer conversion schedule, the other fund's conversion
schedule will apply. The length of time that you hold both the original and
exchanged Class B shares in both funds will count toward the conversion
schedule. The conversion schedule may be modified in certain other cases as
well.
CLASS C SHARES
If you redeem Class C shares within one year after purchase, you may be charged
a deferred sales charge of %. The charge will apply to the lesser of the
original cost of the shares being redeemed or the proceeds of your redemption.
You will not be charged a deferred sales charge when you redeem shares that you
acquire through reinvestment of Fund dividends. The deferred sales charge
relating to Class C shares may be reduced or waived in connection with
involuntary termination of an account in which Fund shares are held and
withdrawals through the Systematic Withdrawal Plan.
Class C shares do not offer a conversion privilege.
22
MERCURY LOW DURATION FUND
<PAGE> 221
[CHECKMARK ICON] Account Choices
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
--------------------------------------------------------------------------------
The chart below summarizes how to buy, sell, transfer and exchange shares
through your financial consultant, selected securities dealer, broker,
investment adviser, service provider or other financial intermediary. You may
also buy shares through the Transfer Agent. To learn more about buying shares
through the Transfer Agent, call 1-800-236-4479. Because the selection of a
mutual fund involves many considerations, your financial consultant, selected
securities dealer or other financial intermediary may help you with this
decision. The Fund does not issue share certificates.
Because of the high cost of maintaining smaller shareholder accounts, the Fund
may redeem the shares in your account (without charging any deferred sales
charge) if the net asset value of your account falls below $500 due to
redemptions you have made. You will be notified that the value of your account
is less than $500 before the Fund makes an involuntary redemption. You will then
have 60 days to make an additional investment to bring the value of your account
to at least $500 before the Fund takes any action. This involuntary redemption
does not apply to retirement plans or Uniform Gifts or Transfers to Minors Act
accounts.
MERCURY LOW DURATION FUND 23
<PAGE> 222
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BUY SHARES First, select the share class Refer to the pricing of shares table on page 18. Be sure to
appropriate for you read this prospectus carefully.
-------------------------------------------------------------------------------------------------
Next, determine the amount of The minimum initial investment for the Fund is $1,000 for
your investment all accounts except: - $500 for certain fee-based programs
- $100 for retirement plans (The minimums for initial
investments may be waived under certain circumstances.)
-------------------------------------------------------------------------------------------------
Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. Purchase orders
other financial intermediary placed prior to the close of regular trading on the New York
submit your purchase order Stock Exchange (generally, 4:00 p.m. Eastern time) are
priced at the net asset value determined that day. Certain
financial intermediaries, however, may require submission of
orders prior to that time.
Purchase orders placed after that time are priced at the net
asset value determined on the next business day. The Fund
may reject any order to buy shares and may suspend the sale
of shares at any time. Certain financial intermediaries may
charge a fee to process a purchase. For example, Merrill
Lynch, Pierce, Fenner & Smith Incorporated currently charges
a $5.35 processing fee. The fees charged by other financial
intermediaries may be higher or lower.
-------------------------------------------------------------------------------------------------
Or contact the Transfer Agent To purchase shares directly, call the Transfer Agent at
1-800-236-4479 and request a purchase application. Mail the
completed purchase application to the Transfer Agent at the
address on the back cover of this prospectus.
------------------------------------------------------------------------------------------------------------------------
ADD TO YOUR Purchase additional shares The minimum investment for additional purchases is generally
INVESTMENT $100 for all accounts except: - $50 for certain fee-based
programs - $1 for retirement plans (The minimums for
additional purchases may be waived under certain
circumstances.)
-------------------------------------------------------------------------------------------------
Acquire additional shares All dividends are automatically reinvested without a sales
through the automatic dividend charge.
reinvestment plan
-------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan your selected securities dealer or other financial
intermediary. The current minimum for such automatic
reinvestments is $100. The minimum may be waived or revised
under certain circumstances.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
24 MERCURY LOW DURATION FUND
<PAGE> 223
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
TRANSFER SHARES TO Transfer to a participating You may transfer your Fund shares to another selected
ANOTHER SECURITIES securities dealer or other securities dealer or other financial intermediary if
DEALER OR OTHER financial intermediary authorized dealer agreements are in place between the
FINANCIAL Distributor and the transferring intermediary and the
INTERMEDIARY Distributor and the receiving intermediary. Certain
shareholder services may not be available for all
transferred shares. You may only purchase additional shares
of funds previously owned before the transfer. All future
trading of these shares must be coordinated by the receiving
financial intermediary.
-------------------------------------------------------------------------------------------------
Transfer to a non-participating You must either: - Transfer your shares to an account with
securities dealer or other the Transfer Agent; or - Sell your shares, paying any
financial intermediary applicable deferred sales charge.
------------------------------------------------------------------------------------------------------------------------
SELL YOUR SHARES Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. For your
other financial intermediary redemption request to be priced at the net asset value on
submit your sales order the day of your request, you must submit your request to
your selected securities dealer or other financial
intermediary prior to that day's close of regular trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern
time). Certain financial intermediaries, however, may
require submission of orders prior to that time. Redemption
requests placed after that time are priced at the net asset
value at the close of regular trading on the next business
day.
Certain financial intermediaries may charge a fee to process
a sale of shares. For example, Merrill Lynch, Pierce, Fenner
& Smith Incorporated currently charges a $5.35 processing
fee. No processing fee is charged if you redeem the shares
directly through the Transfer Agent. The fees charged by
other financial intermediaries may be higher or lower.
The Fund may reject an order to sell shares under certain
circumstances.
-------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by writing to
the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter. A signature guarantee will generally be
required but may be waived in certain limited circumstances.
You can obtain a signature guarantee from a bank, securities
dealer, securities broker, credit union, savings
association, national securities exchange and registered
securities association. A notary public seal will not be
acceptable. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY LOW DURATION FUND 25
<PAGE> 224
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SELL SHARES Participate in the Fund's You can choose to receive systematic payments from your Fund
SYSTEMATICALLY Systematic Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. You can
generally arrange through your selected securities dealer or
other financial intermediary for systematic sales of shares
of a fixed dollar amount on a monthly, bi-monthly,
quarterly, semi-annual or annual basis, subject to certain
conditions. Under either method, you must have dividends
automatically reinvested.
For Class B and C shares, your total annual withdrawals
cannot be more than 10% per year of the value of your shares
at the time your plan is established. The deferred sales
charge is waived for systematic redemptions. Ask your
financial intermediary for details.
------------------------------------------------------------------------------------------------------------------------
EXCHANGE YOUR Select the fund into which you You can exchange your shares of the Fund for shares of other
SHARES want to exchange. Be sure to Mercury mutual funds or for shares of the Summit Cash
read that fund's prospectus Reserves Fund. You must have held the shares used in the
exchange for at least 15 calendar days before you can
exchange to another fund.
Each class of Fund shares is generally exchangeable for
shares of the same class of another Mercury fund. If you own
Class I shares and wish to exchange into a fund in which you
have no Class I shares (and are not eligible to buy Class I
shares), you will exchange into Class A shares. If you own
Class I or Class A shares and wish to exchange into Summit,
you will exchange into Class A shares of Summit. Class B or
Class C shares can be exchanged for Class B shares of
Summit.
Some of the Mercury mutual funds may impose a different
initial or deferred sales charge schedule. If you exchange
Class I or A shares for shares of a fund with a higher
initial sales charge than you originally paid, you may be
charged the difference at the time of exchange. If you
exchange Class B or Class C shares for shares of a fund with
a different deferred sales charge schedule, the higher
schedule will apply. The time you hold Class B or C shares
in both funds will count when determining your holding
period for calculating a deferred sales charge at redemp-
tion. Your time in both funds will also count when
determining the holding period for a conversion from Class B
to Class A shares.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
26 MERCURY LOW DURATION FUND
<PAGE> 225
[CHECKMARK ICON] Account Choices
NET ASSET VALUE -- the market value in U.S. dollars of the Fund's total assets
after deducting liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
--------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open as of the close of regular trading on the Exchange based on
prices at the time of closing. Regular trading on the Exchange generally closes
at 4:00 p.m. Eastern time. The net asset value used in determining your price is
the next one calculated after your purchase or redemption order is placed.
Foreign securities owned by the Fund may trade on weekends or other days when
the Fund does not price its shares. As a result, the Fund's net asset value may
change on days when you will not be able to purchase or redeem the Fund's
shares.
The Fund may accept orders from certain authorized financial intermediaries or
their designees. The Fund will be deemed to receive an order when accepted by
the intermediary or designee and the order will receive the net asset value next
computed by the Fund after such acceptance. If the payment for a purchase order
is not made by a designated later time, the order will be canceled and the
financial intermediary could be held liable for any losses.
Generally, Class I shares will have the highest net asset value because that
class has the lowest expenses, and Class A shares will have a higher net asset
value than Class B or Class C shares. Also dividends paid on Class I and Class A
shares will generally be higher than dividends paid on Class B and Class C
shares because Class I and Class A shares have lower expenses.
FEE-BASED PROGRAMS
--------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by the Investment
Adviser or an affiliate of the Investment Adviser, or by selected securities
dealers or other financial intermediaries that have an agreement with the
Distributor, you may be able to buy Class I shares at net asset value, including
by exchanges from other share classes. Sales charges on the shares being
exchanged may be reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
MERCURY LOW DURATION FUND 27
<PAGE> 226
[CHECKMARK ICON] Account Choices
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed ordinary income or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
If you leave one of these programs, your shares may be redeemed or automatically
exchanged into another class of the Fund's shares or into the Summit fund. The
class you receive may be the class you originally owned when you entered the
program, or in certain cases, a different class. If the exchange is into Class B
shares, the period before conversion to Class A shares may be modified. Any
redemption or exchange will be at net asset value. However, if you participate
in the program for less than a specified period, you may be charged a fee in
accordance with the terms of the program.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your financial
consultant, selected securities dealer or other financial intermediary.
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
The Fund will distribute any net investment income monthly and any net realized
long-term or short-term capital gains at least annually. The Fund may also pay a
special distribution at the end of the calendar year to comply with Federal tax
requirements. DIVIDENDS may be reinvested automatically in shares of the Fund at
net asset value without a sales charge or may be taken in cash. If your account
is with a securities dealer or other financial intermediary that has an
agreement with the Fund, contact your dealer or intermediary about which option
you would like. If your account is with the Transfer Agent and you would like to
receive dividends in cash, contact the Transfer Agent. The Fund anticipates that
the majority of its dividends, if any, will consist of ordinary income. Capital
gains, if any, may be taxable to you at different rates, depending, in part, on
how long the Fund has held the assets sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your shares and any
gain on the transaction may be subject to tax. Capital gain dividends are
generally taxed at different rates than ordinary income dividends.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax treaties between certain countries
and the U.S. may reduce or eliminate such taxes.
28
MERCURY LOW DURATION FUND
<PAGE> 227
[CHECKMARK ICON] Account Choices
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
By law, the Fund must withhold 31% of your dividends and redemption proceeds if
you have not provided a taxpayer identification number or social security number
or if the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
MERCURY LOW DURATION FUND 29
<PAGE> 228
[MANAGEMENT TEAM ICON] The Management Team
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
Mercury Advisors' the Fund's Investment Adviser, manages the Fund's investments
under the overall supervision of the Board of Trustees of the Trust. The
Investment Adviser has the responsibility for making all investment decisions
for the Fund. The Trust pays the Investment Adviser a fee at the annual rate of
0.21% of the average daily net assets of the Low Duration Portfolio of the
Trust. The Fund pays the Investment Adviser an administrative fee at the annual
rate of 0.25% of the average daily net assets of the Fund.
The Investment Adviser was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
The Investment Adviser and its affiliates had approximately $558 billion in
investment company and other portfolio assets under management as of June 30,
2000.
For the fiscal year ended June 30, 2000, the Fund paid to the Investment Adviser
fees for advisory and administrative services of 0.46% of the Fund's average net
assets. Although not required to do so, the Investment Adviser has agreed to
make reimbursements so that the regular annual operating expenses of the Fund
will be limited as shown in the table on page 5. The Investment Adviser has
agreed to these expense limits through June 2001, and will thereafter give
shareholders at least 30 days' notice if this reimbursement policy will change.
Prior to the date of this prospectus, the Investment Adviser provided portfolio
management directly to the Fund.
The Investment Adviser is allowed to allocate brokerage based on sales of shares
of funds managed by the Investment Adviser.
MASTER/FEEDER STRUCTURE
--------------------------------------------------------------------------------
Unlike many other mutual funds, which directly buy and manage their own
portfolio securities, the Fund seeks to achieve its investment objective by
investing all its assets in the corresponding Low Duration Master Portfolio of
the Trust. Investors in the Fund will acquire an indirect interest in the
underlying Portfolio.
Other "feeder" funds may also invest in the "master" Portfolio. This structure
may enable the Fund to reduce costs through economies of scale. A larger
30
MERCURY LOW DURATION FUND
<PAGE> 229
[MANAGEMENT TEAM ICON] The Management Team
investment portfolio may also reduce certain transaction costs to the extent
that contributions to and redemptions from the master from different feeders may
offset each other and produce a lower net cash flow.
The Fund may withdraw from the Low Duration Master Portfolio at any time and may
invest all of its assets in another pooled investment vehicle or retain an
investment adviser to manage the Fund's assets directly.
Smaller feeder funds may be harmed by the actions of larger feeder funds. For
example, a larger feeder fund could have more voting power than the Fund over
the operations of the Low Duration Master Portfolio.
Whenever the Low Duration Master Portfolio holds a vote of its feeder funds, the
Fund will pass the vote through to its own shareholders.
MERCURY LOW DURATION FUND 31
<PAGE> 230
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned on an investment in the
Fund (assuming reinvestment of all dividends and distributions). These financial
highlights were audited by PricewaterhouseCoopers LLP. The accountants' report
and the Fund's financial statements are included in the Fund's annual report,
which is available upon request. Further performance information is contained in
the annual report.
<TABLE>
<CAPTION>
CLASS A(1)
CLASS I(1) --------------
------------------------------------------------------------------- FOR THE YEAR
FOR THE YEAR ENDED JUNE 30, ENDED JUNE 30,
INCREASE (DECREASE) IN ------------------------------------------------------------------- --------------
NET ASSET VALUE: 2000 1999 1998 1997 1996 2000(2)
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $ 10.20 $ 10.23 $ 10.12 $ 10.15
---------------------------------------------------------------------------------------------------------------------------------
Investment income -- net 0.60 0.66 0.66 0.68
---------------------------------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss) on
investments -- net (0.28) 0.05 0.10 0.06
---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations 0.32 0.71 0.76 0.74
---------------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions
Investment income -- net (0.59) (0.68) (0.64) (0.72)
---------------------------------------------------------------------------------------------------------------------------------
Realized gain on investments -- net (0.02) (0.06) (0.01) (0.05)
---------------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions (0.61) (0.74) (0.65) (0.77)
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $ 9.91 $ 10.20 $ 10.23 $ 10.12
---------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
---------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share 3.15% 7.19% 7.79% 7.47%
---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
---------------------------------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement 0.58% 0.58% 0.58% 0.58%
---------------------------------------------------------------------------------------------------------------------------------
Expenses 0.64% 0.65% 0.66% 0.60%
---------------------------------------------------------------------------------------------------------------------------------
Investment income -- net 5.71% 6.46% 6.34% 7.09%
---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
---------------------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in millions) $410.00 $253.20 $171.20 $189.20
---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover 201% 119% 202% 50%
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) As of October , 2000, Investor Class shares were redesignated Class I
shares and Distributor Class shares were redesignated Class A shares.
No sales loads were charged prior to this time.
(2) The Class commenced operations on September 24, 1999.
* Total investment return excludes the effects of sales charges.
(+) Annualized.
(++) Not annualized.
32 MERCURY LOW DURATION FUND
<PAGE> 231
<TABLE>
<S> <C>
FUND
Mercury Low Duration Fund
of Mercury HW Funds
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(800-236-4479)
INVESTMENT ADVISER
Administrative Offices:
Mercury Advisors
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 41621
Jacksonville, Florida 32232-1621
(800-236-4479)
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
100 E. Wisconsin Ave., Suite 1500
Milwaukee, Wisconsin 53202
DISTRIBUTOR
FAM Distributors, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109-3661
COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610-4795
</TABLE>
<PAGE> 232
SHAREHOLDER REPORTS
Additional information about the Fund's investments will be available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report you will find a discussion of the relevant market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling
1-800-236-4479.
The Fund will send you one copy of each shareholder report and certain other
mailings regardless of the number of Fund accounts you have. To receive separate
shareholder reports for each account, call your financial consultant or other
financial intermediary or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and brokerage or mutual
fund account number. If you have any questions, please call your financial
consultant or other financial intermediary or the Transfer Agent at
1-800-236-4479.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at Financial Data Services, Inc., P.O. Box 41621, Jacksonville, Florida
32232-1621 or by calling 1-800-236-4479.
Contact your financial consultant or other financial intermediary or the Fund at
the telephone number or address indicated on the inside back cover of this
prospectus if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet Site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION IN THIS PROSPECTUS.
Investment Company Act File #811-4182.
CODE #MHW-1070-1000
(C) Mercury Advisors
[TELEPHONE ICON] To Learn More
Mercury Low
Duration Fund
OF MERCURY HW FUNDS
PROSPECTUS - October , 2000
<PAGE> 233
Mercury Short-Term Investment Fund
OF MERCURY HW FUNDS
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING INFORMATION
ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST
AND KEEP IT FOR FUTURE REFERENCE.
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.
PROSPECTUS - October , 2000
<PAGE> 234
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
[GLOBE ICON]
FUND FACTS
-----------------------------------------------------------------
About the Mercury Short-Term Investment Fund................ 2
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[MAGNIFYING GLASS ICON]
ABOUT THE DETAILS
-----------------------------------------------------------------
How the Fund Invests........................................ 7
Investment Risks............................................ 9
Statement of Additional Information......................... 15
[CHECKMARK ICON]
ACCOUNT CHOICES
-----------------------------------------------------------------
Pricing of Shares........................................... 16
How to Buy, Sell, Transfer and Exchange Shares.............. 18
How Shares are Priced....................................... 22
Fee-Based Programs.......................................... 22
Dividends and Taxes......................................... 23
[MANAGEMENT TEAM ICON]
THE MANAGEMENT TEAM
-----------------------------------------------------------------
Management of the Fund...................................... 25
Financial Highlights........................................ 26
[TELEPHONE ICON]
TO LEARN MORE
-----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 235
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
U.S. GOVERNMENT SECURITIES -- include direct obligations issued by the U.S.
Treasury and securities issued or guaranteed by U.S. government agencies and
instrumentalities.
CORPORATE BONDS -- bonds issued by corporations, as distinct from bonds issued
by a government or its agencies or instrumentalities.
ASSET-BACKED SECURITIES -- bonds backed by loan paper or accounts receivable
originated by banks, credit card companies, or other providers of credit.
MORTGAGE-BACKED SECURITIES -- securities that give the holder the right to
receive a portion of principal and/or interest payments made on a pool of
residential or commercial mortgage loans, which in some cases are guaranteed by
government agencies.
DURATION -- a measure of how much the price of a bond would change compared to a
change in market interest rates
PREPAYMENT RISK -- the risk that certain obligations will be paid off by the
obligor more quickly than anticipated and the value of these securities will
fall.
EXTENSION RISK -- the risk that certain obligations will be paid off more slowly
by the obligor than anticipated and the value of these securities will fall.
VOLATILITY -- the amount and frequency of changes in a security's value.
"JUNK" BOND -- bond with a credit rating of BB/Ba or lower by rating agencies.
[GLOBE ICON] Fund Facts
ABOUT THE MERCURY SHORT-TERM INVESTMENT FUND
--------------------------------------------------------------------------------
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to maximize total return, consistent with
capital preservation.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests in a diversified portfolio of bonds of different maturities,
including U.S. GOVERNMENT SECURITIES, CORPORATE BONDS, ASSET-BACKED SECURITIES
and MORTGAGE-BACKED SECURITIES. At least 70% of its investments will be in
securities rated A or better. Up to 30% of its investments may be in securities
rated BBB/Baa and up to 10% of its investments may be in securities rated below
investment grade (none below B). The Fund's DURATION will generally not exceed
one year.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of Fund shares, may go up or down. These changes may occur in response to
interest rate changes or other factors that may affect a particular issuer or
obligation. Generally, when interest rates go up, the value of bonds goes down.
The value of the Fund's shares also may be affected by market conditions and
economic or political developments. The longer the duration of the Fund, the
more the Fund's price will go down if interest rates go up. If the value of the
Fund's investments goes down, you may lose money.
The Fund invests in mortgage-backed and asset-backed securities. In addition to
normal bond risks, these securities are subject to PREPAYMENT RISK and EXTENSION
RISK, and may involve more VOLATILITY than other bonds of similar maturities.
The Fund also may invest in "JUNK" BONDS, which have more credit risk and tend
to be less liquid than higher-rated securities.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency. The
Fund is not a money market fund.
See "Investment Risks" for more information about the risks associated with the
Fund.
2
MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 236
[GLOBE ICON] Fund Facts
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are you looking for an investment that provides income.
- Want a professionally managed and diversified portfolio.
- Are willing to accept the risk that the value of your investment
may decline as the result of interest rate movements in order to
seek high current return.
- Are prepared to receive taxable distributions.
MERCURY SHORT-TERM INVESTMENT FUND 3
<PAGE> 237
[GLOBE ICON] Fund Facts
RISK/RETURN BAR CHART
--------------------------------------------------------------------------------
The bar charts and tables below provide some indication of the risks of
investing in the Fund by showing changes in the year to year performance of the
Fund and by showing how the Fund's average annual total returns for 1 and 5
years and for its life compare with those of a broad measure of market
performance. How the Fund has performed in the past is not necessarily an
indication of how the Fund will perform in the future.
<TABLE>
<CAPTION>
<S> <C>
1994 4.42%
1995 7.83%
1996 6.17%
1997 6.18%
1998 5.77%
1999 4.67%
</TABLE>
Total return for the six months ended June 30, 2000: 2.18%.
During the period shown in the bar chart, the highest return for a quarter was
2.23% (quarter ended March 31, 1995) and the lowest return for a quarter was
0.71% (quarter ended December 31, 1998).
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS PAST PAST SINCE
(FOR THE PERIODS ENDED DECEMBER 31, 1999) ONE YEAR FIVE YEARS INCEPTION
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
CLASS I*+ 4.67% 6.12% 6.06%(1)
Merrill Lynch 6 Month U.S. Treasury Bill Index 4.64% 5.53% 5.06%
---------------------------------------------------------------------------------------
</TABLE>
The Merrill Lynch 6 month U.S. Treasury Bill Index is an unmanaged Index
comprised of U.S. Treasury bills with maturities of six months which are
guaranteed as to the timely payment of principal and interest by the U.S.
government. The Fund invests in securities that are not reflected in the Index
or guaranteed.
* Includes the effect of sales charges, which were not imposed until October
, 2000.
+ As of October , 2000, Investor Class shares were redesignated Class I
shares.
(1) Inception date is May 18, 1993.
4
MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 238
[GLOBE ICON] Fund Facts
UNDERSTANDING EXPENSES
Fund investors pay various expenses, either directly or indirectly. Listed below
are some of the main types of expenses, which all mutual funds may charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
INVESTMENT ADVISORY FEE -- a fee paid to the Investment Adviser for managing the
Fund.
FEES AND EXPENSES
--------------------------------------------------------------------------------
The Fund offers a single class of shares.
THIS TABLE SHOWS THE DIFFERENT FEES AND EXPENSES THAT YOU MAY PAY IF YOU BUY AND
HOLD SHARES OF THE FUND. FUTURE EXPENSES MAY BE GREATER OR LESS THAN THOSE
INDICATED BELOW.
<TABLE>
<CAPTION>
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)(a): CLASS I*
------------------------------------------------------------------------
<S> <C>
Maximum Sales Charge (Load) imposed on purchases (as a
percentage of offering price) 2.00%(b)
------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a percentage of
original purchase price or redemption proceeds, whichever is
lower) None(c)
------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend Reinvestments None
------------------------------------------------------------------------
Redemption Fee None
------------------------------------------------------------------------
Exchange Fee None
------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED
FROM THE FUND'S TOTAL ASSETS):
------------------------------------------------------------------------
INVESTMENT ADVISORY FEE(d) 0.40%
------------------------------------------------------------------------
DISTRIBUTION AND/OR SERVICE (12b-1) FEES None
------------------------------------------------------------------------
Other Expenses (including transfer agency fees) 0.33%
------------------------------------------------------------------------
TOTAL ANNUAL OPERATING EXPENSES 0.73%
------------------------------------------------------------------------
Expense Reimbursement(d) 0.25%
------------------------------------------------------------------------
NET ANNUAL FUND OPERATING EXPENSES 0.48%
------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C>
() * As of October , 2000, Investor Class shares were
redesignated Class I shares.
(a) Certain securities dealers or other financial intermediaries
may charge a fee to process a purchase or sale of shares.
See "How to Buy, Sell, Transfer and Exchange Shares."
(b) Some investors may qualify for reductions in the sales
charge (load).
(c) You may pay a deferred sales charge if you purchase $1
million or more and you redeem within one year.
(d) The Investment Adviser has contractually agreed to waive
management fees and/or reimburse expenses through June 30,
2001, as shown in the table.
</TABLE>
MERCURY SHORT-TERM INVESTMENT FUND 5
<PAGE> 239
[GLOBE ICON] Fund Facts
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, and that the Fund's operating expenses remain the same except for
the expense reimbursement in effect for the first year. This assumption is not
meant to indicate you will receive a 5% annual rate of return. Your annual
return may be more or less than the 5% used in these examples. Although your
actual costs may be higher or lower, based on these assumptions, your costs
would be:
<TABLE>
<CAPTION>
CLASS I
-------------------------------------------------------------------------------
<S> <C>
ONE YEAR $ 248
-------------------------------------------------------------------------------
THREE YEARS $ 404
-------------------------------------------------------------------------------
FIVE YEARS $ 574
-------------------------------------------------------------------------------
TEN YEARS $1,065
-------------------------------------------------------------------------------
</TABLE>
6
MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 240
ABOUT THE PORTFOLIO MANAGERS -- Michael Sanchez has been a co-Portfolio Manager
of the Fund since joining the Investment Adviser in 1996. Before joining the
Investment Adviser, Mr. Sanchez was with Provident Investment Counsel as senior
vice president and portfolio manager from 1991 to 1995 and with ARCO Investment
Management Company as Director of Fixed Income Investments from 1988 to 1991.
John Queen has been a co-Portfolio Manager of the Fund since 1997. Prior to
joining the Investment Adviser in 1997, Mr. Queen was associated with The
Capital Group as a member of an analyst team responsible for $8 billion in
fixed-income assets.
ABOUT THE INVESTMENT ADVISER -- The Fund is managed by Mercury Advisors.
[MAGNIFYING GLASS ICON] About the Details
HOW THE FUND INVESTS
--------------------------------------------------------------------------------
The Fund's investment objective is to maximize total return consistent with
capital preservation. The Fund invests in bonds and seeks to maintain a
portfolio duration that will generally not exceed one year. The Fund also seeks
to maintain a dollar-weighted average portfolio maturity that will generally not
exceed three years, based on the effective maturity of the Fund's securities.
TYPES OF INVESTMENTS
The Fund seeks to achieve its objective by investing mainly in investment grade,
interest-bearing securities of varying maturities. These include:
- U.S. Government securities
- preferred stocks
- mortgage-backed and other asset-backed securities
- corporate bonds
- bonds that are convertible into stocks
- bank certificates of deposit, fixed time deposits and bankers'
acceptances
- repurchase agreements, reverse repurchase agreements and dollar
rolls
- obligations of foreign governments or their subdivisions, agencies
and instrumentalities
- obligations of international agencies or supra-national entities
- municipal bonds
RATINGS LIMITATIONS
- at least 70% of total assets rated at least A or, if short-term,
the second highest quality grade, by a major rating agency
- up to 30% of total assets rated Baa by Moody's or BBB by S&P
- up to 10% of total assets rated below investment grade, but none
below B
The Investment Adviser can invest in unrated securities and will assign them the
rating of a rated security of comparable quality. After the Fund buys a
security, it may be given a lower rating or stop being rated. This will not
require the Fund to sell it, but the Investment Adviser will consider the change
in rating in deciding whether to keep the security.
MATURITY AND DURATION REQUIREMENTS
Maturity. The EFFECTIVE MATURITY of a bond is the weighted average period over
which principal is expected to be repaid. STATED MATURITY is the date
MERCURY SHORT-TERM INVESTMENT FUND 7
<PAGE> 241
[MAGNIFYING GLASS ICON] About the Details
when the issuer is scheduled to make the final payment of principal. Effective
maturity is different than stated maturity because it estimates the effect of
expected principal prepayments and call provisions.
Duration. Duration measures the potential volatility of the price of a bond or
a portfolio of bonds prior to maturity. Duration is the magnitude of the change
in price of a bond relative to a given change in the market interest rate.
Duration incorporates a bond's yield, coupon interest payments, final maturity,
call and put features and prepayment exposure into one measure.
For any bond with interest payments occurring before principal is repaid,
duration is ordinarily less than maturity. Generally, the lower the stated or
coupon rate of interest of a bond, the longer the duration. The higher the
stated or coupon rate of interest of a bond, the shorter the duration. The
calculation of duration is based on estimates.
Duration is a tool to measure interest rate risk. Assuming a 1% change in
interest rates and the durations shown below, the Fund's price would change as
follows:
<TABLE>
<CAPTION>
DURATION CHANGE IN INTEREST RATES
---------------------------------------------------------------------
<C> <S>
.75 yrs. 1% decline W .75% gain in Fund price
----------------------------------------------------------------------
1% rise W .75% decline in Fund price
----------------------------------------------------------------------
</TABLE>
Other factors such as changes in credit quality, prepayments, the shape of the
yield curve and liquidity affect the price of the Fund and may correlate with
changes in interest rates. These factors can increase swings in the Fund's share
price during periods of volatile interest rate changes.
FOREIGN BONDS
The Fund may invest in foreign bonds as follows:
- up to 25% of total assets in foreign bonds that are denominated in
U.S. dollars
- up to 15% of total assets in foreign bonds that are not
denominated in U.S. dollars
- up to 15% of total assets in emerging market foreign bonds
MONEY MARKET INVESTMENTS
To meet redemptions and when waiting to invest cash receipts, the Fund may
invest in short-term, investment grade bonds, money market mutual funds and
other money market instruments. Also, the Fund temporarily can invest up to
8
MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 242
[MAGNIFYING GLASS ICON] About the Details
100% of its assets in short-term, investment grade bonds and other money market
instruments in response to adverse market, economic or political conditions. The
Fund may not achieve its objective using this type of investing.
PORTFOLIO TURNOVER
As a result of the strategies described above, the Fund may have an annual
portfolio turnover rate above 100%. Portfolio turnover is generally the
percentage found by dividing the lesser of portfolio purchases or sales by the
monthly average value of the portfolio. High portfolio turnover (100% or more)
results in higher mark ups and other transaction costs and can affect the Fund's
performance. It also can result in a greater amount of distributions as ordinary
income rather than long-term capital gains.
INVESTMENT RISKS
--------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK
Market risk is the risk that the market will go down in value, including the
possibility that the market will go down sharply and unpredictably. Selection
risk is the risk that the investments that Fund management selects will
underperform the market or other funds with similar investment objectives and
investment strategies.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities are the right to receive a portion of principal
and/or interest payments made on a pool of residential or commercial mortgage
loans. When interest rates fall, borrowers may refinance or otherwise repay
principal on their mortgages earlier than scheduled. When this happens, certain
types of mortgage-backed securities will be paid off more quickly than
originally anticipated. Prepayment reduces the yield to maturity and average
life of the mortgage-backed securities. In addition, when the Fund reinvests the
proceeds of a prepayment, it may receive a lower interest rate than the rate on
the security that was prepaid. This risk is known as "prepayment risk." When
interest rates rise, certain types of mortgage-backed securities will be paid
off more slowly than originally anticipated and the value of these securities
will fall. This risk is known as extension risk.
MERCURY SHORT-TERM INVESTMENT FUND 9
<PAGE> 243
[MAGNIFYING GLASS ICON] About the Details
Because of prepayment risk and extension risk, mortgage-backed securities react
differently to changes in interest rates than other bonds. Small movements in
interest rates (both up and down) may quickly and significantly reduce the value
of certain mortgage-backed securities.
Mortgage-backed securities are issued by Federal government agencies like the
Government National Mortgage Association ("Ginnie Mae"), the Federal Home Loan
Mortgage Association ("Freddie Mac"), or the Federal National Mortgage
Association ("Fannie Mae"). Principal and interest payments on mortgage-backed
securities issued by Federal government agencies are guaranteed by either the
Federal government or the government agency. This means that such securities
have very little credit risk. Other mortgage-backed securities are issued by
private corporations rather than Federal agencies. Private mortgage-backed
securities have credit risk as well as prepayment risk and extension risk.
Mortgage-backed securities may be either pass-through securities or
collateralized mortgage obligations (CMOs). Pass-through securities represent a
right to receive principal and interest payments collected on a pool of
mortgages, which are passed through to security holders (less servicing costs).
CMOs are created by dividing the principal and interest payments collected on a
pool of mortgages into several revenue streams (tranches) with different
priority rights to portions of the underlying mortgage payments. Certain CMO
tranches may represent a right to receive interest only (IOs), principal only
(POs) or an amount that remains after other floating-rate tranches are paid (an
inverse floater). These securities are frequently referred to as "mortgage
derivatives" and may be extremely sensitive to changes in interest rates. If the
Fund invests in CMO tranches (including CMO tranches issued by government
agencies) and interest rates move in a manner not anticipated by the Investment
Adviser, it is possible that the Fund could lose all or substantially all of its
investment.
ASSET-BACKED SECURITIES
Like traditional bonds, the value of asset-backed securities typically increases
when interest rates fall and decreases when interest rates rise. Certain asset-
backed securities may also be subject to the risk of prepayment. In a period of
declining interest rates, borrowers may pay what they owe on the underlying
assets more quickly than anticipated. Prepayment reduces the yield to maturity
and the average life of the asset-backed securities. In addition, when the Fund
reinvests the proceeds of a prepayment, it may receive a lower interest rate
than the rate on the security that was prepaid. In a period of rising interest
rates, prepayments may occur at a slower rate than expected. As a result, the
average maturity of the Fund's portfolio will increase. The value of long-term
securities changes more widely in response to changes in interest rates than
shorter-term securities.
10
MERCURY SHORT-TERM INVESTMENT FUND
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[MAGNIFYING GLASS ICON] About the Details
CREDIT RISK
Credit risk is the risk that the issuer of bonds will be unable to pay the
interest or principal when due. The degree of credit risk depends on both the
financial condition of the issuer and on the terms of the specific bonds.
INTEREST RATE RISK
Interest rate risk is the risk that prices of bonds generally increase when
interest rates decline and decrease when interest rates increase. Prices of
longer term securities generally change more in response to interest rate
changes than do prices of shorter term securities.
CALL AND REDEMPTION RISK
Investments in bonds carry the risk that a bond's issuer will call the bond for
redemption prior to the bond's maturity. If there is an early call of a bond,
the Fund may lose income and may have to invest the proceeds of the redemption
in bonds with lower yields than the called bond.
JUNK BONDS
Junk bonds are bonds that are rated below investment grade by the major rating
agencies or are unrated securities that the Fund's Investment Adviser believes
are of comparable quality to bonds rated below investment grade. Although junk
bonds generally pay higher rates of interest than investment grade bonds, they
are high risk investments that may cause income and principal losses for the
Fund. Junk bonds generally are less liquid and experience more price volatility
than higher rated debt securities. The issuers of junk bonds may have a larger
amount of outstanding debt relative to their assets than issuers of investment
grade bonds. In the event of an issuer's bankruptcy, claims of other creditors
may have priority over the claims of junk bond holders, leaving few or no assets
available to repay junk bond holders. Junk bonds may be subject to greater call
and redemption risk than higher rated debt securities.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD COMMITMENTS
These types of investments involve the risk that the security the Fund buys will
lose value prior to its delivery to the Fund. There also is the risk that the
security will not be issued or that the other party will not meet its
obligation, in which case the Fund loses the investment opportunity of the
assets it has set aside to pay for the security and any gain in the security's
price.
MERCURY SHORT-TERM INVESTMENT FUND 11
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[MAGNIFYING GLASS ICON] About the Details
VARIABLE RATE DEMAND OBLIGATIONS
These are floating rate securities that consist of an interest in a long-term
bond and the conditional right to demand payment prior to the bond's maturity
from a bank or other financial institution. If the bank or other financial
institution is unable to pay on demand, the Fund may be adversely affected. In
addition, these securities are subject to credit risk.
INDEXED AND INVERSE FLOATING RATE SECURITIES
The Fund may invest in securities whose potential returns are directly related
to changes in an underlying index or interest rate, known as indexed securities.
The return on indexed securities will rise when the underlying index or interest
rate rises and fall when the index or interest rate falls. The Fund may also
invest in securities whose return is inversely related to changes in an interest
rate (inverse floaters). In general, inverse floaters change in value in a
manner that is opposite to most bonds -- that is, interest rates on inverse
floaters will decrease when short-term rates increase and increase when
short-term rates decrease. Investments in indexed securities and inverse
floaters may subject the Fund to the risk of reduced or eliminated interest
payments. Investments in indexed securities also may subject the Fund to loss of
principal. In addition, certain indexed securities and inverse floaters may
increase or decrease in value at a greater rate than the underlying interest
rate, which effectively leverages the Fund's investment. As a result, the market
value of such securities will generally be more volatile than that of fixed rate
securities. Both indexed securities and inverse floaters can be derivative
securities and can be considered speculative.
SOVEREIGN DEBT
The Fund may invest in sovereign debt securities. These securities are issued or
guaranteed by foreign government entities. Investments in sovereign debt subject
the Fund to the risk that a government entity may delay or refuse to pay
interest or repayment of principal on its sovereign debt. Some of these reasons
may include cash flow problems, insufficient foreign currency reserves,
political considerations, the relative size of its debt position to its economy
or its failure to put in place economic reforms required by the International
Monetary Fund or other multilateral agencies. If a government entity defaults,
it may ask for more time in which to pay or for further loans. There is no legal
process for collecting sovereign debts that a government does not pay.
CORPORATE LOANS
Corporate loans are subject to the risk of loss of principal and income.
Borrowers do not always provide collateral for corporate loans and the value of
12
MERCURY SHORT-TERM INVESTMENT FUND
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[MAGNIFYING GLASS ICON] About the Details
the collateral may not completely cover the borrower's obligations at the time
of a default. If a borrower files for protection from its creditors under the
U.S. bankruptcy laws, these laws may limit the Fund's rights to its collateral.
In addition, the value of collateral may erode during a bankruptcy case. In the
event of a bankruptcy, the holder of a corporate loan may not recover its
principal, may experience a long delay in recovering its investment and may not
receive interest during the delay.
RISKS OF CONVERTIBLE SECURITIES
Convertibles are generally bonds or preferred stocks that may be converted into
common stock. Convertibles typically pay current income, as either interest
(bond convertibles) or dividends (preferred stocks). A convertible's value
usually reflects both the stream of current income payments and the value of the
underlying common stock. The market value of a convertible performs like regular
bonds; that is, if market interest rates rise, the value of a convertible
usually falls. Since it is convertible into common stock, the convertible also
has the same types of market and issuer risk as the underlying common stock.
FOREIGN MARKET RISK
The Fund may invest a portion of its assets in foreign securities. Such
investments involve special risks not present in U.S. investments that can
increase the chances that the Fund will lose money. In particular, investments
in foreign securities involve the following risks, which are generally greater
for investments in emerging markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
MERCURY SHORT-TERM INVESTMENT FUND 13
<PAGE> 247
[MAGNIFYING GLASS ICON] About the Details
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair the Fund's
ability to purchase or sell foreign securities or transfer its
assets or income back into the U.S., or otherwise adversely affect
the Fund's operations.
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal
remedies available to investors in some foreign countries may be
less extensive than those available to investors in the U.S.
- Prices of foreign securities may go up and down more than prices
of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and a Fund's assets may be uninvested
and not earning returns. The Fund also may miss investment
opportunities or be unable to sell an investment because of these
delays.
- The value of the Fund's foreign holdings (and hedging transactions
in foreign currencies) will be affected by changes in currency
exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- If the Fund purchases a bond issued by a foreign government, the
government may be unwilling or unable to make payments when due.
There may be no formal bankruptcy proceeding to collect amounts
owed by a foreign government.
EUROPEAN ECONOMIC AND MONETARY UNION (EMU)
A number of European countries have entered into EMU in an effort to reduce
trade barriers between themselves and eliminate fluctuations in their
currencies. EMU establishes a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These
14
MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 248
[MAGNIFYING GLASS ICON] About the Details
securities trade and make dividend and other payments only in euros. Like other
investment companies and business organizations, including the companies in
which the Fund invests, the Fund could be adversely affected if the transition
to euro, or EMU as a whole, does not take effect as planned or if a
participating country withdraws from EMU.
DERIVATIVES
Derivatives involve the following risks:
- CREDIT RISK -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Fund.
- CURRENCY RISK -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
- LEVERAGE RISK -- Leverage risk is the risk associated with certain
types of investments or trading strategies that relatively small
market movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- LIQUIDITY RISK -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time that
the seller would like or at the price that the seller believes the
security is currently worth.
- INDEX RISK -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
STATEMENT OF ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERCURY SHORT-TERM INVESTMENT FUND 15
<PAGE> 249
[CHECKMARK ICON] Account Choices
PRICING OF SHARES
--------------------------------------------------------------------------------
The Fund offers a single class of shares.
The Fund's shares are distributed by FAM Distributors, Inc. (the "Distributor").
Certain financial institutions may charge you additional fees in connection with
transactions in Fund shares. The Investment Adviser, the Distributor or their
affiliates may make payments out of their own resources to selected securities
dealers and other financial intermediaries for providing services intended to
result in the sale of Fund shares or for shareholder servicing activities.
To better understand the pricing of the Fund's shares, we have summarized the
information below:
<TABLE>
<CAPTION>
CLASS I*
---------------------------------------------------------------------------------------
<S> <C>
Availability LIMITED TO CERTAIN INVESTORS INCLUDING: - Investor Class and
current Class I
shareholders.
- Certain retirement plans.
- Participants in certain sponsored programs.
- Certain affiliates or customers of selected securities
dealers and other financial intermediaries.
</TABLE>
[- Certain institutional investors.]
<TABLE>
<S> <C>
---------------------------------------------------------------------------------------
Initial Sales Charge? YES. PAYABLE AT TIME OF PURCHASE. LOWER SALES CHARGES
AVAILABLE FOR LARGER INVESTMENTS.
---------------------------------------------------------------------------------------
Deferred Sales NO. (MAY BE CHARGED FOR PURCHASES OVER $1 MILLION THAT ARE
Charge? REDEEMED WITHIN ONE YEAR.)
---------------------------------------------------------------------------------------
Account Maintenance NO.
and Distribution
Fees?
---------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares.
16
MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 250
[CHECKMARK ICON] Account Choices
RIGHT OF ACCUMULATION -- permits you to pay the sales charge applicable to the
cost or value (whichever is higher) of all shares you own in the Mercury mutual
funds.
LETTER OF INTENT -- permits you to pay the sales charge that would be applicable
if you add up all shares of Mercury mutual funds that you agree to buy within a
13 month period. Certain restrictions apply.
CLASS I SHARES* -- INITIAL SALES CHARGE OPTION
If you select Class I shares, you will pay a sales charge at the time of
purchase as shown in the following table. Securities dealers' compensation will
be as shown in the last column.
<TABLE>
<CAPTION>
DEALER
AS A % OF COMPENSATION
AS A % OF YOUR AS A % OF
YOUR INVESTMENT OFFERING PRICE INVESTMENT** OFFERING PRICE
---------------------------------------------------------------------------------------
<S> <C> <C> <C>
LESS THAN $25,000 2.00% % %
---------------------------------------------------------------------------------------
$25,000 BUT LESS THAN
$50,000 % % %
---------------------------------------------------------------------------------------
$50,000 BUT LESS THAN
$100,000 % % %
---------------------------------------------------------------------------------------
$100,000 BUT LESS THAN
$250,000 % % %
---------------------------------------------------------------------------------------
$250,000 BUT LESS THAN
$1,000,000 % % %
---------------------------------------------------------------------------------------
$1,000,000 AND OVER*** 0.00% 0.00% 0.00%
---------------------------------------------------------------------------------------
</TABLE>
* As of October , 2000, Investor Class shares were redesignated Class I
shares.
** Rounded to the nearest one-hundredth percent.
*** If you invest $1,000,000 or more in Class I shares, you may not pay an
initial sales charge. In that case, the Investment Adviser compensates the
selling dealer or other financial intermediary from its own resources. If
you redeem your shares within one year after purchase, you may be charged a
deferred sales charge. This charge is 1% of the lesser of the original cost
of the shares being redeemed or your redemption proceeds. A sales charge of
0.75% will be charged on purchases of $1,000,000 or more of Class I shares
by certain employer sponsored retirement or savings plans.
No initial sales charge applies to Class I shares that you buy through
reinvestment of dividends.
A reduced or waived sales charge on a purchase of Class I shares may apply for:
- Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT
- Certain trusts managed by banks, thrifts or trust companies
including those affiliated with the Investment Adviser or its
affiliates
- Certain employer-sponsored retirement or savings plans
- Certain investors, including directors or trustees of mutual funds
sponsored by the Investment Adviser or its affiliates, employees
of the Investment Adviser and its affiliates and employees or
customers of selected securities dealers
MERCURY SHORT-TERM INVESTMENT FUND 17
<PAGE> 251
[CHECKMARK ICON] Account Choices
- Certain fee-based programs managed by the Investment Adviser or
its affiliates
- Certain fee-based programs managed by selected securities dealers
that have an agreement with the Distributor
- Purchases through certain financial advisers, selected securities
dealers, brokers, investment advisers, service providers and other
financial intermediaries
- Purchases through certain accounts over which the Investment
Adviser or an affiliate exercises investment discretion
[- Certain institutional investors]
If you redeem Class I shares and within 30 days buy new shares of the same
class, you will not pay a sales charge on the new purchase amount. The amount
eligible for this "Reinstatement Privilege" may not exceed the amount of your
redemption proceeds. To exercise the privilege, contact your financial
consultant, selected securities dealer, or other financial intermediary or the
Fund's Transfer Agent at 1-800-236-4479.
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
--------------------------------------------------------------------------------
The chart below summarizes how to buy, sell, transfer and exchange shares
through your financial consultant, selected securities dealer, broker,
investment adviser, service provider or other financial intermediary. You may
also buy shares through the Transfer Agent. To learn more about buying shares
through the Transfer Agent, call 1-800-236-4479. Because the selection of a
mutual fund involves many considerations, your financial consultant, selected
securities dealer or other financial intermediary may help you with this
decision. The Fund does not issue share certificates.
Because of the high cost of maintaining smaller shareholder accounts, the Fund
may redeem the shares in your account (without charging any deferred sales
charge) if the net asset value of your account falls below $500 due to
redemptions you have made. You will be notified that the value of your account
is less than $500 before the Fund makes an involuntary redemption. You will then
have 60 days to make an additional investment to bring the value of your account
to at least $500 before the Fund takes any action. This involuntary redemption
does not apply to retirement plans or Uniform Gifts or Transfers to Minors Act
accounts.
18
MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 252
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BUY SHARES Determine the amount of your The minimum initial investment for the Fund is $1,000 for
investment all accounts except: - $500 for certain fee-based programs
- $100 for retirement plans (The minimums for initial
investments may be waived under certain circumstances.)
-------------------------------------------------------------------------------------------------
Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. Purchase orders
other financial intermediary placed prior to the close of regular trading on the New York
submit your purchase order Stock Exchange (generally, 4:00 p.m. Eastern time) are
priced at the net asset value determined that day. Certain
financial intermediaries, however, may require submission of
orders prior to that time.
Purchase orders placed after that time are priced at the net
asset value determined on the next business day. The Fund
may reject any order to buy shares and may suspend the sale
of shares at any time. Certain financial intermediaries may
charge a fee to process a purchase. For example, Merrill
Lynch, Pierce, Fenner & Smith Incorporated currently charges
a $5.35 processing fee. The fees charged by other financial
intermediaries may be higher or lower.
-------------------------------------------------------------------------------------------------
Or contact the Transfer Agent To purchase shares directly, call the Transfer Agent at
1-800-236-4479 and request a purchase application. Mail the
completed purchase application to the Transfer Agent at the
address on the back cover of this prospectus.
------------------------------------------------------------------------------------------------------------------------
ADD TO YOUR Purchase additional shares The minimum investment for additional purchases is generally
INVESTMENT $100 for all accounts except: - $50 for certain fee-based
programs - $1 for retirement plans (The minimums for
additional purchases may be waived under certain
circumstances.)
-------------------------------------------------------------------------------------------------
Acquire additional shares All dividends are automatically reinvested without a sales
through the automatic dividend charge.
reinvestment plan
-------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan your selected securities dealer or other financial
intermediary. The current minimum for such automatic
reinvestments is $100. The minimum may be waived or revised
under certain circumstances.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY SHORT-TERM INVESTMENT FUND
19
<PAGE> 253
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
TRANSFER SHARES TO Transfer to a participating You may transfer your Fund shares to another selected
ANOTHER SECURITIES securities dealer or other securities dealer or other financial intermediary if
DEALER OR OTHER financial intermediary authorized dealer agreements are in place between the
FINANCIAL Distributor and the transferring intermediary and the
INTERMEDIARY Distributor and the receiving intermediary. Certain
shareholder services may not be available for all
transferred shares. You may only purchase additional shares
of funds previously owned before the transfer. All future
trading of these shares must be coordinated by the receiving
intermediary.
-------------------------------------------------------------------------------------------------
Transfer to a non-participating You must either: - Transfer your shares to an account with
securities dealer or other the Transfer Agent; or - Sell your shares, paying any
financial intermediary applicable deferred sales charge.
------------------------------------------------------------------------------------------------------------------------
SELL YOUR SHARES Have your financial consultant, The price of your shares is based on the next calculation of
selected securities dealer or net asset value after your order is placed. For your
other financial intermediary redemption request to be priced at the net asset value on
submit your sales order the day of your request, you must submit your request to
your selected securities dealer or other financial
intermediary prior to that day's close of regular trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern
time). Certain financial intermediaries, however, may
require submission of orders prior to that time. Redemption
requests placed after that time are priced at the net asset
value at the close of regular trading on the next business
day.
Certain financial intermediaries may charge a fee to process
a sale of shares. For example, Merrill Lynch, Pierce, Fenner
& Smith Incorporated currently charges a $5.35 processing
fee. No processing fee is charged if you redeem the shares
directly through the Transfer Agent. The fees charged by
other financial intermediaries may be higher or lower.
The Fund may reject an order to sell shares under certain
circumstances.
-------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by writing to
the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter. A signature guarantee will generally be
required but may be waived in certain limited circumstances.
You can obtain a signature guarantee from a bank, securities
dealer, securities broker, credit union, savings
association, national securities exchange and registered
securities association. A notary public seal will not be
acceptable. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
20 MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 254
[CHECKMARK ICON] Account Choices
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SELL SHARES Participate in the Fund's You can choose to receive systematic payments from your Fund
SYSTEMATICALLY Systematic Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. You can
generally arrange through your selected securities dealer or
other financial intermediary for systematic sales of shares
of a fixed dollar amount on a monthly, bi-monthly,
quarterly, semi-annual or annual basis, subject to certain
conditions. Under either method, you must have dividends
automatically reinvested. Ask your financial intermediary
for details.
------------------------------------------------------------------------------------------------------------------------
EXCHANGE YOUR Select the fund into which you You can exchange your shares of the Fund for shares of other
SHARES want to exchange. Be sure to Mercury mutual funds or for shares of the Summit Cash
read that fund's prospectus Reserves Fund. You must have held the shares used in the
exchange for at least 15 calendar days before you can
exchange to another fund.
If you wish to exchange into a fund in which you have no
Class I shares (and are not eligible to buy Class I shares),
you will exchange into Class A shares. If you wish to
exchange into Summit, you will exchange into Class A shares
of Summit.
Some of the Mercury mutual funds may impose a different
initial or deferred sales charge schedule. If you exchange
Class I shares for shares of a fund with a higher initial
sales charge than you originally paid, you may be charged
the difference at the time of exchange.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERCURY SHORT-TERM INVESTMENT FUND
21
<PAGE> 255
[CHECKMARK ICON] Account Choices
NET ASSET VALUE -- the market value in U.S. dollars of the Fund's total assets
after deducting liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
--------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open as of the close of regular trading on the Exchange based on
prices at the time of closing. Regular trading on the Exchange generally closes
at 4:00 p.m. Eastern time. The net asset value used in determining your price is
the next one calculated after your purchase or redemption order is placed.
Foreign securities owned by the Fund may trade on weekends or other days when
the Fund does not price its shares. As a result, the Fund's net asset value may
change on days when you will not be able to purchase or redeem the Fund's
shares.
The Fund may accept orders from certain authorized financial intermediaries or
their designees. The Fund will be deemed to receive an order when accepted by
the intermediary or designee and the order will receive the net asset value next
computed by the Fund after such acceptance. If the payment for a purchase order
is not made by a designated later time, the order will be canceled and the
financial intermediary could be held liable for any losses.
FEE-BASED PROGRAMS
--------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by the Investment
Adviser or an affiliate of the Investment Adviser, or by selected securities
dealers or other financial intermediaries that have an agreement with the
Distributor, you may be able to buy Class I shares at net asset value,
[including by exchanges from other share classes]. Sales charges on the shares
being exchanged may be reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
22
MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 256
[CHECKMARK ICON] Account Choices
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed ordinary income or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
If you leave one of these programs, your shares may be redeemed or automatically
exchanged into another class of the Fund's shares or into the Summit fund. The
class you receive may be the class you originally owned when you entered the
program, or in certain cases, a different class. Any redemption or exchange will
be at net asset value. However, if you participate in the program for less than
a specified period, you may be charged a fee in accordance with the terms of the
program.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your financial
consultant, selected securities dealer or other financial intermediary.
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
The Fund will distribute any net investment income monthly and any net realized
long-term or short-term capital gains at least annually. The Fund may also pay a
special distribution at the end of the calendar year to comply with Federal tax
requirements. DIVIDENDS may be reinvested automatically in shares of the Fund at
net asset value without a sales charge or may be taken in cash. If your account
is with a selected securities dealer or other financial intermediary that has an
agreement with the Fund, contact your dealer or intermediary about which option
you would like. If your account is with the Transfer Agent and you would like to
receive dividends in cash, contact the Transfer Agent. The Fund anticipates that
the majority of its dividends, if any, will consist of ordinary income. Capital
gains, if any, may be taxable to you at different rates, depending, in part, on
how long the Fund has held the assets sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your shares and any
gain on the transaction may be subject to tax. Capital gain dividends are
generally taxed at different rates than ordinary income dividends.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax treaties between certain countries
and the U.S. may reduce or eliminate such taxes.
If you are neither a lawful permanent resident nor a citizen of the U.S. or if
you are a foreign entity, the Fund's ordinary income dividends (which include
distributions of net short-term capital gains) will generally be subject to a
30% U.S. withholding tax, unless a lower treaty rate applies.
MERCURY SHORT-TERM INVESTMENT FUND 23
<PAGE> 257
[CHECKMARK ICON] Account Choices
By law, the Fund must withhold 31% of your dividends and redemption proceeds if
you have not provided a taxpayer identification number or social security number
or if the number you have provided is incorrect.
This section summarizes some of the consequences under current Federal tax law
of an investment in the Fund. It is not a substitute for personal tax advice.
Consult your personal tax adviser about the potential tax consequences of an
investment in the Fund under all applicable tax laws.
24
MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 258
[MANAGEMENT TEAM ICON] The Management Team
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
Mercury Advisors, the Fund's Investment Adviser, manages the Fund's investments
under the overall supervision of the Board of Trustees. The Investment Adviser
has the responsibility for making all investment decisions for the Fund. For
this fiscal year ended June 30, 2000, the Fund pays the Investment Adviser a fee
at the annual rate of 0.40% of the average daily net assets of the Fund.
The Investment Adviser was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
The Investment Adviser and its affiliates had approximately $555 billion in
investment company and other portfolio assets under management as of June 30,
2000.
Although not required to do so, the Investment Adviser has agreed to make
reimbursements so that the regular annual operating expenses of the Fund will be
limited as shown in the table on page 5. The Investment Adviser has agreed to
these expense limits through June 2001, and will thereafter give shareholders at
least 30 days' notice if this reimbursement policy will change.
The Investment Adviser is allowed to allocate brokerage based on sales of shares
of funds managed by the Investment Adviser.
MERCURY SHORT-TERM INVESTMENT FUND 25
<PAGE> 259
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned on an investment in the
Fund (assuming reinvestment of all dividends and distributions). These financial
highlights were audited by PricewaterhouseCoopers LLP. The accountants' report
and the Fund's financial statements are included in the Fund's annual report,
which is available upon request. Further performance information is contained in
the annual report.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED JUNE 30,
INCREASE (DECREASE) IN -------------------------------------------------------
NET ASSET VALUE: 2000(1) 1999 1998 1997 1996
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
---------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $10.13 $10.15 $10.17 $10.12
---------------------------------------------------------------------------------------------------------------------
Investment income -- net 0.57 0.63 0.58 0.66
---------------------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss) on investments -- net (0.11) (0.00) (0.01) 0.05
---------------------------------------------------------------------------------------------------------------------
Total from investment operations 0.46 0.63 0.57 0.71
---------------------------------------------------------------------------------------------------------------------
Less dividends and distributions
Investment income -- net (0.54) (0.65) (0.59) (0.66)
Return of capital -- -- (0.00) --
---------------------------------------------------------------------------------------------------------------------
Total dividends and distributions (0.54) (0.65) (0.59) (0.66)
---------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $10.05 $10.13 $10.15 $10.17
---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
---------------------------------------------------------------------------------------------------------------------
Based on net asset value per share 4.70% 6.37% 5.77% 7.23%
---------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
---------------------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement 0.48% 0.48% 0.48% 0.48%
---------------------------------------------------------------------------------------------------------------------
Expenses 0.68% 0.92% 0.96% 0.88%
---------------------------------------------------------------------------------------------------------------------
Investment income -- net 5.52% 6.36% 5.82% 6.55%
---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
---------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in millions) $50.90 $28.00 $21.70 $18.70
---------------------------------------------------------------------------------------------------------------------
Portfolio turnover 144% 121% 154% 60%
---------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) As of October , 2000, Investor Class shares were redesignated Class I
shares. No sales loads were charged prior to this time.
()* Total investment return excludes the effects of sales charges.
26 MERCURY SHORT-TERM INVESTMENT FUND
<PAGE> 260
<TABLE>
<S> <C>
FUND
Mercury Short-Term Investment Fund
of Mercury HW Funds
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(800-236-4479)
INVESTMENT ADVISER
Administrative Offices:
Mercury Advisors
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 41621
Jacksonville, Florida 32232-1621
(800-236-4479)
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
100 E. Wisconsin Ave., Suite 1500
Milwaukee, Wisconsin 53202
DISTRIBUTOR
FAM Distributors, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109-3661
COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610-4795
</TABLE>
<PAGE> 261
[TELEPHONE ICON] To Learn More
SHAREHOLDER REPORTS
Additional information about the Fund's investments will be available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report you will find a discussion of the relevant market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling
1-800-236-4479.
The Fund will send you one copy of each shareholder report and certain other
mailings regardless of the number of Fund accounts you have. To receive separate
shareholder reports for each account, call your financial consultant or other
financial intermediary or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and brokerage or mutual
fund account number. If you have any questions, please call your financial
consultant or other financial intermediary or the Transfer Agent at
1-800-236-4479.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at Financial Data Services, Inc., P.O. Box 41621, Jacksonville, Florida
32232-1621 or by calling 1-800-236-4479.
Contact your financial consultant or other financial intermediary or the Fund at
the telephone number or address indicated on the inside back cover of this
prospectus if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet Site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION IN THIS PROSPECTUS.
Investment Company Act File #811-4182.
CODE #MHW-1080-1000
(C) Mercury Advisors
Mercury Short-Term
Investment Fund
OF MERCURY HW FUNDS
PROSPECTUS - October , 2000
<PAGE> 262
Mercury HW Equity Fund for
Insurance Companies
OF MERCURY HW FUNDS
ARTWORK
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING INFORMATION
ABOUT RISKS. PLEASE READ IT BEFORE YOU INVEST
AND KEEP IT FOR FUTURE REFERENCE.
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.
PROSPECTUS - October , 2000
<PAGE> 263
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
[GLOBE ICON]
FUND FACTS
-----------------------------------------------------------------
About the Mercury HW Equity Fund for Insurance Companies.... 2
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[MAGNIFYING GLASS ICON]
ABOUT THE DETAILS
-----------------------------------------------------------------
How the Fund Invests........................................ 7
Investment Risks............................................ 7
Statement of Additional Information......................... 11
[CHECKMARK ICON]
ACCOUNT CHOICES
-----------------------------------------------------------------
How to Buy Shares........................................... 12
How to Redeem Shares........................................ 12
How Shares are Priced....................................... 14
Dividends and Taxes......................................... 14
[MANAGEMENT TEAM ICON]
THE MANAGEMENT TEAM
-----------------------------------------------------------------
Management of the Fund...................................... 15
Financial Highlights........................................ 16
[TELEPHONE ICON]
TO LEARN MORE
-----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES
<PAGE> 264
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
COMMON STOCK -- units of ownership of a corporation.
PRICE-TO-EARNINGS RATIO -- price of a stock divided by its earnings per share.
YIELD -- percentage rate of return paid on a stock in dividends and share
repurchases.
PRICE-TO-BOOK VALUE RATIO -- price of a stock divided by its book value per
share.
[GLOBE ICON] Fund Facts
ABOUT THE MERCURY HW EQUITY FUND FOR INSURANCE
COMPANIES
--------------------------------------------------------------------------------
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to seek current income and long-term growth
of income, accompanied by growth of capital.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests primarily in COMMON STOCKS of U.S. companies.
In investing the Fund's assets, Mercury Advisors (the "Investment Adviser")
follows a value style. This means that the Investment Adviser buys stocks that
it believes are currently undervalued by the market and thus have a lower price
than their true worth. Typical value characteristics include:
- low PRICE-TO-EARNINGS RATIO relative to the market
- high YIELD relative to the market
- low PRICE-TO-BOOK VALUE RATIO relative to the market
- financial strength
Stocks may be "undervalued" because they are part of an industry that is out of
favor with investors generally. Even in those industries, though, individual
companies may have high rates of growth of earnings and be financially sound. At
the same time, the price of their common stock may be depressed because
investors associate the companies with their industries.
This value discipline sometimes prevents or limits investments in stocks that
are in well-known indexes, like the S&P 500 Index. Also, the return of the Fund
will not necessarily be similar to the return of the S&P 500 Index.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of Fund shares, may go up or down. These changes may occur because the
stock market is rising or falling. At other times, there are specific factors
that may affect the value of a particular investment. If the value of the Fund's
investments goes down, you may lose money.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Corporation or any other government agency.
2
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES
<PAGE> 265
[GLOBE ICON] Fund Facts
See "Investment Risks" for more information about the risks associated with the
Fund.
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are seeking long-term growth of capital and can withstand the
share price volatility of equity investing.
- Are seeking a diversified portfolio of equity securities.
- Want a professionally managed and diversified portfolio.
- Are willing to accept the risk that the value of your investment
may decline in order to seek long-term capital appreciation.
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES 3
<PAGE> 266
[GLOBE ICON] Fund Facts
RISK/RETURN BAR CHART
--------------------------------------------------------------------------------
The bar charts and tables below provide some indication of the risks of
investing in the Fund by showing changes in the year to year performance of the
Fund and by showing how the Fund's average annual total returns for 1, and 5
years and for its life compare with those of a broad measure of market
performance. How the Fund has performed in the past is not necessarily an
indication of how the Fund will perform in the future.
Total return for the six months ended June 30, 2000: -8.66%.
During the period shown in the bar chart, the highest return for a quarter was
13.80% (quarter ended June 30, 1997) and the lowest return for a quarter was
-11.51% (quarter ended September 30, 1999).
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
(FOR THE PERIODS ENDED DECEMBER 31, PAST PAST SINCE
1999) ONE YEAR FIVE YEARS INCEPTION
-----------------------------------------------------------------------------------------
<S> <C> <C> <C>
INVESTOR CLASS -4.29% 16.62% 13.04%(1)
S&P 500 INDEX 21.14% 28.66% 16.32%
-----------------------------------------------------------------------------------------
</TABLE>
The S&P 500 Index is a capital weighted, unmanaged index representing the
aggregate market value of the common equity of 500 stocks primarily traded on
the New York Stock Exchange.
(1) Inception date is January 29, 1993.
4
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES
<PAGE> 267
[GLOBE ICON] Fund Facts
UNDERSTANDING EXPENSES
Fund investors pay various expenses, either directly or indirectly. Listed below
are some of the main types of expenses, which all mutual funds may charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER:
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
INVESTMENT ADVISORY FEE -- a fee paid to the Investment Adviser for managing the
Fund.
FEES AND EXPENSES
--------------------------------------------------------------------------------
The Fund offers a single class of shares.
THIS TABLE SHOWS THE EXPENSES THAT YOU MAY PAY IF YOU BUY AND HOLD SHARES OF THE
FUND. FUTURE EXPENSES MAY BE GREATER OR LESS THAN THOSE INDICATED BELOW.
<TABLE>
<CAPTION>
INVESTOR
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)(A): CLASS
------------------------------------------------------------------------
<S> <C>
Maximum Sales Charge (Load) imposed on purchases (as a
percentage of offering price) None
------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a percentage of
original purchase price or redemption proceeds, whichever is
lower) None
------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend Reinvestments None
------------------------------------------------------------------------
Redemption Fee None
------------------------------------------------------------------------
Exchange Fee None
------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED
FROM THE FUND'S TOTAL ASSETS):
------------------------------------------------------------------------
INVESTMENT ADVISORY FEE(a) 0.53%
------------------------------------------------------------------------
DISTRIBUTION AND/OR SERVICE (12b-1) FEES None
------------------------------------------------------------------------
Other Expenses None
------------------------------------------------------------------------
ANNUAL OPERATING EXPENSES 1.02%
------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C>
(a) Although not required to do so, the Investment Adviser
voluntarily pays all of the Fund's operating expenses other
than the investment advisory fee.
</TABLE>
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES 5
<PAGE> 268
[GLOBE ICON] Fund Facts
EXAMPLES:
This example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds.
This example assumes that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year and that the Fund's
operating expenses remain the same. This assumption is not meant to indicate you
will receive a 5% annual rate of return. Your annual return may be more or less
than the 5% used in these examples. Although your actual costs may be higher or
lower, based on these assumptions, your costs would be:
<TABLE>
<CAPTION>
CLASS I
-------------------------------------------------------------------------------
<S> <C>
ONE YEAR $ 54
-------------------------------------------------------------------------------
THREE YEARS $170
-------------------------------------------------------------------------------
FIVE YEARS $296
-------------------------------------------------------------------------------
TEN YEARS $665
-------------------------------------------------------------------------------
</TABLE>
6
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES
<PAGE> 269
ABOUT THE PORTFOLIO MANAGERS -- Gail Bardin is a managing director of the
Investment Adviser and began co-managing the Fund in April 1994. She has been a
portfolio manager of the Investment Adviser since 1988.
Sheldon Lieberman joined the Investment Adviser in 1994 and began co-managing
the Fund in August 1997. Before joining the Investment Adviser, Mr. Lieberman
was the Chief Investment Officer for the Los Angeles County Employees Retirement
Association.
ABOUT THE INVESTMENT ADVISER -- Mercury Advisors manages the Fund.
[MAGNIFYING GLASS ICON] About the Details
HOW THE FUND INVESTS
--------------------------------------------------------------------------------
The Fund's investment objective is to provide current income and long-term
growth of income, accompanied by growth of capital.
The Fund invests mostly in common stocks of large U.S. companies. Normally, the
Fund invests at least 80% of its total assets in stocks that pay dividends. It
also may invest in stocks that don't pay dividends, but have growth potential
unrecognized by the market or changes in business or management that indicate
growth potential.
The Fund can invest up to 10% of its total assets in foreign securities.
MONEY MARKET INVESTMENTS
To meet redemptions and when waiting to invest cash receipts, the Fund may
invest in short-term, investment grade bonds, money market mutual funds and
other money market instruments. Also, the Fund temporarily can invest up to 100%
of its assets in short-term, investment grade bonds and other money market
instruments in response to adverse market, economic or political conditions. The
Fund may not achieve its objectives using this type of investing.
INVESTMENT RISKS
--------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK
Market risk is the risk that the market will go down in value, including the
possibility that the market will go down sharply and unpredictably. Selection
risk is the risk that the investments that Fund management selects will
underperform the market or other funds with similar investment objectives and
investment strategies.
FOREIGN MARKET RISK
The Fund may invest up to 10% of its total assets in foreign securities. Such
investments involve special risks not present in U.S. investments that can
increase the chances that the Fund will lose money. In particular, investments
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES 7
<PAGE> 270
[MAGNIFYING GLASS ICON] About the Details
in foreign securities involve the following risks, which are generally greater
for investments in emerging markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair the Fund's
ability to purchase or sell foreign securities or transfer its
assets or income back into the U.S., or otherwise adversely affect
the Fund's operations.
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal
remedies available to investors in some foreign countries may be
less extensive than those available to investors in the U.S.
- Because there are generally fewer investors on foreign exchanges
and a smaller number of shares traded each day, it may be
difficult for the Fund to buy and sell securities on those
exchanges. In addition, prices of foreign securities may go up and
down more than prices of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and the Fund's assets may be
8
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES
<PAGE> 271
[MAGNIFYING GLASS ICON] About the Details
uninvested and not earning returns. The Fund also may miss
investment opportunities or be unable to sell an investment
because of these delays.
- The value of the Fund's foreign holdings (and hedging transactions
in foreign currencies) will be affected by changes in currency
exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- International trade barriers or economic sanctions against certain
foreign countries may adversely affect the Fund's holdings.
EUROPEAN ECONOMIC AND MONETARY UNION (EMU)
A number of European countries have entered into EMU in an effort to reduce
trade barriers between themselves and eliminate fluctuations in their
currencies. EMU establishes a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These securities trade and make dividend and other payments only in euros. Like
other investment companies and business organizations, including the companies
in which the Fund invests, the Fund could be adversely affected the transition
to euro, or EMU as a whole, does not take effect as planned or if a
participating country withdraws from EMU.
RISKS OF CONVERTIBLE SECURITIES
Convertibles are generally bonds or preferred stocks that may be converted into
common stock. Convertibles typically pay current income, as either interest
(bond convertibles) or dividends (preferred stocks). A convertible's value
usually reflects both the stream of current income payments and the value of the
underlying common stock. The market value of a convertible performs like regular
bonds; that is, if market interest rates rise, the value of a convertible
usually falls. Since it is convertible into common stock, the convertible also
has the same types of market and issuer risk as the underlying common stock.
DEBT SECURITIES
Debt securities, such as bonds, involve credit risk, which is the risk that the
borrower will not make timely payments of principal and interest. These
securities are also subject to interest rate risk, which is the risk that the
value of the security may fall when interest rates rise. In general, the market
price of
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES 9
<PAGE> 272
[MAGNIFYING GLASS ICON] About the Details
debt securities with longer maturities will go up or down more in response to
changes in interest rates than shorter term securities.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD COMMITMENTS
When-issued securities, delayed-delivery securities and forward commitments
involve the risk that the security the Fund buys will lose value prior to its
delivery to the Fund. There also is the risk that the security will not be
issued or that the other party will not meet its obligation, in which case the
Fund loses the investment opportunity of the assets it has set aside to pay for
the security and any gain in the security's price.
DERIVATIVES
Derivatives involve the following risks:
- CREDIT RISK -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Fund.
- CURRENCY RISK -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
- LEVERAGE RISK -- Leverage risk is the risk associated with certain
types of investments or trading strategies that relatively small
market movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- LIQUIDITY RISK -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time that
the seller would like or at the price that the seller believes the
security is currently worth.
- INDEX RISK -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
10
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES
<PAGE> 273
[MAGNIFYING GLASS ICON] About the Details
STATEMENT OF ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES 11
<PAGE> 274
[CHECKMARK ICON] Account Choices
HOW TO BUY SHARES
--------------------------------------------------------------------------------
Shares of the Fund are offered only to insurance companies. The minimum initial
investment in the Fund is $1,000,000. There is no minimum subsequent investment.
The Fund reserves the right to reject any order.
Investors may invest in the Fund by sending a request and payment to the
Transfer Agent:
Financial Data Services, Inc.
P.O. Box 41621
Jacksonville, FL 32232-1621
Investors opening a new account must send a completed Purchase Application to
the address above.
Before wiring money, investors should call 800-236-4479 to notify the Transfer
Agent of the wire to ensure proper credit when the wire is received. To purchase
shares by wiring Federal Funds, payment should be wired to First Union National
Bank of Florida. Investors should give their financial institutions the
following wire instructions:
First Union National Bank of Florida
ABA #063000021
For credit to Financial Data Services
Acct #2112600019018
For further credit to Mercury HW Fund Account # [Your account number]
[Shareholder name]
The wire should indicate that the investment is being made in the Mercury HW
Equity Fund for Insurance Companies. Shares of the Fund will be purchased for
the account of the investor at the net asset value next determined after receipt
of the investor's wire. Shareholder inquiries should be directed to the Fund.
HOW TO REDEEM SHARES
--------------------------------------------------------------------------------
A shareholder wishing to redeem shares (sell them back to the Fund) may do so at
any time by writing or delivering instructions to the Transfer Agent:
Financial Data Services, Inc.
P.O. Box 41621
Jacksonville, FL 32232-1621
12
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES
<PAGE> 275
[MAGNIFYING GLASS ICON] Account Choices
The redemption request should identify the Fund, specify the number of shares to
be redeemed and be signed by a duly authorized officer of the insurance company.
If the request is in proper form, the shares specified will be redeemed at the
net asset value next determined after receipt of the request. In addition to
written instructions, if any shares being redeemed are represented by share
certificates, the certificates must be surrendered. The certificates must either
be endorsed or accompanied by a stock power signed by a duly authorized officer
of the insurance company, and signatures must be guaranteed. Any questions
concerning documents needed should be directed to (800) 236-4479.
DELAYS IN REDEEMING SHARES
At certain times when allowed by the Securities and Exchange Commission, we may
delay sending your check or wiring your redemption proceeds.
PAYMENTS
Payment also may be delayed up to 12 days if you bought shares with a check.
CHANGES TO REDEMPTION PROCEDURES
The redemption procedures may be modified at any time on 30 days' notice to
shareholders.
REDEMPTION IN KIND
The Fund reserves the right to pay shareholders securities instead of cash in
certain circumstances.
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES 13
<PAGE> 276
[CHECKMARK ICON] Account Choices
NET ASSET VALUE -- the market value in U.S. dollars of the Fund's total assets
after deducting liabilities, divided by the number of shares outstanding.
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
Unless your investment is in a tax-deferred account, you may want to avoid
buying shares shortly before the Fund pays a dividend. The reason? If you buy
shares when a fund has realized but not yet distributed ordinary income or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
HOW SHARES ARE PRICED
--------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE Shares are also redeemed at
their net asset value. The Fund calculates its net asset value (generally by
using market quotations) each day the New York Stock Exchange is open as of the
close of regular trading on the Exchange based on prices at the time of closing,
except that the net asset value need not be calculated on a day on which no
order to purchase or redeem shares of the Fund is received. Regular trading on
the Exchange generally closes at 4:00 p.m. Eastern time. The net asset value
used in determining your price is the next one calculated after your purchase or
redemption order is placed. Foreign securities owned by the Fund may trade on
weekends or other days when the Fund does not price its shares. As a result, the
Fund's net asset value may change on days when you will not be able to purchase
or redeem the Fund's shares.
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
The Fund will distribute any net investment income quarterly and any net
realized long-term or short-term capital gains at least annually. The Fund may
also pay a special distribution at the end of the calendar year to comply with
Federal tax requirements. DIVIDENDS may be reinvested automatically in shares of
the Fund at net asset value or may be taken in cash. The Fund anticipates that
the majority of its dividends, if any, will consist of ordinary income. Capital
gains, if any, may be taxable to you at different rates, depending, in part, on
how long the Fund has held the assets sold.
You will pay tax on dividends from the Fund whether you receive them in cash or
additional shares. If you redeem Fund shares or exchange them for shares of
another fund, you generally will be treated as having sold your shares and any
gain on the transaction may be subject to tax. Capital gain dividends are
generally taxed at different rates than ordinary income dividends.
Dividends and interest received by the Fund may give rise to withholding and
other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes.
14
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES
<PAGE> 277
[MANAGEMENT TEAM ICON] The Management Team
MANAGEMENT OF THE FUND
--------------------------------------------------------------------------------
Mercury Advisors, the Fund's Investment Adviser, manages the Fund's investments
under the overall supervision of the Board of Trustees. The Investment Adviser
has the responsibility for making all investment decisions for the Fund. For the
fiscal year ended June 30, 2000, the Fund paid the Investment Adviser a fee at
the annual rate of 0.75% of the average daily net assets of the Fund.
The Investment Adviser was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
The Investment Adviser and its affiliates had approximately $555 billion in
investment company and other portfolio assets under management as of June 30,
2000.
Although not required to do so, the Investment Adviser voluntarily pays all of
the Fund's operating expenses other than the investment advisory fee.
The Investment Adviser is allowed to allocate brokerage based on sales of shares
of funds managed by the Investment Adviser.
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES 15
<PAGE> 278
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The financial highlights tables are intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the tables
represent the rate that an investor would have earned (or lost) on an investment
in the Fund (assuming reinvestment of all dividends and distributions). These
financial highlights were audited by PricewaterhouseCoopers LLP. The
accountants' report and the Fund's financial statements are included in the
Fund's annual report, which is available upon request. Further performance
information is contained in the annual report.
<TABLE>
<CAPTION>
CLASS I
----------------------------------------------------------------
FOR THE YEAR ENDED JUNE 30,
INCREASE (DECREASE) IN ----------------------------------------------------------------
NET ASSET VALUE: 2000 1999 1998 1997 1996
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
-------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $ 18.55 $ 16.32 $ 13.51 $ 11.53
-------------------------------------------------------------------------------------------------------------------------
Investment income -- net 0.41 0.41 0.39 0.34
-------------------------------------------------------------------------------------------------------------------------
Realized and unrealized gain (loss) on investments -- net 0.70 3.31 3.30 2.26
-------------------------------------------------------------------------------------------------------------------------
Total from investment operations 1.11 3.72 3.69 2.60
-------------------------------------------------------------------------------------------------------------------------
Less dividends and distributions
Investment income -- net (0.41) (0.41) (0.40) (0.40)
Realized gain on investments -- net (1.79) (1.08) (0.48) (0.22)
-------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions (2.20) (1.49) (0.88) (0.62)
-------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $ 17.46 $ 18.55 $ 16.32 $ 13.51
-------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
-------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share 7.29% 23.69% 28.20% 22.93%
-------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
-------------------------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement 0.52% 0.52% 0.53% 0.54%
-------------------------------------------------------------------------------------------------------------------------
Expenses 0.65% 0.73% 0.75% 0.76%
-------------------------------------------------------------------------------------------------------------------------
Investment income -- net 2.28% 2.06% 2.50% 3.00%
-------------------------------------------------------------------------------------------------------------------------
Supplemental Data:
-------------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in millions) $ 43.7 $ 40.7 $ 33.0 $ 24.6
-------------------------------------------------------------------------------------------------------------------------
Portfolio turnover 14% 21% 22% 21%
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
16 MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES
<PAGE> 279
<TABLE>
<S> <C>
FUND
Mercury HW Equity Fund for Insurance Companies
of Mercury HW Funds
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017-5400
(800-236-4479)
INVESTMENT ADVISER
Administrative Offices:
Mercury Advisors
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
725 South Figueroa Street,
Suite 4000
Los Angeles, California 90017-5400
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 41621
Jacksonville, Florida 32232-1621
(800-236-4479)
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
100 E. Wisconsin Ave., Suite 1500
Milwaukee, Wisconsin 53202
DISTRIBUTOR
FAM Distributors, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109-3661
COUNSEL
Gardner, Carton & Douglas
321 North Clark Street
Chicago, Illinois 60610-4795
</TABLE>
<PAGE> 280
[TELEPHONE ICON] To Learn More
SHAREHOLDER REPORTS
Additional information about the Fund's investments will be available in the
Fund's annual and semi-annual reports to shareholders. In the Fund's annual
report you will find a discussion of the relevant market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling
1-800-236-4479.
The Fund will send you one copy of each shareholder report and certain other
mailings regardless of the number of Fund accounts you have. To receive separate
shareholder reports for each account, write to the Transfer Agent at its mailing
address. Include your name, address, tax identification number and brokerage or
mutual fund account number. If you have any questions, please call the Transfer
Agent at 1-800-236-4479.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at Financial Data Services, Inc., P.O. Box 41621, Jacksonville, Florida
32232-1621 or by calling 1-800-236-4479.
Contact the Fund at the telephone number or address indicated on the inside back
cover of this prospectus if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 for information on the operation of the public
reference room. This information is also available on the SEC's Internet Site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION IN THIS PROSPECTUS.
Investment Company Act File #811-4182.
CODE #MHW-1010-1000
(C) Mercury Advisors
Mercury HW Equity Fund
for Insurance Companies
OF MERCURY HW FUNDS
ARTWORK
PROSPECTUS - October , 2000
<PAGE> 281
STATEMENT OF ADDITIONAL INFORMATION
MERCURY HW LARGE CAP VALUE FUND
OF MERCURY HW FUNDS
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017 - Phone No.
(800) 236-4479
------------------------
Mercury HW Large Cap Value Fund (the "Fund") is a fund of Mercury HW Funds
(the "Trust"). The Trust is a diversified, open-end, management investment
company which is organized as a Massachusetts business trust. The investment
objective of the Fund is to seek to provide current income and long-term growth
of income, accompanied by growth of capital. The Fund seeks to achieve its
investment objective by investing primarily in U.S. stocks. No assurance can be
given that the investment objective of the Fund will be realized. For more
information on the Fund's investment objective and policies, see "Investment
Objective and Policies."
The Fund offers a single class (Class I) of shares. Only certain investors
are eligible to purchase Class I shares. See "Purchase of Shares."
------------------------
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the prospectus of the Fund, dated October , 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Fund at
1-800-236-4479 or your financial consultant or other financial intermediary, or
by writing to the Fund at Financial Data Services, Inc., P.O. Box 41621,
Jacksonville, Florida 32232-1621. The Prospectus is incorporated by reference
into this Statement of Additional Information, and this Statement of Additional
Information is incorporated by reference into the Prospectus. The Fund's
financial statements are incorporated by reference to its annual report for the
fiscal year ended June 30, 2000. You may request copies of the annual report at
no charge by calling 1-800-236-4479 between 8:00 a.m. and 8:00 p.m. on any
business day.
------------------------
MERCURY ADVISORS -- INVESTMENT ADVISER
FAM DISTRIBUTORS, INC. -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is October , 2000
<PAGE> 282
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Trust History............................................... 3
Investment Objective and Policies........................... 3
Investment Restrictions................................... 3
Bonds..................................................... 4
Repurchase Agreements..................................... 4
U.S. Government Securities................................ 4
Corporate Debt Securities................................. 5
Convertible Securities.................................... 5
Derivative Instruments.................................... 5
Foreign Securities........................................ 6
Foreign Investment Risks.................................. 7
Swap Agreements........................................... 8
Illiquid Securities....................................... 8
Borrowing................................................. 9
When-Issued Securities.................................... 9
Real Estate Investment Trusts............................. 10
Shares of Other Investment Companies...................... 10
Limited Partnerships...................................... 10
Short Sales Against-the-Box............................... 10
Corporate Loans........................................... 10
Temporary Defensive Position.............................. 10
Management of the Fund...................................... 10
Advisory Arrangements..................................... 12
Accounting and Administrative Services.................... 13
Code of Ethics............................................ 14
Purchase of Shares.......................................... 14
Class I Shares............................................ 15
Reduced Initial Sales Charges............................. 16
Redemption of Shares........................................ 17
Redemption................................................ 18
Repurchase................................................ 18
Reinstatement Privilege -- Class I Shares................. 19
Pricing of Shares........................................... 19
Determination of Net Asset Value.......................... 19
Computation of Offering Price Per Share................... 20
Portfolio Transactions and Brokerage........................ 21
Transactions in Portfolio Securities...................... 21
Shareholder Services........................................ 22
Investment Account........................................ 22
Exchange Privilege........................................ 23
Fee-Based Programs........................................ 24
Retirement Plans.......................................... 24
Automatic Investment Plans................................ 24
Automatic Dividend Reinvestment Plan...................... 24
Systematic Withdrawal Plans............................... 25
Dividends and Tax Status.................................... 25
Performance Data............................................ 26
General Information......................................... 27
Description of Shares..................................... 27
Issuance of Fund Shares for Securities.................... 28
Redemption in Kind........................................ 28
Independent Auditors...................................... 28
Custodian................................................. 28
Transfer Agent............................................ 28
Legal Counsel............................................. 29
Reports to Shareholders................................... 29
Shareholder Inquiries..................................... 29
Additional Information.................................... 29
Principal Holders......................................... 29
</TABLE>
2
<PAGE> 283
TRUST HISTORY
The Trust was organized on August 22, 1984 as a Massachusetts business
trust. Before October 7, 1994, the Trust was called "Olympic Trust," and before
October , 2000, the Trust was called "Hotchkis and Wiley Funds." The Trust is
a diversified, open-end, management investment company currently consisting of
ten separate funds. Prior to October , 2000, the Fund was called the Equity
Income Fund.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide current income and
long-term growth of income, accompanied by growth of capital. Reference is made
to the discussion under "How the Fund Invests" and "Investment Risks" in the
Prospectus for information with respect to the Fund's investment objective and
policies.
Mercury Advisors (the "Investment Adviser"), the Fund's investment adviser,
is responsible for the management of the Fund's portfolio.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of the Fund's outstanding
voting securities, as defined in the Investment Company Act of 1940, as amended
(the "1940 Act"). Under the 1940 Act, the vote of the holders of a "majority" of
the Fund's outstanding voting securities means the vote of the holders of the
lesser of (1) 67% of the shares of the Fund represented at a meeting at which
the holders of more than 50% of its outstanding shares are represented or (2)
more than 50% of the outstanding shares.
Except as noted, the Fund may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Fund's total assets (determined at the time of investment) would
then be invested in securities of a single issuer; or (ii) more than
25% of the Fund's total assets (determined at the time of investment)
would be invested in one or more issuers having their principal
business activities in a single industry.
2. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions),
provided that the deposit or payment by the Fund of initial or
maintenance margin in connection with futures or options is not
considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short (short sale
against-the-box), and unless not more than 25% of the Fund's net assets
(taken at current value) is held as collateral for such sales at any
one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Fund may borrow from a bank for temporary or emergency purposes in
amounts not exceeding 10% (taken at the lower of cost or current value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings; the Fund will not purchase any
additional portfolio securities while such borrowings are outstanding.
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would
then hold more than 10% of the outstanding voting securities of an
issuer.
3
<PAGE> 284
6. Buy or sell commodities or commodity contracts or real estate or
interests in real estate, although it may purchase and sell securities
which are secured by real estate and securities of companies which
invest or deal in real estate. (For the purposes of this restriction,
forward foreign currency exchange contracts are not deemed to be
commodities or commodity contracts.)
7. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws.
8. Make investments for the purpose of exercising control or management.
9. Participate on a joint or joint and several basis in any trading
account in securities.
10. Make loans, except through repurchase agreements.
11. Purchase or sell foreign currencies.
Any percentage limitation on the Fund's investments is determined when the
investment is made, unless otherwise noted.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement where the seller agrees to
repurchase a security from the Fund at a mutually agreed-upon time and price.
The period of maturity is usually quite short, possibly overnight or a few days,
although it may extend over a number of months. The resale price is more than
the purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Fund's money is invested in the repurchase agreement. The
Fund's repurchase agreements will at all times be fully collateralized in an
amount at least equal to the resale price. The instruments held as collateral
are valued daily, and if the value of instruments declines, the Fund will
require additional collateral. In the event of a default, insolvency or
bankruptcy by a seller, the Fund will promptly seek to liquidate the collateral.
In such circumstances, the Fund could experience a delay or be prevented from
disposing of the collateral. To the extent that the proceeds from any sale of
such collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
BONDS
The term "bond" or "bonds" as used in the Prospectus is intended to include
all manner of fixed-income securities, debt securities and other debt
obligations unless specifically defined otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. The Fund will
invest in securities of such instrumentality only when the Investment Adviser is
satisfied that the credit risk with respect to any instrumentality is
acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely, either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (1) Treasury obligations from which the interest coupons
4
<PAGE> 285
have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member bank representing ownership of Treasury obligation
components; or (4) receipts evidencing the component parts (corpus or coupons)
of Treasury obligations that have not actually been stripped. Such receipts
evidence ownership of component parts of Treasury obligations (corpus or
coupons) purchased by a third party (typically an investment banking firm) and
held on behalf of the third party in physical or book-entry form by a major
commercial bank or trust company pursuant to a custody agreement with the third
party. These custodial receipts are known by various names, including "Treasury
Receipts," "Treasury Investment Growth Receipts" ("TIGRs") and "Certificates of
Accrual on Treasury Securities" ("CATS"), and are not issued by the U.S.
Treasury; therefore they are not U.S. Government securities, although the
underlying bonds represented by these receipts are debt obligations of the U.S.
Treasury.
CORPORATE DEBT SECURITIES
The Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, are in the Investment Adviser's opinion comparable
in quality to corporate debt securities in which the Fund may invest. The rate
of return or return of principal on some debt obligations may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying common stock.
The price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
DERIVATIVE INSTRUMENTS
As indicated in the prospectus, to the extent consistent with its
investment objective and policies and the investment restrictions listed in this
Statement of Additional Information, the Fund may purchase and write call and
put options on securities and securities indexes and enter into forward
contracts. The Fund also may enter into swap agreements with respect to interest
rates and securities indexes. The Fund may use these techniques to hedge against
changes in interest rates or securities prices or as part of its overall
investment strategies. The Fund will mark as segregated cash, U.S. government
securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily (or, as permitted by applicable regulation, enter into
certain offsetting positions), to cover its obligations under forward contracts,
swap agreements and options to avoid leveraging of the Fund.
5
<PAGE> 286
Options on Securities and on Securities Indexes. The Fund may purchase put
options on securities to protect holdings in an underlying or related security
against a substantial decline in market value. The Fund may purchase call
options on securities to protect against substantial increases in prices of
securities the Fund intends to purchase pending its ability to invest in such
securities in an orderly manner. The Fund may sell put or call options it has
previously purchased, which could result in a net gain or loss depending on
whether the amount realized on the sale is more or less than the premium and
other transaction costs paid on the put or call option which is sold. The Fund
may write a call or put option only if the option is "covered" by the Fund
holding a position in the underlying securities or by other means which would
permit immediate satisfaction of the Fund's obligation as writer of the option.
Prior to exercise or expiration, an option may be closed out by an offsetting
purchase or sale of an option of the same series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
FOREIGN SECURITIES
The Fund may invest in American Depositary Receipts ("ADRs"), other
securities convertible into securities of issuers based in foreign countries or
other foreign securities that can be purchased and sold in U.S. dollars. ADRs
are receipts, usually issued by a U.S. bank or trust company, evidencing
ownership of the underlying securities; EDRs are European receipts evidencing a
similar arrangement. Generally, ADRs are issued in registered form, denominated
in U.S. dollars, and are designed for use in the U.S. securities markets.
6
<PAGE> 287
FOREIGN INVESTMENT RISKS
Foreign Market Risk. The Fund may invest a portion of its assets in foreign
securities. Foreign security investment involves special risks not present in
U.S. investments that can increase the chances that the Fund will lose money.
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of capital, resources, and
balance of payments position. Certain such economies may rely heavily on
particular industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a particular country
or countries, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. Investments in foreign markets may
also be adversely affected by governmental actions such as the imposition of
capital controls, nationalization of companies or industries, expropriation of
assets, or the imposition of punitive taxes. In addition, the governments of
certain countries may prohibit or impose substantial restrictions on foreign
investing in their capital markets or in certain industries. Any of these
actions could severely affect security prices, impair the Fund's ability to
purchase or sell foreign securities or otherwise adversely affect the Fund's
operations. Other foreign market risks include difficulties in pricing
securities, defaults on foreign government securities, difficulties in enforcing
favorable legal judgments in foreign courts, and political and social
instability. Legal remedies available to investors in certain foreign countries
may be less extensive than those available to investors in the United States or
other foreign countries.
EMU. For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU established a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU participants by July 1, 2002. Upon implementation of EMU,
certain securities issued in participating EU countries (beginning with
government and corporate bonds) were redenominated in the euro, and are now
listed, traded, declaring dividends and making other payments only in euros.
No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on the Fund's investments
in Europe generally or in specific countries participating in EMU.
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some countries may not have laws
to protect investors the way that the United States securities laws do.
Accounting standards in other countries are not necessarily the same as in the
United States. If the accounting standards in another country do not require as
much disclosure or detail as U.S. accounting standards, it may be harder for the
Fund's portfolio managers to completely and accurately determine a company's
financial condition.
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Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
SWAP AGREEMENTS
The Fund may enter into interest rate and index swap agreements for
purposes of attempting to obtain a particular desired return at a lower cost to
the Fund than if the Fund had invested directly in an instrument that yielded
the desired return. Swap agreements are two party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to
more than one year. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized on
particular predetermined investments or instruments. The gross returns to be
exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate or in a "basket" of
securities representing a particular index. The "notional amount" of the swap
agreement is only a fictive basis on which to calculate the obligations which
the parties to a swap agreement have agreed to exchange. The Fund's obligations
(or rights) under a swap agreement will generally be equal only to the net
amount to be paid or received under the agreement based on the relative values
of the positions held by each party to the agreement (the "net amount"). The
Fund's obligations under a swap agreement will be accrued daily (offset against
any amounts owing to the Fund) and any accrued but unpaid net amounts owed to a
swap counter-party will be covered by marketing as segregated cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, to avoid any potential leveraging of the Fund's
portfolio. The Fund will not enter into a swap agreement with any single party
if the net amount owed or to be received under existing contracts with that
party would exceed 5% of the Fund's assets.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Investment Adviser's
ability to correctly predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, the Fund bears the risk
of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counter-party.
Restrictions imposed by the Internal Revenue Code may limit the Fund's ability
to use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps market,
including potential government regulation, could adversely affect the Fund's
ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions of
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended ("Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
that have a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Limitations on resale may have an adverse effect on the
marketability of portfolio securities and a mutual fund might be unable to
dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemption within
seven days. The absence of a trading market can make it difficult to ascertain a
market value for illiquid investments. Also market quotations are less readily
available. The judgment of the Investment Adviser may at times play a greater
role in valuing these securities than in the case of unrestricted securities. A
mutual fund might also have to register such restricted securities in order to
dispose of them resulting in additional expense and delay. Adverse market
conditions could impede such a public offering of securities.
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In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Investment Adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least one nationally recognized statistical
rating organizations ("NRSRO"), or, if unrated, be of comparable quality in the
view of the Investment Adviser; and (2) it must not be in default as to
principal or interest. Investing in Rule 144A securities could have the effect
of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
BORROWING
The Fund may borrow for temporary or emergency purposes in amounts not
exceeding 10% of the Fund's total assets. This borrowing may be unsecured. The
1940 Act requires the Fund to maintain continuous asset coverage (that is, total
assets including borrowings, less liabilities exclusive of borrowings) of 300%
of the amount borrowed. Borrowing subjects the Fund to interest costs which may
or may not be recovered by appreciation of the securities purchased, and can
exaggerate the effect on net asset value of any increase or decrease in the
market value of the Fund's portfolio. This is the speculative factor known as
leverage.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value of the security each day in determining the Fund's net asset
value. The Fund will also mark as segregated with its custodian cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, equal in value to its obligations for when-issued
securities.
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REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain Internal Revenue Code requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties, as well as
greater income potential than an investment in common stocks. Like any
investment in real estate, though, a REIT's performance depends on several
factors, such as its ability to find tenants for its properties, to renew leases
and to finance property purchases and renovations.
SHARES OF OTHER INVESTMENT COMPANIES
The Fund can invest in securities of other investment companies except to
the extent prohibited by law. Like all equity investments, these investments may
go up or down in value. They also may not perform in correlation with the Fund's
principal strategies. The Fund will pay additional fees through its investments
in other investment companies.
LIMITED PARTNERSHIPS
The Fund can invest in limited partnership interests.
SHORT SALES AGAINST-THE-BOX
The Fund can borrow and sell "short" securities when it also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund's
total assets can be held as collateral for short sales at any one time.
CORPORATE LOANS
The Fund can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Fund may not
recover its investment, or there might be a delay in the Fund's recovery. By
investing in a corporate loan, the Fund becomes a member of the syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, the Fund may invest
all or part of its assets in short-term investment grade debt obligations of the
U.S. government, its agencies and instrumentalities, bank certificates of
deposit, bankers' acceptances, high quality commercial paper, demand notes and
repurchase agreements.
MANAGEMENT OF THE FUND
The Trustees oversee the actions of the Fund's Investment Adviser and other
service providers and decide upon matters of general policy. The Trustees also
review the actions of the Trust's officers, who conduct and
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supervise the daily business operations of the Trust. The Trustees (* denotes
"interested" Trustee as defined in the 1940 Act, due to the relationship with
the Investment Adviser) and officers of the Trust are:
MICHAEL BAXTER* (37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since 1999);
Managing Director of the Investment Adviser (since 1996); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since 1994); Chairman, Gamma Services Corp.
(venture capital) (since 1968); Principal, Gavin, Dailey & Partners (consulting)
(since 1993); U.S. Ambassador to Mexico (1981 - 1986); Director, Apex Mortgage
Capital, Inc., Atlantic Richfield Co., International Wire Corp. and Krause's
Furniture.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (since 1986); Member of CIEBA's Executive Committee (since
1988) and its Chairman (from 1991 - 1992); Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds (1986 - 1993); Member of the Investment Advisory Committees of
the State of New York Common Retirement Fund and the Howard Hughes Medical
Institute (since 1997); Director, Duke Management Company (since 1992) and Vice
Chairman (since 1998); Director, Kimco Realty Corporation (since 1997);
Director, LaSalle Street Fund (since 1995); Member of the Investment Advisory
Committee of the Virginia Retirement System (since 1998); Director, Montpelier
Foundation (since 1998); Trustee or Director of 31 registered investment
companies (consisting of 47 portfolios) for which the Investment Adviser or an
advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since
1999); Managing Director of the Investment Adviser (since 1998); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (49) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 66 registered investment companies
(consisting of 70 portfolios) for which the Investment Adviser or an advisory
affiliate is the adviser.
NANCY D. CELICK (48) -- President -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Chief Administrative Officer of the Investment
Adviser (since 1998); Chief Financial Officer of the Investment Adviser
(1993 - 1998); Chief Financial Officer of Kennedy-Wilson, Inc. (auction
marketing services) (1992 - 1993); Chief Financial Officer of First National
Corporation (bank holding company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-901. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services,
Inc. (since 1999); Vice President of FAM Distributors, Inc. (since 1999); First
Vice President of the Investment Adviser (1990 - 1997).
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ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
GRACIE FERMELIA (38) -- Vice President and Assistant Secretary -- 725 South
Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Director of the
Investment Adviser (since 2000); Vice President of the Investment Adviser
(1994 - 2000); Senior Manager, Price Waterhouse (1985 - 1994).
The Trust does not pay salaries to any of its officers or fees to any of
its Trustees affiliated with the Investment Adviser. The following table sets
forth the aggregate compensation paid to the Trustees during the Trust's fiscal
year ended June 30, 2000 and the aggregate compensation paid to the Trustees for
service on the Trust's Board and that of any other fund for which the Investment
Adviser serves as investment adviser or which has an investment adviser that is
an affiliated person of the Investment Adviser ("Fund Complex") for the year
ended December 31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $ $ 34,000
John A. G. Gavin................................... $ $ 25,000
Joe Grills......................................... $ $232,000
Nigel Hurst-Brown.................................. $ -0- $ -0-
Robert B. Hutchinson**............................. $ $ 34,000
Madeleine A. Kleiner............................... $ $ 18,000
Merle T. Welshans**................................ $ $ 34,000
Richard R. West.................................... $ $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of Mercury HW Variable Trust, the Fund
Asset Management Master Trust and Merrill Lynch Investment Managers Funds,
Inc. Messrs. Grills and West also serve on the boards of other investment
companies advised by the Investment Adviser or its advisory affiliates.
** Messrs. Hutchinson and Welshans retired on November 12, 1999.
The Trustees may be eligible for reduced sales charges on purchases of
Class I shares. See "Reduced Initial Sales Charges -- Purchase Privileges of
Certain Persons."
For information as to ownership of shares, see "General
Information -- Principal Holders."
ADVISORY ARRANGEMENTS
Investment Advisory Services and Fee. The Trust on behalf of the Fund has
entered into an investment advisory agreement with the Investment Adviser as
investment adviser (the "Advisory Agreement"). Subject to the supervision of the
Trustees, the Investment Adviser is responsible for the actual management of the
Fund and constantly reviews the Fund's holdings in light of its own research
analysis and that from other relevant sources. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser. The Investment Adviser performs certain of the other administrative
services and provides all office space, facilities, equipment and necessary
personnel for management of the Fund. The Investment Adviser receives for its
services to the Fund a monthly fee at an annual rate of 0.75% of the Fund's
average daily net assets. For purposes of this calculation, average daily net
assets is determined at the end of each month on the basis of the average net
assets of the Fund for each day during the month.
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<PAGE> 293
Prior to October , 2000, the Fund was party to an investment advisory
agreement under which it paid Merrill Lynch Investment Managers, L.P., an
affiliate of the Investment Adviser, a fee at the annual rate of 0.75% of its
average daily net assets. For the fiscal years ended June 30, 2000, 1999 and
1998, the Fund paid Merrill Lynch Investment Managers, L.P. $ ,
$1,176,425 and $1,424,185, respectively. For the fiscal years ended June 30,
2000 and 1999, as a result of its agreement to limit Fund expenses, MLIM waived
a portion of its fee in the amounts of $ and $2,088, respectively.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients of the Investment Adviser or an affiliate when one or more clients of
the Investment Adviser or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Payment of Fund Expenses. The Advisory Agreement obligates the Investment
Adviser to provide investment advisory services and to pay, or cause an
affiliate to pay, for maintaining its staff and personnel and to provide office
space, facilities and necessary personnel for the Fund. The Investment Adviser
is also obligated to pay, or cause an affiliate to pay, the fees of all officers
and Trustees who are affiliated persons of the Investment Adviser. The Fund
pays, or causes to be paid, all other expenses incurred in the operation of the
Fund (except to the extent paid by FAM Distributors, Inc. (the "Distributor")),
including, among other things, taxes, expenses for legal and auditing services,
costs of printing proxies, shareholder reports, copies of the Registration
Statement, charges of the custodian, any sub-custodian and the transfer agent,
expenses of portfolio transactions, expenses of redemption of shares, commission
fees, expenses of registering the shares under Federal, state or non-U.S. laws,
fees and actual out-of-pocket expenses of non-interested Trustees, accounting
and pricing costs (including the daily calculation of net asset value),
insurance, interest, brokerage costs, litigation and other extraordinary or
non-recurring expenses, and other expenses properly payable by the Fund.
Organization of the Investment Adviser. The Investment Adviser is a limited
partnership, the partners of which are Merrill Lynch & Co., Inc. ("ML & Co."), a
financial services holding company and the parent of Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"), and Princeton Services, Inc. ML &
Co. and Princeton Services, Inc. are "controlling persons" of the Investment
Adviser as defined under the 1940 Act because of their ownership of its voting
securities and their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Advisory Agreement will remain in effect from year to year if approved annually
(a) by the Board of Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees of the Trust who are
not parties to the Advisory Agreement or interested persons (as defined in the
1940 Act) of any such party. The Advisory Agreement is not assignable and will
automatically terminate in the event of its assignment. In addition, such
contract may be terminated by the vote of a majority of the outstanding voting
securities of the Fund or by the Investment Adviser without penalty on 60 days'
written notice to the other party.
ACCOUNTING AND ADMINISTRATIVE SERVICES
The Trust has entered into a Fund Accounting and Administration Servicing
Agreement (the "Fund Accounting Agreement") with the Investment Adviser acting
as service provider. The Fund Accounting Agreement obligates the Investment
Adviser to provide certain accounting and administrative services to the Trust.
The Trust reimburses the Investment Adviser for its costs in connection with
such services.
Transfer Agency Services. The Transfer Agent, a subsidiary of ML & Co.,
acts as the Fund's Transfer Agent pursuant to a Transfer Agency, Dividend
Disbursing Agency and Shareholder Servicing Agency
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<PAGE> 294
Agreement (the "Transfer Agency Agreement"). Pursuant to the Transfer Agency
Agreement, the Transfer Agent is responsible for the issuance, transfer and
redemption of shares and the opening and maintenance of shareholder accounts.
Pursuant to the Transfer Agency Agreement, the Transfer Agent receives a fee
ranging from $16.00 to $20.00 per account (depending on the level of services
required) and certain other fees relating to special processing of sub-transfer
agency relationships. The Transfer Agent is entitled to reimbursement for
certain transaction charges and out-of-pocket expenses incurred by the Transfer
Agent under the Transfer Agency Agreement. For purposes of the Transfer Agency
Agreement, the term "account" includes a shareholder account maintained directly
by the Transfer Agent and any other account representing the beneficial interest
of a person in the relevant share class on a recordkeeping system.
Distribution Expenses. The Fund has entered into a distribution agreement
with the Distributor in connection with the continuous offering of shares of the
Fund (the "Distribution Agreement"). The Distribution Agreement obligates the
Distributor to pay certain expenses in connection with the offering of the
shares of the Fund. After the prospectuses, statements of additional information
and periodic reports have been prepared, set in type and mailed to shareholders,
the Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to dealers and investors. The Distributor also pays
for other supplementary sales literature and advertising costs. The Distribution
Agreement is subject to the same renewal requirements and termination provisions
as the Advisory Agreement described above.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act that covers the Trust, the Investment Adviser and the
Distributor (the "Code of Ethics"). The Code of Ethics significantly restricts
the personal investing activities of all employees of the Investment Adviser and
the Distributor and, as described below, imposes additional more onerous
restrictions on fund investment personnel.
The Code of Ethics requires that all employees of the Investment Adviser
and the Distributor pre-clear any personal securities investments (with limited
exceptions, such as mutual funds, high-quality short-term securities and direct
obligations of the U.S. government). The pre-clearance requirement and
associated procedures are designed to identify any substantive prohibition or
limitation applicable to the proposed investment. The substantive restrictions
applicable to all employees of the Investment Adviser and the Distributor
include a ban on acquiring any securities in a "hot" initial public offering. In
addition, investment personnel are prohibited from profiting on short-term
trading in securities. No employee may purchase or sell any security that at the
time is being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Investment Adviser. Furthermore, the Code of Ethics provides for trading
"blackout periods" which prohibit trading by investment personnel of the Fund
within seven calendar days, before or after, of trading by the Fund in the same
or equivalent security.
PURCHASE OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus for certain information as to the purchase of
Fund shares.
The Fund issues a single class (Class I) of shares. Each share of the Fund
represents an identical interest in the investment portfolio of the Fund, and
has the same rights.
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share plus any sales charge applicable to the
shares. The applicable offering price for purchase orders is based upon the net
asset value of the Fund next determined after receipt of the purchase order by
the Distributor. As to purchase orders received by selected securities dealers
or other financial intermediaries prior to the close of regular trading on the
New York Stock Exchange (the "NYSE") (generally 4:00 p.m., Eastern time) which
includes orders received after the determination of net asset value on the
previous day, the applicable offering price will be based on the net asset value
on the day the order is placed with the Distributor, provided that the
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orders are received by the Distributor prior to 30 minutes after the close of
regular trading on the NYSE on that day. If the purchase orders are not received
prior to 30 minutes after the close of regular trading on the NYSE on that day,
such orders shall be deemed received on the next business day. Selected
securities dealers or other financial intermediaries have the responsibility of
submitting purchase orders to the Fund not later than 30 minutes after the close
of regular trading on the NYSE in order to purchase shares at that day's
offering price.
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares at any time in response to conditions in the securities markets or
otherwise and may thereafter resume such offering from time to time. Any order
may be rejected by the Fund or the Distributor. Neither the Distributor nor the
selected securities dealers or other financial intermediaries are permitted to
withhold placing orders to benefit themselves by a price change. Certain
selected securities dealers or other financial intermediaries may charge a
processing fee to confirm a sale of shares. For example, the fee currently
charged by Merrill Lynch is $5.35. Purchases made directly through the Transfer
Agent are not subject to the processing fee.
CLASS I SHARES
Class I shares will be subject to an initial sales charge, unless you
qualify for a reduction or waiver of the sales charge. See "Reduced Initial
Sales Charges." The term "purchase," as used in the Prospectus and this
Statement of Additional Information in connection with an investment in Class I
shares of the Fund, refers to a single purchase by an individual or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his or her spouse and their children under
the age of 21 years purchasing shares for his, her or their own account and to
single purchases by a trustee or other fiduciary purchasing shares for a single
trust estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company," as that
term is defined in the 1940 Act, but does not include purchases by any such
company that has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
Class I shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class I shares. Investors
who owned Investor Class shares or who currently own Class I shares of the Fund
in a shareholder account are entitled to purchase additional Class I shares of
the Fund in that account. Certain employer-sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class I shares at net asset
value provided such plans meet the required minimum number of eligible employees
or required amount of assets advised by the Investment Adviser or any of its
affiliates. Also eligible to purchase Class I shares at net asset value are
participants in certain investment programs including certain managed accounts
for which a trust institution, thrift or bank trust department provides
discretionary trustee services, certain collective investment trusts for which a
trust institution, thrift, or bank trust department serves as trustee, certain
purchases made in connection with certain fee-based programs and certain
purchases made through certain financial advisers that meet and adhere to
standards established by the Investment Adviser. Class I shares are available at
net asset value to corporate warranty insurance reserve fund programs and U.S.
branches of foreign banking institutions, provided that the participant has $3
million or more initially invested in affiliate-advised investment companies. In
addition, Class I shares are offered at net asset value to ML & Co. and its
subsidiaries and their directors and employees, to members of the Boards of
investment companies advised by the Investment Adviser or its affiliates,
including the Fund, and to employees of certain selected securities dealers or
other financial intermediaries. Class I shares may also be offered at net asset
value to certain accounts over which the Investment Adviser or an affiliate
exercises investment discretion[, and to certain institutional investors].
Although some investors who previously purchased Class I shares may no longer be
eligible to purchase Class I shares of other affiliate-advised funds, those
previously purchased Class I shares, together with Class A, Class B and Class C
share holdings of other Mercury mutual funds, will count toward a right of
accumulation which may qualify the investor for a reduced initial sales charge
on new initial sales charge purchases.
15
<PAGE> 296
The Distributor may reallow discounts to selected securities dealers or
other financial intermediaries and retain the balance over such discounts. At
times the Distributor may reallow the entire sales charge to such selected
securities dealers or other financial intermediaries. Since selected securities
dealers or other financial intermediaries selling Class I shares of the Fund
will receive a concession equal to most of the sales charge, they may be deemed
to be underwriters under the Securities Act.
REDUCED INITIAL SALES CHARGES
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
to obtain such investments.
Reinvested Dividends. No initial sales charges are imposed upon shares
issued as a result of the automatic reinvestment of dividends.
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other Mercury mutual funds. For any such right of accumulation to be
made available, the Distributor must be provided at the time of purchase, by the
purchaser or the purchaser's selected securities dealer or other financial
intermediary, with sufficient information to permit confirmation of
qualification. Acceptance of the purchase order is subject to such confirmation.
The right of accumulation may be amended or terminated at any time. Shares held
in the name of a nominee or custodian under pension, profit-sharing, or other
employee benefit plans may not be combined with other shares to qualify for the
right of accumulation.
Letter of Intent. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class I shares of the Fund or any other Mercury
mutual funds made within a 13-month period starting with the first purchase
pursuant to the Letter of Intent. The Letter of Intent is available only to
investors whose accounts are established and maintained at the Fund's Transfer
Agent. The Letter of Intent is not available to employee benefit plans for which
affiliates of the Investment Adviser provide plan participant record-keeping
services. The Letter of Intent is not a binding obligation to purchase any
amount of Class I shares; however, its execution will result in the purchaser
paying a lower sales charge at the appropriate quantity purchase level. A
purchase not originally made pursuant to a Letter of Intent may be included
under a subsequent Letter of Intent executed within 90 days of such purchase if
the Distributor is informed in writing of this intent within such 90-day period.
The value of Class I shares of the Fund and of other Mercury mutual funds
presently held, at cost or maximum offering price (whichever is higher), on the
date of the first purchase under the Letter of Intent, may be included as a
credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied only to new
purchases. If the total amount of shares does not equal the amount stated in the
Letter of Intent (minimum of $25,000), the investor will be notified and must
pay, within 20 days of the execution of such Letter, the difference between the
sales charge on the Class I shares purchased at the reduced rate and the sales
charge applicable to the shares actually purchased through the Letter. Class I
shares equal to 5.0% of the intended amount will be held in escrow during the
13-month period (while remaining registered in the name of the purchaser) for
this purpose. The first purchase under the Letter of Intent must be at least
5.0% of the dollar amount of such Letter. If a purchase during the term of such
Letter would otherwise be subject to a further reduced sales charge based on the
right of accumulation, the purchaser will be entitled on that purchase and
subsequent purchases to that further reduced percentage sales charge but there
will be no retroactive reduction of the sales charges on any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intent will be deducted from
the total purchases made under such Letter. An exchange from the Summit Cash
Reserves Fund ("Summit") into the Fund that creates a sales charge will count
toward completing a new or existing Letter of Intent from the Fund.
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<PAGE> 297
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and certain
other arrangements may purchase Class I shares at net asset value, based on the
number of employees or number of employees eligible to participate in the plan
and/or the aggregate amount invested by the plan in specified investments.
Minimum purchase requirements may be waived or varied for such plans. For
additional information regarding purchases by employer-sponsored retirement or
savings plans and certain other arrangements, call your plan administrator or
your selected securities dealer or other financial intermediary.
Managed Trusts. Class I shares are offered at net asset value to certain
trusts to which trust institutions, thrifts, and bank trust departments provide
discretionary trustee services.
Purchase Privileges of Certain Persons. Trustees of the Trust and of other
investment companies advised by the Investment Adviser or its affiliates,
directors and employees of ML & Co. and its subsidiaries (the term
"subsidiaries," when used herein with respect to ML & Co., includes the
Investment Adviser, Merrill Lynch Investment Managers, L.P., Merrill Lynch
Investment Managers International Limited and certain other entities directly or
indirectly wholly owned and controlled by ML & Co.), employees of certain
selected securities dealers, and any trust, pension, profit-sharing or other
benefit plan for such persons, may purchase Class I shares of the Fund at net
asset value. The Fund realizes economies of scale and reduction of sales-
related expenses by virtue of the familiarity of these persons with the Fund.
Employees and Trustees wishing to purchase shares of the Fund must satisfy the
Fund's suitability standards.
Class I shares are also offered at net asset value to certain accounts over
which the Investment Adviser or an affiliate exercises investment discretion[,
and to certain institutional investors.]
Purchases Through Certain Financial Intermediaries. Reduced sales charges
may be applicable for purchases of Class I shares of the Fund through certain
financial advisers, selected securities dealers and other financial
intermediaries that meet and adhere to standards established by the Investment
Adviser from time to time.
A waived sales charge on a purchase of Class I shares will apply to current
beneficial shareholders who were also beneficial shareholders of the Fund as of
the opening of business of the Fund on October , 2000.
REDEMPTION OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Except for any deferred sales charge that may be applicable, there
will be no charge for redemption if the redemption request is sent directly to
the Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists, as defined by the
Commission, as a result of which disposal of portfolio securities or
determination of the net asset value of the Fund is not reasonably practicable,
and for such other periods as the Commission may by order permit for the
protection of shareholders of the Fund.
The value of shares of the Fund at the time of redemption may be more or
less than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
The Trust has entered into a joint committed line of credit with other
investment companies advised by the Investment Adviser and its affiliates and a
syndicate of banks that is intended to provide the Fund with a temporary source
of cash to be used to meet redemption requests from Fund shareholders in
extraordinary or emergency circumstances.
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<PAGE> 298
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so by tendering the shares directly to the Fund's Transfer Agent, Financial Data
Services, Inc., P.O. Box 41621, Jacksonville, Florida 32232-1621. Redemption
requests delivered other than by mail should be delivered to Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting redemption. Redemption
requests should not be sent to the Fund. The redemption request in either event
requires the signature(s) of all persons in whose name(s) the shares are
registered, signed exactly as such name(s) appear(s) on the Transfer Agent's
register. The signature(s) on the redemption request may require a guarantee by
an "eligible guarantor institution" as defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications. In the
event a signature guarantee is required, notarized signatures are not
sufficient. In general, signature guarantees are waived on redemptions of less
than $50,000 as long as the following requirements are met: (i) all requests
require the signature(s) of all persons in whose name(s) shares are recorded on
the Transfer Agent's register; (ii) all checks must be mailed to the stencil
address of record on the Transfer Agent's register and (iii) the stencil address
must not have changed within 30 days. Certain rules may apply regarding certain
account types such as but not limited to UGMA/UTMA accounts, Joint Tenancies
with Rights of Survivorship, contra broker transactions and institutional
accounts. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority.
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the Transfer
Agent at 1-800-236-4479. The request must be made by the shareholder of record
and be for an amount less than $50,000. Before telephone requests will be
honored, signature approval from all shareholders of record on the account must
be obtained. The shares being redeemed must have been held for at least 15 days.
Telephone redemption requests will not be honored in the following situations:
the accountholder is deceased, the proceeds are to be sent to someone other than
the shareholder of record, funds are to be wired to the client's bank account, a
systematic withdrawal plan is in effect, the request is by an individual other
than the accountholder of record, the account is held by joint tenants who are
divorced, the address has changed within the last 30 days or share certificates
have been issued on the account.
Since this account feature involves a risk of loss from unauthorized or
fraudulent transactions, the Transfer Agent will take certain precautions to
protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address registered
on the account and the social security number registered on the account. The
Fund or the Transfer Agent may temporarily suspend telephone transactions at any
time.
For shareholders redeeming directly with the Transfer Agent, payments will
be mailed within seven days of receipt of a proper notice of redemption. At
various times the Fund may be requested to redeem shares for which it has not
yet received good payment (e.g., cash, Federal funds or certified check drawn on
a U.S. bank). The Fund may delay or cause to be delayed the mailing of a
redemption check until such time as good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank) has been collected for the purchase of
such Fund shares, which usually will not exceed 10 days. In the event that a
shareholder account held directly with the Transfer Agent contains a fractional
share balance, such fractional share balance will be automatically redeemed by
the Fund.
REPURCHASE
The Fund also will repurchase its shares through a shareholder's listed
selected securities dealer or other financial intermediary. The Fund normally
will accept orders to repurchase shares by wire or telephone from dealers for
their customers at the net asset value next computed after the order is placed.
Shares will be priced at the net asset value calculated on the day the request
is received, provided that the request for repurchase is submitted to the
selected securities dealer or other financial intermediary prior to the close of
regular trading
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<PAGE> 299
on the NYSE (generally, regular trading on the NYSE closes at 4:00 p.m., Eastern
time) and such request is received by the Fund from such selected securities
dealer or other financial intermediary not later than 30 minutes after the close
of regular trading on the NYSE on the same day.
Selected securities dealers and other financial intermediaries have the
responsibility of submitting such repurchase requests to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to obtain
that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any applicable
deferred sales charge). Securities firms that do not have agreements with the
Distributor, however, may impose a transaction charge on the shareholder for
transmitting the notice of repurchase to the Fund. Certain selected securities
dealers and other financial intermediaries may charge a processing fee to
confirm a repurchase of shares. For example, the fee currently charged by
Merrill Lynch is $5.35. Fees charged by other selected securities dealers may be
higher or lower. Repurchases made through the Transfer Agent, on accounts held
at the Transfer Agent, are not subject to the processing fee. The Fund reserves
the right to reject any order for repurchase, which right of rejection might
adversely affect shareholders seeking redemption through the repurchase
procedure. A shareholder whose order for repurchase is rejected by the Fund,
however, may redeem Fund shares as set forth above.
REINSTATEMENT PRIVILEGE -- CLASS I SHARES
Shareholders of the Fund who have redeemed their Class I shares have a
privilege to reinstate their accounts by purchasing Class I shares of the Fund
at the net asset value without a sales charge up to the dollar amount redeemed.
The reinstatement privilege may be exercised by sending a notice of exercise
along with a check for the amount to be reinstated to the Transfer Agent within
30 days after the date the request for redemption was accepted by the Transfer
Agent or the Distributor. Alternatively, the reinstatement privilege may be
exercised through the investor's financial consultant within 30 days after the
date the request for redemption was accepted by the Transfer Agent or the
Distributor. The reinstatement will be made at the net asset value per share
next determined after the notice of reinstatement is received and cannot exceed
the amount of the redemption proceeds.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "Account Choices -- How Shares are Priced" in the
Prospectus.
The net asset value of the shares of the Fund is determined once daily
Monday through Friday as of the close of regular trading on the NYSE on each day
the NYSE is open for trading based on prices at the time of closing. Regular
trading on the NYSE generally closes at 4:00 p.m., Eastern time. Any assets or
liabilities initially expressed in terms of non-U.S. dollar currencies are
translated into U.S. dollars at the prevailing market rates as quoted by one or
more banks or dealers on the day of valuation. The NYSE is not open for trading
on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Net asset value of the Fund is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Investment Adviser are accrued daily.
Portfolio securities, including ADRs, EDRs or GDRs, that are traded on
stock exchanges are valued at the last sale price (regular way) on the exchange
on which such securities are traded, as of the close of regular trading on the
day the securities are being valued or, lacking any sales, at the last available
bid price for long positions, and at the last available ask price for short
positions. In cases where securities are traded on more than one exchange, the
securities are valued on the exchange designated by or under the authority of
the Board of Trustees as the primary market. Long positions in securities traded
in the OTC market are valued at
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<PAGE> 300
the last available bid price in the OTC market prior to the time of valuation.
Short positions in securities traded in the OTC market are valued at the last
available ask price in the OTC market prior to the time of valuation. Portfolio
securities that are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market. When the Fund
writes an option, the amount of the premium received is recorded on the books of
the Fund as an asset and an equivalent liability. The amount of the liability is
subsequently valued to reflect the current market value of the option written,
based upon the last sale price in the case of exchange-traded options or, in the
case of options traded in the OTC market, the last ask price. Options purchased
by the Fund are valued at their last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last bid price.
Other investments, including financial futures contracts and related options,
are stated at market value. Securities and assets for which market quotations
are not readily available are valued at fair value as determined in good faith
by or under the direction of the Board of Trustees. Such valuations and
procedures will be reviewed periodically by the Board of Trustees.
Generally, trading in non-U.S. securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of regular trading on the NYSE. The values of
such securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of regular trading on the NYSE. Occasionally,
events affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of regular trading
on the NYSE that may not be reflected in the computation of the Fund's net asset
value.
Each investor in the Fund may add to or reduce its investment in the Fund
on each day the NYSE is open for trading. The value of each investor's interest
in the Fund will be determined as of the close of regular trading on the NYSE by
multiplying the net asset value of the Fund by the percentage, effective for
that day, that represents that investor's share of the aggregate interests in
the Fund. The close of regular trading on the NYSE is generally 4:00 p.m.,
Eastern time. Any additions or withdrawals to be effected on that day will then
be effected. The investor's percentage of the aggregate beneficial interests in
the Fund will then be recomputed as the percentage equal to the fraction (i) the
numerator of which is the value of such investor's investment in the Fund as of
the time of determination on such day plus or minus, as the case may be, the
amount of any additions to or withdrawals from the investor's investment in the
Fund effected on such day, and (ii) the denominator of which is the aggregate
net asset value of the Fund as of such time on such day plus or minus, as the
case may be, the amount of the net additions to or withdrawals from the
aggregate investments in the Fund by all investors in the Fund. The percentage
so determined will then be applied to determine the value of the investor's
interest in the Fund after the close of regular trading on the NYSE on the next
determination of net asset value of the Fund.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for shares of the
Fund based on the net asset value of the Fund's shares on June 30, 2000 is as
follows:
<TABLE>
<CAPTION>
CLASS I
-------
<S> <C>
Net Assets.................................................. $
-------
Number of Shares Outstanding................................
-------
Net Asset Value Per Share (net assets divided by number of
shares outstanding)....................................... $
-------
Sales Charge (for Class I Shares; 5.25% of Offering Price;
( % of net amount invested))*.........................
-------
Offering Price.............................................. $
-------
</TABLE>
---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable. No sales charges were imposed as of June 30, 2000.
20
<PAGE> 301
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Subject to policies established by the Board of Trustees, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Fund, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and operational facilities of the firm and the
firm's risk in positioning a block of securities. While the Investment Adviser
generally seeks reasonably competitive commission rates, the Fund does not
necessarily pay the lowest spread or commission available. In addition,
consistent with the Conduct Rules of the NASD and policies established by the
Board of Trustees, the Investment Adviser may consider sales of Fund shares as a
factor in the selection of brokers or dealers to execute portfolio transactions
for the Fund; however, whether or not a particular broker or dealer sells shares
of the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Fund.
Subject to obtaining the best net results, brokers who provide supplemental
investment research to the Investment Adviser may receive orders for
transactions by the Fund. Such supplemental research services ordinarily consist
of assessments and analyses of the business or prospects of a company, industry
or economic sector. Information so received will be in addition to and not in
lieu of the services required to be performed by the Investment Adviser under
the Investment Advisory Agreement and the expenses of the Investment Adviser
will not necessarily be reduced as a result of the receipt of such supplemental
information. If in the judgment of the Investment Adviser the Fund will benefit
from supplemental research services, the Investment Adviser is authorized to pay
brokerage commissions to a broker furnishing such services that are in excess of
commissions that another broker may have charged for effecting the same
transactions. Certain supplemental research services may primarily benefit one
or more other investment companies or other accounts for which the Investment
Adviser exercises investment discretion. Conversely, the Fund may be the primary
beneficiary of the supplemental research services received as a result of
portfolio transactions effected for such other accounts or investment companies.
Foreign equity securities may be held by the Fund in the form of ADRs,
EDRs, GDRs or other securities convertible into foreign equity securities. ADRs,
EDRs and GDRs may be listed on stock exchanges, or traded in over-the-counter
markets in the United States or Europe, as the case may be. ADRs, like other
securities traded in the United States, will be subject to negotiated commission
rates. The Fund's ability and decisions to purchase or sell portfolio securities
of foreign issuers may be affected by laws or regulations relating to the
convertibility and repatriation of assets. Because the shares of the Fund are
redeemable on a daily basis in U.S. dollars, the Fund intends to manage the
portfolio so as to give reasonable assurance that it will be able to obtain U.S.
dollars to the extent necessary to meet anticipated redemptions. Under present
conditions, it is not believed that these considerations will have significant
effect on the Fund's portfolio strategies.
The Fund may invest in certain securities traded in the OTC market and
intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Fund and
persons who are affiliated with such affiliated persons are prohibited from
dealing with the Fund as principal in the purchase and sale of securities unless
a permissive order allowing such transactions is obtained from the Commission.
Since transactions in the OTC market usually involve transactions with the
dealers acting as principal for their own accounts, the Fund will not deal with
affiliated persons, including Merrill Lynch and its affiliates, in connection
with such transactions. However, an affiliated person of the Fund may serve as
its broker in OTC transactions conducted on an agency basis provided that, among
other things, the fee or commission received by such affiliated broker is
reasonable and fair compared to the fee or commission received by non-affiliated
brokers in connection with comparable transactions. In addition, the Fund may
not purchase securities during the existence of any underwriting syndicate for
such securities of which Merrill Lynch or an affiliate is a member or in a
private placement in which Merrill Lynch or an affiliate serves as placement
agent except
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<PAGE> 302
pursuant to procedures approved by the Board of Trustees that either comply with
rules adopted by the Commission or with interpretations of the Commission staff.
See "Investment Objective and Policies -- Investment Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch or its affiliates acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund. Securities may be held by, or be appropriate
investments for, the Fund as well as other funds or investment advisory clients
of the Investment Adviser or its affiliates.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or its affiliates
when one or more clients of the Investment Adviser or its affiliates are selling
the same security. If purchases or sales of securities arise for consideration
at or about the same time that would involve the Fund or other clients or funds
for which the Investment Adviser or an affiliate acts as investment adviser,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Investment Adviser or
its affiliates during the same period may increase the demand for securities
being purchased or the supply of securities being sold, there may be an adverse
effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below that are
designed to facilitate investment in its shares. Full details as to each such
service and copies of the various plans or how to change options with respect
thereto, can be obtained from the Fund by calling the telephone number on the
cover page hereof, or from the Distributor or your selected securities dealer or
other financial intermediary. Certain of these services are available only to
U.S. investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of dividends. The statements
also will show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
dividends. A shareholder with an account held at the Transfer Agent may make
additions to his or her Investment Account at any time by mailing a check
directly to the Transfer Agent. The Fund does not issue share certificates.
Shareholders considering transferring their Class I shares from a selected
securities dealer to another brokerage firm or financial institution should be
aware that, if the firm to which the Class I shares are to be transferred will
not take delivery of shares of the Fund, a shareholder either must redeem the
shares so that the cash proceeds can be transferred to the account at the new
firm or such shareholder must continue to maintain an Investment Account at the
Transfer Agent for those shares.
Certain shareholder services may not be available for the transferred
shares. After the transfer, the shareholder may purchase additional shares of
funds owned before the transfer, and all future trading of these assets must be
coordinated by the new firm.
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<PAGE> 303
Shareholders considering transferring a tax-deferred retirement account,
such as an individual retirement account, from a selected securities dealer or
other financial intermediary to another brokerage firm or financial institution
should be aware that, if the firm to which the retirement account is to be
transferred will not take delivery of shares of the Fund, a shareholder must
either redeem the shares so that the cash proceeds can be transferred to the
account at the new firm, or such shareholder must continue to maintain a
retirement account at a selected securities dealer or other financial
intermediary for those shares.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other Mercury mutual funds and Summit, a series of Financial
Institutions Series Trust, which is a Merrill Lynch-sponsored money market fund
specifically designated as available for exchange by holders of Class I shares.
Shares with a net asset value of at least $100 are required to qualify for the
exchange privilege and any shares used in an exchange must have been held by the
shareholder for at least 15 days. Before effecting an exchange, shareholders
should obtain a currently effective prospectus of the fund into which the
exchange is to be made. Exercise of the exchange privilege is treated as a sale
of the exchanged shares and a purchase of the acquired shares for Federal income
tax purposes.
Exchanges of Class I Shares. Under the Fund's pricing system, Class I
shareholders may exchange Class I shares of the Fund for Class I shares of a
second Mercury mutual fund. If the Class I shareholder wants to exchange Class I
shares for shares of a second Mercury mutual fund, but does not hold Class I
shares of the second fund in his or her account at the time of exchange and is
not otherwise eligible to acquire Class I shares of the second fund, the
shareholder will receive Class A shares of the second fund as a result of the
exchange.
Exchanges of Class I shares outstanding ("outstanding Class I shares") for
Class I or Class A shares of another Mercury mutual fund, or for Class A shares
of Summit ("new Class I or Class A shares") are transacted on the basis of
relative net asset value per Class I or Class A share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously paid
on the outstanding Class I shares and the sales charge payable at the time of
the exchange on the new Class I or Class A shares. With respect to outstanding
Class I shares as to which previous exchanges have taken place, the "sales
charge previously paid" shall include the aggregate of the sales charges paid
with respect to such Class I shares in the initial purchase and any subsequent
exchange. Class I shares issued pursuant to dividend reinvestment are sold on a
no-load basis. For purposes of the exchange privilege, Class I shares acquired
through dividend reinvestment shall be deemed to have been sold with a sales
charge equal to the sales charge previously paid on the Class I shares on which
the dividend was paid. Based on this formula, Class I shares of the Fund
generally may be exchanged into the Class I and Class A shares, respectively, of
the other funds with a reduced or without a sales charge.
Exchanges for Shares of a Money Market Fund. Class I shares are
exchangeable for Class A shares of Summit. Class A shares of Summit have an
exchange privilege back into Class I or Class A shares of affiliate-advised
Funds. This exchange privilege does not apply with respect to certain fee-based
programs for which alternative exchange arrangements may exist. Please see your
financial consultant for further information.
Prior to October 12, 1998, exchanges from other affiliate-advised Funds
into a money market fund were directed to certain affiliate-advised money market
funds other than Summit. Shareholders who exchanged affiliate-advised Fund
shares for such other money market funds and subsequently wish to exchange those
money market fund shares for shares of the Fund will be subject to the CDSC
schedule applicable to such Fund shares, if any. The holding period for those
money market fund shares will not count toward satisfaction of the holding
period requirement for reduction of the CDSC imposed on such shares, if any,
and, with respect to Class B shares, toward satisfaction of the Conversion
Period. However, the holding period for Class B or Class C shares of the Fund
received in exchange for such money market fund shares will be aggregated with
the holding period for the fund shares originally exchanged for such money
market fund shares for purposes of reducing the CDSC or satisfying the
Conversion Period.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her financial consultant, who will advise the
relevant Fund of the exchange. Shareholders of the Fund and
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shareholders of the other funds described above with shares for which
certificates have not been issued may exercise the exchange privilege by wire
through their selected securities dealers or other financial intermediaries. The
Fund reserves the right to require a properly completed Exchange Application.
This exchange privilege may be modified or terminated in accordance with the
rules of the Commission. The Fund reserves the right to limit the number of
times an investor may exercise the exchange privilege. Certain funds may suspend
the continuous offering of their shares to the general public at any time and
may thereafter resume such offering from time to time. The exchange privilege is
available only to U.S. shareholders in states where the exchange legally may be
made. It is contemplated that the exchange privilege may be applicable to other
new mutual funds whose shares may be distributed by the Distributor.
FEE-BASED PROGRAMS
Certain fee-based programs, including pricing alternatives for securities
transactions (each referred to in this paragraph as a "Program"), may permit the
purchase of Class I shares at net asset value. Under specified circumstances,
participants in certain Programs may deposit other classes of shares, which will
be exchanged for Class I shares. Initial or deferred sales charges otherwise due
in connection with such exchanges may be waived or modified. Termination of
participation in certain Programs may result in the redemption of shares held
therein. [In addition, upon termination of participation in a Program, shares
that have been held for less than specified periods within such Program may be
subject to a fee based on the current value of such shares.] These Programs also
generally prohibit such shares from being transferred to another account, to
another broker-dealer or to the Transfer Agent. Additional information regarding
certain specific Programs offered through particular selected securities dealers
or other financial intermediaries (including charges and limitations on
transferability applicable to shares that may be held in such Programs) is
available in each such Program's client agreement and from the Transfer Agent at
1-800-236-4479.
RETIREMENT PLANS
The minimum initial purchase to establish a retirement plan is $100.
Dividends received in retirement plans are exempt from Federal taxation until
distributed from the plans. Different tax rules apply to Roth IRA plans and
educational savings plans. Investors considering participation in any retirement
or education savings plan should review specific tax laws relating thereto and
should consult their attorneys or tax advisers with respect to the establishment
and maintenance of any such plan.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class I shares at the applicable public offering price. These
purchases may be made either through the shareholder's securities dealer or by
mail directly to the Transfer Agent, acting as agent for such securities dealer.
You may also add to your account by automatically investing a specific amount in
the Fund on a periodic basis through your selected securities dealer or other
financial intermediary. The current minimum for such automatic additional
investments is $100. This minimum may be waived or revised under certain
circumstances.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Shareholders may, at any time, by written notification to their selected
securities dealer or other financial intermediary if their account is maintained
with a selected securities dealer or other financial intermediary, or by written
notification or by telephone (1-800-236-4479) to the Transfer Agent, if their
account is maintained with the Transfer Agent, elect to have subsequent
dividends of ordinary income and/or capital gains paid with respect to shares of
the Fund in cash, rather than reinvested in shares of the Fund (provided that,
in the event that a payment on an account maintained at the Transfer Agent would
amount to $10.00 or less, a shareholder will not receive such payment in cash
and such payment will automatically be reinvested in additional shares).
Commencing ten days after the receipt by the Transfer Agent of such notice,
those instructions will be effected. The Fund is not responsible for any failure
of delivery to the shareholder's address of record and no interest will accrue
on amounts represented by uncashed dividend checks. Cash payments can also be
directly deposited to the shareholder's bank account.
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<PAGE> 305
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals are available for shareholders with
shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed from
those on deposit in the shareholder's account to provide the withdrawal payment
specified by the shareholder. The shareholder may specify the dollar amount to
be redeemed. Redemptions will be made at net asset value as of the close of
regular trading on the NYSE (generally, the NYSE closes at 4:00 p.m., Eastern
time) on the 24th day of each month or the 24th day of the last month of each
quarter, whichever is applicable. If the NYSE is not open for business on such
date, the shares will be redeemed at the net asset value determined after the
close of regular trading on the NYSE on the following business day. The check
for the withdrawal payment will be mailed, or the direct deposit for withdrawal
payment will be made, on the next business day following redemption. When a
shareholder is making systematic withdrawals, dividends on all shares in the
Investment Account are reinvested automatically in Fund shares. A shareholder's
systematic withdrawal plan may be terminated at any time, without a charge or
penalty, by the shareholder, the Fund, the Transfer Agent or the Distributor.
If an investor wishes to change the amount being withdrawn in a systematic
withdrawal plan the investor should contact his or her financial consultant.
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax liabilities.
The Fund will not knowingly accept purchase orders for shares of the Fund from
investors who maintain a systematic withdrawal plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
DIVIDENDS AND TAX STATUS
The Fund has qualified as a regulated investment company. Qualification as
a regulated investment company requires, among other things, that (1) at least
90% of the Fund's annual gross income, without offset for losses from the sale
or other disposition of securities, be derived from payments with respect to
securities loans, interest, dividends and gains from the sale or other
disposition of stock, securities, or foreign currencies or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities, or currencies; and (2) the Fund diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of the Fund's assets is represented by cash, U.S. Government securities,
securities of other regulated investment companies, and other securities limited
in respect of any one issuer to an amount not greater than 5% of the Fund's
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. Government securities or the securities of other
regulated investment companies). In addition, in order not to be subject to
federal taxation, the Fund must distribute to its shareholders at least 90% of
its investment company taxable income earned in each year.
The Fund is required to pay an excise tax to the extent it does not
distribute to its shareholders during any calendar year at least 98% of its
ordinary income for that calendar year, 98% of the excess of its capital gains
over its capital losses for the one-year period ending October 31 in such
calendar year, and all undistributed ordinary income and capital gains for the
preceding respective one-year period. The Fund intends to meet these
distribution requirements to avoid excise tax liability. The Fund also intends
to continue distributing to shareholders all of the excess of net long-term
capital gain over net short-term capital loss on sales of
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<PAGE> 306
securities. If the net asset value of shares of the Fund should, by reason of a
distribution of realized capital gains, be reduced below a shareholder's cost,
such distribution would to that extent be a return of capital to that
shareholder even though taxable to the shareholder, and a sale of shares by a
shareholder at net asset value at that time would establish a capital loss for
federal tax purposes.
In determining the extent to which the Fund's dividends may be eligible for
the 70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisors regarding other requirements applicable to the dividends received
deduction.
Any loss realized on a sale, redemption or exchange of shares of the Fund
by a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by the Fund constitute a
replacement of shares.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined in accordance with a formula specified
by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time. The Fund's total return may be
expressed either as a percentage or as a dollar amount in order to illustrate
such total return on a hypothetical $1,000 investment in the Fund at the
beginning of each specified period.
Average annual total returns for the periods ended June 30, 2000 are as
follows:
<TABLE>
<CAPTION>
ONE FIVE TEN SINCE
YEAR YEARS YEARS INCEPTION
----- ----- ----- ---------
<S> <C> <C> <C> <C> <C>
Class I........................... 19.83% 9.82% 11.00% 9.72% (Since 6/24/87)
</TABLE>
In order to reflect the reduced sales charges applicable to certain
investors, as described under "Purchase of Shares" and "Redemption of Shares,"
respectively, the total return data quoted by the Fund in advertisements
directed to such investors may take into account the reduced, and not the
maximum, sales charge and therefore may reflect greater total return since, due
to the reduced sales charges or the waiver of sales charges, a lower amount of
expenses is deducted.
26
<PAGE> 307
In advertising and sales literature, the Fund may compare its performance
to that of various broad market indexes, including without limitation the
Standard & Poor's 500 Composite Stock Price Index and other published indexes.
When comparing its performance to a market index, the Fund may refer to various
statistical measures derived from the historic performance of the Fund and the
index, such as standard deviation and beta. In addition, the Fund may refer in
advertising or sales literature to (i) mutual fund performance ratings, rankings
and comparisons (including risk-adjusted ratings, rankings and comparisons),
(ii) other comparisons of mutual fund data including assets, expenses, fees and
other data, and (iii) other discussions reported in or assigned by Barron's
Business Week, CDA Investment Technology, Inc., Financial World, Forbes
Magazine, Fortune Magazine, Lipper Inc., Money Magazine, U.S. News & World
Report, The Wall Street Journal and other industry publications. The Fund may
also make reference to awards that may be given to the Investment Adviser. As
with other performance data, performance comparisons should not be considered
indicative of the Fund's relative performance for any future period.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest and to divide or combine
the shares into a greater or lesser number of shares without thereby changing
the proportionate beneficial interest in the Fund. Each share represents an
interest in the Fund proportionately equal to the interest of each other share.
Upon the Trust's liquidation, all shareholders would share pro rata in the net
assets of the Fund in question available for distribution to shareholders. If
they deem it advisable and in the best interest of shareholders, the Board of
Trustees may create additional classes of shares. The Board of Trustees has
created ten series of shares, and may create additional series in the future,
which have separate assets and liabilities.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a
Fund's shares may advise the Trustees in writing that they wish to communicate
with other shareholders for the purpose of requesting a meeting to remove a
Trustee. The Trustees will then, if requested by the applicants, mail at the
applicants' expense the applicants' communication to all other shareholders.
The Trust or the Fund may be terminated if approved by the vote of a
majority of the Trustees or by the approval of the holders of a majority of the
Trust's outstanding shares, as defined in the 1940 Act. If not so terminated,
the Trust will continue indefinitely.
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Trust or its Trustees. The Declaration of Trust provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for its
27
<PAGE> 308
obligations. While Massachusetts law permits a shareholder of a trust such as
this to be held personally liable as a partner under certain circumstances, the
risk of a shareholder incurring financial loss on account of shareholder
liability is highly unlikely and is limited to the relatively remote
circumstances in which the Trust would be unable to meet its obligations.
Common expenses incurred by the Trust are allocated among the portfolios
based upon: (1) relative net assets; (2) as incurred on a specific
identification basis; or (3) evenly among the portfolios, depending on the
nature of the expenditure.
Except for (1) changes which do not adversely affect the rights of Trust
shareholders; (2) a change in the name of the Trust, or a series or class
thereof; (3) authorization of a new series or class; (4) changes to supply any
omission or correct any ambiguous or defective provision; or (5) changes
required by any federal, state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust without the affirmative vote of the holders of at least 67%
of the Trust's outstanding shares at a meeting at which more than 50% of its
outstanding shares are present in person or represented by proxy. The holders of
shares have no preemptive or conversion rights. Shares when issued are fully
paid and non-assessable, except as set forth above.
ISSUANCE OF FUND SHARES FOR SECURITIES
Investors may purchase Fund shares for consideration consisting of
securities rather than cash when, in the judgment of the Investment Adviser, the
securities: (a) meet the investment objective and policies of the Fund, (b) are
liquid and not subject to restrictions on resale, and (c) have a value that is
readily ascertainable via listing on or trading in a recognized United States or
international exchange or market.
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment wholly
in cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of the Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund during
any 90 day period for any one shareholder. Should redemptions by any shareholder
exceed such limitation the Fund will have the option of redeeming the excess in
cash or in kind. If shares are redeemed in kind, the redeeming shareholder would
incur brokerage costs in converting the assets into cash.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202, has been selected as the independent auditors of the Fund. The
independent auditors are responsible for auditing the annual financial
statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109-3661, acts as custodian of the Fund's assets (the "Custodian"). The
Custodian is responsible for safeguarding and controlling the Fund's cash and
securities, handling the receipt and delivery of securities and collecting
interest and dividends on the Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly-owned subsidiary of ML & Co., acts as the
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement (the "Transfer Agency Agreement").
28
<PAGE> 309
The Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts.
LEGAL COUNSEL
Gardner, Carton & Douglas, 321 North Clark Street, Chicago, Illinois 60610,
is counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio and
other information. An annual report containing financial statements audited by
independent auditors is sent to shareholders each year. After the end of each
year, shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
PRINCIPAL HOLDERS
[to come]
29
<PAGE> 310
STATEMENT OF ADDITIONAL INFORMATION
MERCURY HW MID-CAP VALUE FUND
OF MERCURY HW FUNDS
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017 - Phone No.
(800) 236-4479
------------------------
Mercury HW Mid-Cap Value Fund (the "Fund") is a fund of the Mercury HW
Funds (the "Trust"). The Trust is a diversified, open-end, management investment
company which is organized as a Massachusetts business trust. The investment
objective of the Fund is to seek to provide current income and long-term growth
of income, accompanied by growth of capital. The Fund seeks to achieve its
investment objective by investing primarily in stocks of U.S. companies with
market capitalizations of less than $10 billion. No assurance can be given that
the investment objective of the Fund will be realized. For more information on
the Fund's investment objective and policies, see "Investment Objective and
Policies."
The Fund offers a single class (Class I) of shares. Only certain investors
are eligible to purchase Class I shares. See "Purchase of Shares."
------------------------
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the prospectus of the Fund, dated October , 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Fund at
1-800-236-4479 or your financial consultant or other financial intermediary, or
by writing to the Fund at Financial Data Services, Inc., P.O. Box 41621,
Jacksonville, Florida 32232-1621. The Prospectus is incorporated by reference
into this Statement of Additional Information, and this Statement of Additional
Information is incorporated by reference into the Prospectus. The Fund's
financial statements are incorporated by reference to its annual report for the
fiscal year ended June 30, 2000. You may request copies of the annual report at
no charge by calling 1-800-236-4479 between 8:00 a.m. and 8:00 p.m. on any
business day.
------------------------
MERCURY ADVISORS -- INVESTMENT ADVISER
FAM DISTRIBUTORS, INC. -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is October , 2000
<PAGE> 311
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Trust History............................................... 3
Investment Objective and Policies........................... 3
Investment Restrictions................................... 3
Repurchase Agreements..................................... 4
Bonds..................................................... 4
U.S. Government Securities................................ 4
Corporate Debt Securities................................. 5
Convertible Securities.................................... 5
Derivative Instruments.................................... 5
Foreign Securities........................................ 6
Foreign Investment Risks.................................. 7
Swap Agreements........................................... 8
Illiquid Securities....................................... 8
Borrowing................................................. 9
When-Issued Securities.................................... 9
Real Estate Investment Trusts............................. 10
Shares of Other Investment Companies...................... 10
Limited Partnerships...................................... 10
Short Sales Against-the-Box............................... 10
Corporate Loans........................................... 10
Temporary Defensive Position.............................. 10
Management of the Fund...................................... 10
Advisory Arrangements..................................... 12
Accounting and Administrative Services.................... 13
Code of Ethics............................................ 14
Purchase of Shares.......................................... 14
Class I Shares............................................ 15
Reduced Initial Sales Charges............................. 16
Redemption of Shares........................................ 17
Redemption................................................ 18
Repurchase................................................ 18
Reinstatement Privilege -- Class I Shares................. 19
Pricing of Shares........................................... 19
Determination of Net Asset Value.......................... 19
Computation of Offering Price Per Share................... 20
Portfolio Transactions and Brokerage........................ 21
Transactions in Portfolio Securities...................... 21
Shareholder Services........................................ 22
Investment Account........................................ 22
Exchange Privilege........................................ 23
Fee-Based Programs........................................ 24
Retirement Plans.......................................... 24
Automatic Investment Plans................................ 24
Automatic Dividend Reinvestment Plan...................... 24
Systematic Withdrawal Plans............................... 25
Dividends and Tax Status.................................... 25
Performance Data............................................ 26
General Information......................................... 27
Description of Shares..................................... 27
Issuance of Fund Shares for Securities.................... 28
Redemption in Kind........................................ 28
Independent Auditors...................................... 28
Custodian................................................. 28
Transfer Agent............................................ 28
Legal Counsel............................................. 28
Reports to Shareholders................................... 29
Shareholder Inquiries..................................... 29
Additional Information.................................... 29
Principal Holders......................................... 29
</TABLE>
2
<PAGE> 312
TRUST HISTORY
The Trust was organized on August 22, 1984 as a Massachusetts business
trust. Before October 7, 1994, the Trust was called "Olympic Trust," and before
October , 2000, the Trust was called "Hotchkis and Wiley Funds." The Trust is
a diversified, open-end, management investment company currently consisting of
ten separate funds. Prior to October , 2000, the Fund was called the Mid-Cap
Fund.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide current income and
long-term growth of income, accompanied by growth of capital. Reference is made
to the discussion under "How the Fund Invests" and "Investment Risks" in the
Prospectus for information with respect to the Fund's investment objective and
policies.
Mercury Advisors (the "Investment Adviser"), the Fund's investment adviser,
is responsible for the management of the Fund's portfolio.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of the Fund's outstanding
voting securities, as defined in the Investment Company Act of 1940, as amended
(the "1940 Act"). Under the 1940 Act, the vote of the holders of a "majority" of
the Fund's outstanding voting securities means the vote of the holders of the
lesser of (1) 67% of the shares of the Fund represented at a meeting at which
the holders of more than 50% of its outstanding shares are represented or (2)
more than 50% of the outstanding shares.
Except as noted, the Fund may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Fund's total assets (determined at the time of investment) would
then be invested in securities of a single issuer; or (ii) more than
25% of the Fund's total assets (determined at the time of investment)
would be invested in one or more issuers having their principal
business activities in a single industry.
2. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions),
provided that the deposit or payment by the Fund of initial or
maintenance margin in connection with futures or options is not
considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short (short sale
against-the-box), and unless not more than 25% of the Fund's net assets
(taken at current value) is held as collateral for such sales at any
one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Fund may borrow from a bank for temporary or emergency purposes in
amounts not exceeding 10% (taken at the lower of cost or current value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings; the Fund will not purchase any
additional portfolio securities while such borrowings are outstanding.
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would
then hold more than 10% of the outstanding voting securities of an
issuer.
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6. Buy or sell commodities or commodity contracts or real estate or
interests in real estate, although it may purchase and sell securities
which are secured by real estate and securities of companies which
invest or deal in real estate. (For the purposes of this restriction,
forward foreign currency exchange contracts are not deemed to be
commodities or commodity contracts.)
7. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws.
8. Make investments for the purpose of exercising control or management.
9. Participate on a joint or joint and several basis in any trading
account in securities.
10. Make loans, except through repurchase agreements.
11. Purchase or sell foreign currencies.
Any percentage limitation on the Fund's investments is determined when the
investment is made, unless otherwise noted.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement where the seller agrees to
repurchase a security from the Fund at a mutually agreed-upon time and price.
The period of maturity is usually quite short, possibly overnight or a few days,
although it may extend over a number of months. The resale price is more than
the purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Fund's money is invested in the repurchase agreement. The
Fund's repurchase agreements will at all times be fully collateralized in an
amount at least equal to the resale price. The instruments held as collateral
are valued daily, and if the value of instruments declines, the Fund will
require additional collateral. In the event of a default, insolvency or
bankruptcy by a seller, the Fund will promptly seek to liquidate the collateral.
In such circumstances, the Fund could experience a delay or be prevented from
disposing of the collateral. To the extent that the proceeds from any sale of
such collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
BONDS
The term "bond" or "bonds" as used in the Prospectus is intended to include
all manner of fixed-income securities, debt securities and other debt
obligations unless specifically defined otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. The Fund will
invest in securities of such instrumentality only when the Investment Adviser is
satisfied that the credit risk with respect to any instrumentality is
acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely, either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (1) Treasury obligations from which the interest coupons
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have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member bank representing ownership of Treasury obligation
components; or (4) receipts evidencing the component parts (corpus or coupons)
of Treasury obligations that have not actually been stripped. Such receipts
evidence ownership of component parts of Treasury obligations (corpus or
coupons) purchased by a third party (typically an investment banking firm) and
held on behalf of the third party in physical or book-entry form by a major
commercial bank or trust company pursuant to a custody agreement with the third
party. These custodial receipts are known by various names, including "Treasury
Receipts," "Treasury Investment Growth Receipts" ("TIGRs") and "Certificates of
Accrual on Treasury Securities" ("CATS"), and are not issued by the U.S.
Treasury; therefore they are not U.S. Government securities, although the
underlying bonds represented by these receipts are debt obligations of the U.S.
Treasury.
CORPORATE DEBT SECURITIES
The Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, are in the Investment Adviser's opinion comparable
in quality to corporate debt securities in which the Fund may invest. The rate
of return or return of principal on some debt obligations may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying common stock.
The price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
DERIVATIVE INSTRUMENTS
As indicated in the prospectus, to the extent consistent with its
investment objective and policies and the investment restrictions listed in this
Statement of Additional Information, the Fund may purchase and write call and
put options on securities and securities indexes and enter into forward
contracts. The Fund also may enter into swap agreements with respect to interest
rates and securities indexes. The Fund may use these techniques to hedge against
changes in interest rates, or securities prices or as part of its overall
investment strategies. The Fund will mark as segregated cash, U.S. government
securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily (or, as permitted by applicable regulation, enter into
certain offsetting positions), to cover its obligations under forward contracts,
futures contracts, swap agreements and options to avoid leveraging of the Fund.
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Options on Securities and on Securities Indexes. The Fund may purchase put
options on securities to protect holdings in an underlying or related security
against a substantial decline in market value. The Fund may purchase call
options on securities to protect against substantial increases in prices of
securities the Fund intends to purchase pending its ability to invest in such
securities in an orderly manner. The Fund may sell put or call options it has
previously purchased, which could result in a net gain or loss depending on
whether the amount realized on the sale is more or less than the premium and
other transaction costs paid on the put or call option which is sold. The Fund
may write a call or put option only if the option is "covered" by the Fund
holding a position in the underlying securities or by other means which would
permit immediate satisfaction of the Fund's obligation as writer of the option.
Prior to exercise or expiration, an option may be closed out by an offsetting
purchase or sale of an option of the same series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
FOREIGN SECURITIES
The Fund may invest in American Depositary Receipts ("ADRs") or, other
securities convertible into securities of issuers based in foreign countries or
other foreign securities that can be purchased and sold in U.S. dollars. These
securities may not necessarily be denominated in the same currency as the
securities into which they may be converted. ADRs are receipts, usually issued
by a U.S. bank or trust company, evidencing ownership of the underlying
securities; EDRs are European receipts evidencing a similar arrangement.
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Generally, ADRs are issued in registered form, denominated in U.S. dollars, and
are designed for use in the U.S. securities markets; EDRs are issued in bearer
form, denominated in other currencies, and are designed for use in European
securities markets.
FOREIGN INVESTMENT RISKS
Foreign Market Risk. The Fund may invest a portion of its assets in foreign
securities. Foreign security investment involves special risks not present in
U.S. investments that can increase the chances that the Fund will lose money.
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of capital, resources, and
balance of payments position. Certain such economies may rely heavily on
particular industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a particular country
or countries, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. Investments in foreign markets may
also be adversely affected by governmental actions such as the imposition of
capital controls, nationalization of companies or industries, expropriation of
assets, or the imposition of punitive taxes. In addition, the governments of
certain countries may prohibit or impose substantial restrictions on foreign
investing in their capital markets or in certain industries. Any of these
actions could severely affect security prices, impair the Fund's ability to
purchase or sell foreign securities or otherwise adversely affect the Fund's
operations. Other foreign market risks include difficulties in pricing
securities, defaults on foreign government securities, difficulties in enforcing
favorable legal judgments in foreign courts, and political and social
instability. Legal remedies available to investors in certain foreign countries
may be less extensive than those available to investors in the United States or
other foreign countries.
EMU. For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU establishes a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU participants by July 1, 2002. Upon implementation of EMU,
certain securities issued in participating EU countries (beginning with
government and corporate bonds) were redenominated in the euro, and are now
listed, traded, declaring dividends and making other payments only in euros.
No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on the Fund's investments
in Europe generally or in specific countries participating in EMU.
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some
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countries may not have laws to protect investors the way that the United States
securities laws do. Accounting standards in other countries are not necessarily
the same as in the United States. If the accounting standards in another country
do not require as much disclosure or detail as U.S. accounting standards, it may
be harder for the Fund's portfolio managers to completely and accurately
determine a company's financial condition.
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
SWAP AGREEMENTS
The Fund may enter into interest rate and index swap agreements for
purposes of attempting to obtain a particular desired return at a lower cost to
the Fund than if the Fund had invested directly in an instrument that yielded
the desired return. Swap agreements are two party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to
more than one year. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized on
particular predetermined investments or instruments. The gross returns to be
exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate or in a "basket" of
securities representing a particular index. The "notional amount" of the swap
agreement is only a fictive basis on which to calculate the obligations which
the parties to a swap agreement have agreed to exchange. The Fund's obligations
(or rights) under a swap agreement will generally be equal only to the net
amount to be paid or received under the agreement based on the relative values
of the positions held by each party to the agreement (the "net amount"). The
Fund's obligations under a swap agreement will be accrued daily (offset against
any amounts owing to the Fund) and any accrued but unpaid net amounts owed to a
swap counter-party will be covered by marking as segregated cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, to avoid any potential leveraging of the Fund's
portfolio. The Fund will not enter into a swap agreement with any single party
if the net amount owed or to be received under existing contracts with that
party would exceed 5% of the Fund's assets.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Investment Adviser's
ability to correctly predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, the Fund bears the risk
of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counter-party.
Restrictions imposed by the Internal Revenue Code may limit the Fund's ability
to use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps market,
including potential government regulation, could adversely affect the Fund's
ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions of
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended ("Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
that have a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Limitations on resale may have an adverse effect on the
marketability of portfolio securities and a mutual fund might be unable to
dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemption within
seven days. The absence of a trading market can make it difficult to ascertain a
market value for illiquid investments. Also market quotations are less readily
available. The judgment of the
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Investment Adviser may at times play a greater role in valuing these securities
than in the case of unrestricted securities. A mutual fund might also have to
register such restricted securities in order to dispose of them resulting in
additional expense and delay. Adverse market conditions could impede such a
public offering of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Investment Adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least one nationally recognized statistical
rating organizations ("NRSRO"), or, if unrated, be of comparable quality in the
view of the Investment Adviser; and (2) it must not be in default as to
principal or interest. Investing in Rule 144A securities could have the effect
of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
BORROWING
The Fund may borrow for temporary or emergency purposes in amounts not
exceeding 10% of the Fund's total assets. This borrowing may be unsecured. The
1940 Act requires the Fund to maintain continuous asset coverage (that is, total
assets including borrowings, less liabilities exclusive of borrowings) of 300%
of the amount borrowed. Borrowing subjects the Fund to interest costs which may
or may not be recovered by appreciation of the securities purchased, and can
exaggerate the effect on net asset value of any increase or decrease in the
market value of the Fund's portfolio. This is the speculative factor known as
leverage.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value
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of the security each day in determining the Fund's net asset value. The Fund
will also mark as segregated with its custodian cash, U.S. government
securities, equity securities or other liquid, unencumbered assets, marked-
to-market daily, equal in value to its obligations for when-issued securities.
REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain Internal Revenue Code requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties, as well as
greater income potential than an investment in common stocks. Like any
investment in real estate, though, a REIT's performance depends on several
factors, such as its ability to find tenants for its properties, to renew leases
and to finance property purchases and renovations.
SHARES OF OTHER INVESTMENT COMPANIES
The Fund can invest in securities of other investment companies except to
the extent prohibited by law. Like all equity investments, these investments may
go up or down in value. They also may not perform in correlation with the Fund's
principal strategies. The Fund will pay additional fees through its investments
in other investment companies.
LIMITED PARTNERSHIPS
The Fund can invest in limited partnership interests.
SHORT SALES AGAINST-THE-BOX
The Fund can borrow and sell "short" securities when it also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund's
total assets can be held as collateral for short sales at any one time.
CORPORATE LOANS
The Fund can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Fund may not
recover its investment, or there might be a delay in the Fund's recovery. By
investing in a corporate loan, the Fund becomes a member of the syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, the Fund may invest
all or part of its assets in short-term investment grade debt obligations of the
U.S. government, its agencies and instrumentalities, bank certificates of
deposit, bankers' acceptances, high quality commercial paper, demand notes and
repurchase agreements.
MANAGEMENT OF THE FUND
The Trustees oversee the actions of the Fund's Investment Adviser and other
service providers and decide upon matters of general policy. The Trustees also
review the actions of the Trust's officers, who conduct and
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supervise the daily business operations of the Trust. The Trustees (* denotes
"interested" Trustee as defined in the 1940 Act, due to the relationship with
the Investment Adviser) and officers of the Trust are:
MICHAEL BAXTER* (37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since 1999);
Managing Director of the Investment Adviser (since 1996); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since 1994); Chairman, Gamma Services Corp.
(venture capital) (since 1968); Principal, Gavin, Dailey & Partners (consulting)
(since 1993); U.S. Ambassador to Mexico (1981 - 1986); Director, Apex Mortgage
Capital, Inc., Atlantic Richfield Co., International Wire Corp. and Krause's
Furniture.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (since 1986); Member of CIEBA's Executive Committee (since
1988) and its Chairman (from 1991 - 1992); Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds (1986 - 1993); Member of the Investment Advisory Committees of
the State of New York Common Retirement Fund and the Howard Hughes Medical
Institute (since 1997); Director, Duke Management Company (since 1992) and Vice
Chairman (since 1998); Director, Kimco Realty Corporation (since 1997);
Director, LaSalle Street Fund (since 1995); Member of the Investment Advisory
Committee of the Virginia Retirement System (since 1998); Director, Montpelier
Foundation (since 1998); Trustee or Director of 31 registered investment
companies (consisting of 47 portfolios) for which the Investment Adviser or an
advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since
1999); Managing Director of the Investment Adviser (since 1998); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (48) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 66 registered investment companies
(consisting of 70 portfolios) for which the Investment Adviser or an advisory
affiliate is the adviser.
NANCY D. CELICK (48) -- President -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Chief Administrative Officer of the Investment
Adviser (since 1998); Chief Financial Officer of the Investment Adviser
(1993 - 1998); Chief Financial Officer of Kennedy-Wilson, Inc. (auction
marketing services) (1992 - 1993); Chief Financial Officer of First National
Corporation (bank holding company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-9011. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services,
Inc. (since 1999); Vice President of FAM Distributors, Inc. (since 1999); First
Vice President of the Investment Adviser (1990 - 1997).
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<PAGE> 321
ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
GRACIE FERMELIA (38) -- Vice President and Assistant Secretary -- 725 South
Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Director of the
Investment Adviser (since 2000); Vice President of the Investment Adviser
(1994 - 2000); Senior Manager, Price Waterhouse (1985 - 1994).
The Trust does not pay salaries to any of its officers or fees to any of
its Trustees affiliated with the Investment Adviser. The following table sets
forth the aggregate compensation paid to the Trustees during the Trust's fiscal
year ended June 30, 2000 and the aggregate compensation paid to the Trustees for
service on the Trust's Board and that of any other fund for which the Investment
Adviser serves as investment adviser or which has an investment adviser that is
an affiliated person of the Investment Adviser ("Fund Complex") for the year
ended December 31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $ $ 34,000
John A. G. Gavin................................... $ $ 25,000
Joe Grills......................................... $ $232,000
Nigel Hurst-Brown.................................. $ -0- $ -0-
Robert B. Hutchinson**............................. $ $ 34,000
Madeleine A. Kleiner............................... $ $ 18,000
Merle T. Welshans**................................ $ $ 34,000
Richard R. West.................................... $ $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of Mercury HW Variable Trust, Fund
Asset Management Master Trust and Merrill Lynch Investment Managers Funds,
Inc. Messrs. Grills and West also serve on the boards of other investment
companies advised by the Investment Adviser and its advisory affiliates.
** Messrs. Hutchinson and Welshans retired on November 12, 1999.
The Trustees may be eligible for reduced sales charges on purchases of
Class I shares. See "Reduced Initial Sales Charges -- Purchase Privileges of
Certain Persons."
For information as to ownership of shares, see "General
Information -- Principal Holders."
ADVISORY ARRANGEMENTS
Investment Advisory Services and Fee. The Trust on behalf of the Fund has
entered into an investment advisory agreement with the Investment Adviser as
investment adviser (the "Advisory Agreement"). Subject to the supervision of the
Trustees, the Investment Adviser is responsible for the actual management of the
Fund and constantly reviews the Fund's holdings in light of its own research
analysis and that from other relevant sources. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser. The Investment Adviser performs certain of the other administrative
services and provides all office space, facilities, equipment and necessary
personnel for management of the Fund. The Investment Adviser receives for its
services to the Fund a monthly fee at an annual rate of 0.75% of the Fund's
average daily net assets. For purposes of this calculation, average daily net
assets is determined at the end of each month on the basis of the average net
assets of the Fund for each day during the month.
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<PAGE> 322
Prior to October , 2000, the Fund was party to an investment advisory
agreement under which it paid Merrill Lynch Investment Managers, L.P., an
affiliate of the Investment Adviser, a fee at the annual rate of 0.75% of its
average daily net assets. For the fiscal years ended June 30, 2000, 1999 and
1998, as a result of its agreement to limit Fund expenses, Merrill Lynch
Investment Managers, L.P. waived a portion of its fee in the amounts of
$ , $59,578 and $92,525 respectively. For the fiscal years ended June
30, 2000, 1999 and 1998, the Fund paid no advisory fees and Merrill Lynch
Investment Managers, L.P. reimbursed the Fund in the amounts of $ ,
$13,497 and $52,325, respectively.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients of the Investment Adviser or an affiliate when one or more clients of
the Investment Adviser or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Payment of Fund Expenses. The Advisory Agreement obligates the Investment
Adviser to provide investment advisory services and to pay, or cause an
affiliate to pay, for maintaining its staff and personnel and to provide office
space, facilities and necessary personnel for the Fund. The Investment Adviser
is also obligated to pay, or cause an affiliate to pay, the fees of all officers
and Trustees who are affiliated persons of the Investment Adviser. The Fund
pays, or causes to be paid, all other expenses incurred in the operation of the
Fund (except to the extent paid by FAM Distributors, Inc. (the "Distributor")),
including, among other things, taxes, expenses for legal and auditing services,
costs of printing proxies, shareholder reports, copies of the Registration
Statement, charges of the custodian, any sub-custodian and the transfer agent,
expenses of portfolio transactions, expenses of redemption of shares, commission
fees, expenses of registering the shares under Federal, state or non-U.S. laws,
fees and actual out-of-pocket expenses of non-interested Trustees, accounting
and pricing costs (including the daily calculation of net asset value),
insurance, interest, brokerage costs, litigation and other extraordinary or
non-recurring expenses, and other expenses properly payable by the Fund.
Organization of the Investment Adviser. The Investment Adviser is a limited
partnership, the partners of which are Merrill Lynch & Co., Inc. ("ML & Co."), a
financial services holding company and the parent of Merrill Lynch, Pierce,
Fenner and Smith Incorporated ("Merrill Lynch"), and Princeton Services, Inc. ML
& Co. and Princeton Services, Inc. are "controlling persons" of the Investment
Adviser as defined under the 1940 Act because of their ownership of its voting
securities and their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Advisory Agreement will remain in effect from year to year if approved annually
(a) by the Board of Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees of the Trust who are
not parties to the Advisory Agreement or interested persons (as defined in the
1940 Act) of any such party. The Advisory Agreement is not assignable and will
automatically terminate in the event of its assignment. In addition, such
contract may be terminated by the vote of a majority of the outstanding voting
securities of the Fund or by the Investment Adviser without penalty on 60 days'
written notice to the other party.
ACCOUNTING AND ADMINISTRATIVE SERVICES
The Trust has entered into a Fund Accounting and Administration Servicing
Agreement (the "Fund Accounting Agreement") with the Investment Adviser acting
as service provider. The Fund Accounting Agreement obligates the Investment
Adviser to provide certain accounting and administrative services to the Trust.
The Trust reimburses the Investment Adviser for its costs in connection with
such services.
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<PAGE> 323
Transfer Agency Services. The Transfer Agent, a subsidiary of ML & Co.,
acts as the Fund's Transfer Agent pursuant to a Transfer Agency, Dividend
Disbursing Agency and Shareholder Servicing Agency Agreement (the "Transfer
Agency Agreement"). Pursuant to the Transfer Agency Agreement, the Transfer
Agent is responsible for the issuance, transfer and redemption of shares and the
opening and maintenance of shareholder accounts. Pursuant to the Transfer Agency
Agreement, the Transfer Agent receives a fee ranging from $16.00 to $20.00 per
account (depending on the level of services required) and certain other fees
relating to special processing of sub-transfer agency relationships. The
Transfer Agent is entitled to reimbursement for certain transaction charges and
out-of-pocket expenses incurred by the Transfer Agent under the Transfer Agency
Agreement. For purposes of the Transfer Agency Agreement, the term "account"
includes a shareholder account maintained directly by the Transfer Agent and any
other account representing the beneficial interest of a person in the relevant
share class on a recordkeeping system.
Distribution Expenses. The Fund has entered into a distribution agreement
with the Distributor in connection with the continuous offering of shares of the
Fund (the "Distribution Agreement"). The Distribution Agreement obligates the
Distributor to pay certain expenses in connection with the offering of the
shares of the Fund. After the prospectuses, statements of additional information
and periodic reports have been prepared, set in type and mailed to shareholders,
the Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to dealers and investors. The Distributor also pays
for other supplementary sales literature and advertising costs. The Distribution
Agreement is subject to the same renewal requirements and termination provisions
as the Advisory Agreement described above.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act that covers the Trust, the Investment Adviser and the
Distributor (the "Code of Ethics"). The Code of Ethics significantly restricts
the personal investing activities of all employees of the Investment Adviser and
the Distributor and, as described below, imposes additional more onerous
restrictions on fund investment personnel.
The Code of Ethics requires that all employees of the Investment Adviser
and the Distributor pre-clear any personal securities investments (with limited
exceptions, such as mutual funds, high-quality short-term securities and direct
obligations of the U.S. government). The pre-clearance requirement and
associated procedures are designed to identify any substantive prohibition or
limitation applicable to the proposed investment. The substantive restrictions
applicable to all employees of the Investment Adviser and the Distributor
include a ban on acquiring any securities in a "hot" initial public offering. In
addition, investment personnel are prohibited from profiting on short-term
trading in securities. No employee may purchase or sell any security that at the
time is being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Investment Adviser. Furthermore, the Code of Ethics provides for trading
"blackout periods" which prohibit trading by investment personnel of the Fund
within seven calendar days, before or after, of trading by the Fund in the same
or equivalent security.
PURCHASE OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus for certain information as to the purchase of
Fund shares.
The Fund issues a single class (Class I) of shares. Each share of the Fund
represents an identical interest in the investment portfolio of the Fund, and
has the same rights.
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share plus any sales charge applicable to the
shares. The applicable offering price for purchase orders is based upon the net
asset value of the Fund next determined after receipt of the purchase order by
the Distributor. As to purchase orders received by selected securities dealers
or other financial intermediaries prior to the close of regular trading on the
New York Stock Exchange (the "NYSE") (generally 4:00 p.m., Eastern time) which
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<PAGE> 324
includes orders received after the determination of net asset value on the
previous day, the applicable offering price will be based on the net asset value
on the day the order is placed with the Distributor, provided that the orders
are received by the Distributor prior to 30 minutes after the close of regular
trading on the NYSE on that day. If the purchase orders are not received prior
to 30 minutes after the close of regular trading on the NYSE on that day, such
orders shall be deemed received on the next business day. Selected securities
dealers or other financial intermediaries have the responsibility of submitting
purchase orders to the Fund not later than 30 minutes after the close of regular
trading on the NYSE in order to purchase shares at that day's offering price.
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares at any time in response to conditions in the securities markets or
otherwise and may thereafter resume such offering from time to time. Any order
may be rejected by the Fund or the Distributor. Neither the Distributor nor the
selected securities dealers or other financial intermediaries are permitted to
withhold placing orders to benefit themselves by a price change. Certain
selected securities dealers or other financial intermediaries may charge a
processing fee to confirm a sale of shares. For example, the fee currently
charged by Merrill Lynch is $5.35. Purchases made directly through the Transfer
Agent are not subject to the processing fee.
CLASS I SHARES
Class I shares will be subject to an initial sales charge, unless you
qualify for a reduction or waiver of the sales charge. See "Reduced Initial
Sales Charges."
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class I shares of the
Fund, refers to a single purchase by an individual or to concurrent purchases,
which in the aggregate are at least equal to the prescribed amounts, by an
individual, his or her spouse and their children under the age of 21 years
purchasing shares for his, her or their own account and to single purchases by a
trustee or other fiduciary purchasing shares for a single trust estate or single
fiduciary account although more than one beneficiary is involved. The term
"purchase" also includes purchases by any "company," as that term is defined in
the 1940 Act, but does not include purchases by any such company that has not
been in existence for at least six months or which has no purpose other than the
purchase of shares of the Fund or shares of other registered investment
companies at a discount; provided, however, that it shall not include purchases
by any group of individuals whose sole organizational nexus is that the
participants therein are credit cardholders of a company, policyholders of an
insurance company, customers of either a bank or broker-dealer or clients of an
investment adviser.
Class I shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class I shares. Investors
who owned Investor Class shares or who currently own Class I shares of the Fund
in a shareholder account are entitled to purchase additional Class I shares of
the Fund in that account. Certain employer-sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class I shares at net asset
value provided such plans meet the required minimum number of eligible employees
or required amount of assets advised by the Investment Adviser or any of its
affiliates. Also eligible to purchase Class I shares at net asset value are
participants in certain investment programs including certain managed accounts
for which a trust institution, thrift or bank trust department provides
discretionary trustee services, certain collective investment trusts for which a
trust institution, thrift, or bank trust department serves as trustee, certain
purchases made in connection with certain fee-based programs and certain
purchases made through certain financial advisers that meet and adhere to
standards established by the Investment Adviser. Class I shares are available at
net asset value to corporate warranty insurance reserve fund programs and U.S.
branches of foreign banking institutions, provided that the participant has $3
million or more initially invested in Affiliate-Advised investment companies. In
addition, Class I shares are offered at net asset value to ML & Co. and its
subsidiaries and their directors and employees, to members of the Boards of
investment companies advised by the Investment Adviser or its affiliates,
including the Fund, and to employees of certain selected securities dealers or
other financial intermediaries. Class I shares may also be offered at net asset
value to certain accounts over which the Investment Adviser or an affiliate
exercises investment discretion [, and to certain institutional investors].
Although some investors who previously purchased Class I shares may no longer be
eligible to purchase Class I shares of other affiliate-advised funds,
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<PAGE> 325
those previously purchased Class I shares, together with Class A, Class B and
Class C share holdings of other Mercury mutual funds, will count toward a right
of accumulation which may qualify the investor for a reduced initial sales
charge on new initial sales charge purchases.
The Distributor may reallow discounts to selected securities dealers or
other financial intermediaries and retain the balance over such discounts. At
times the Distributor may reallow the entire sales charge to such selected
securities dealers or other financial intermediaries. Since selected securities
dealers or other financial intermediaries selling Class I shares of the Fund
will receive a concession equal to most of the sales charge, they may be deemed
to be underwriters under the Securities Act.
REDUCED INITIAL SALES CHARGES
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
to obtain such investments.
Reinvested Dividends. No initial sales charges are imposed upon shares
issued as a result of the automatic reinvestment of dividends.
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other Mercury mutual funds. For any such right of accumulation to be
made available, the Distributor must be provided at the time of purchase, by the
purchaser or the purchaser's selected securities dealer or other financial
intermediary, with sufficient information to permit confirmation of
qualification. Acceptance of the purchase order is subject to such confirmation.
The right of accumulation may be amended or terminated at any time. Shares held
in the name of a nominee or custodian under pension, profit-sharing, or other
employee benefit plans may not be combined with other shares to qualify for the
right of accumulation.
Letter of Intent. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class I shares of the Fund or any other Mercury
mutual funds made within a 13-month period starting with the first purchase
pursuant to the Letter of Intent. The Letter of Intent is available only to
investors whose accounts are established and maintained at the Fund's Transfer
Agent. The Letter of Intent is not available to employee benefit plans for which
affiliates of the Investment Adviser provide plan participant record-keeping
services. The Letter of Intent is not a binding obligation to purchase any
amount of Class I shares; however, its execution will result in the purchaser
paying a lower sales charge at the appropriate quantity purchase level. A
purchase not originally made pursuant to a Letter of Intent may be included
under a subsequent Letter of Intent executed within 90 days of such purchase if
the Distributor is informed in writing of this intent within such 90-day period.
The value of Class I shares of the Fund and of other Mercury mutual funds
presently held, at cost or maximum offering price (whichever is higher), on the
date of the first purchase under the Letter of Intent, may be included as a
credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied only to new
purchases. If the total amount of shares does not equal the amount stated in the
Letter of Intent (minimum of $25,000), the investor will be notified and must
pay, within 20 days of the execution of such Letter, the difference between the
sales charge on the Class I shares purchased at the reduced rate and the sales
charge applicable to the shares actually purchased through the Letter. Class I
shares equal to 5.0% of the intended amount will be held in escrow during the
13-month period (while remaining registered in the name of the purchaser) for
this purpose. The first purchase under the Letter of Intent must be at least
5.0% of the dollar amount of such Letter. If a purchase during the term of such
Letter would otherwise be subject to a further reduced sales charge based on the
right of accumulation, the purchaser will be entitled on that purchase and
subsequent purchases to that further reduced percentage sales charge but there
will be no retroactive reduction of the sales charges on any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intent will be deducted from
the total purchases made under such Letter. An
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<PAGE> 326
exchange from the Summit Cash Reserves Fund ("Summit") into the Fund that
creates a sales charge will count toward completing a new or existing Letter of
Intent from the Fund.
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and certain
other arrangements may purchase Class I shares at net asset value, based on the
number of employees or number of employees eligible to participate in the plan
and/or the aggregate amount invested by the plan in specified investments.
Minimum purchase requirements may be waived or varied for such plans. For
additional information regarding purchases by employer-sponsored retirement or
savings plans and certain other arrangements, call your plan administrator or
your selected securities dealer or other financial intermediary.
Managed Trusts. Class I shares are offered at net asset value to certain
trusts to which trust institutions, thrifts, and bank trust departments provide
discretionary trustee services.
Purchase Privileges of Certain Persons. Trustees of the Trust and of other
investment companies advised by the Investment Adviser or its affiliates,
directors and employees of ML & Co. and its subsidiaries (the term
"subsidiaries," when used herein with respect to ML & Co., includes the
Investment Adviser, Merrill Lynch Investment Managers, L.P., Merrill Lynch
Investment Managers International Limited and certain other entities directly or
indirectly wholly owned and controlled by ML & Co.), employees of certain
selected securities dealers, and any trust, pension, profit-sharing or other
benefit plan for such persons, may purchase Class I shares of the Fund at net
asset value. The Fund realizes economies of scale and reduction of sales-
related expenses by virtue of the familiarity of these persons with the Fund.
Employees and Trustees wishing to purchase shares of the Fund must satisfy the
Fund's suitability standards.
Class I shares are also offered at net asset value to certain accounts over
which the Investment Adviser or an affiliate exercises investment discretion [,
and to certain institutional investors].
Purchases Through Certain Financial Intermediaries. Reduced sales charges
may be applicable for purchases of Class I shares of the Fund through certain
financial advisers, selected securities dealers and other financial
intermediaries that meet and adhere to standards established by the Investment
Adviser from time to time.
A waived sales charge on a purchase of Class I shares will apply to current
beneficial shareholders who were also beneficial shareholders of the Fund as of
the opening of business of the Fund on October , 2000.
REDEMPTION OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Except for any deferred sales charge that may be applicable, there
will be no charge for redemption if the redemption request is sent directly to
the Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists, as defined by the
Commission, as a result of which disposal of portfolio securities or
determination of the net asset value of the Fund is not reasonably practicable,
and for such other periods as the Commission may by order permit for the
protection of shareholders of the Fund.
The value of shares of the Fund at the time of redemption may be more or
less than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
The Trust has entered into a joint committed line of credit with other
investment companies advised by the Investment Adviser and its affiliates and a
syndicate of banks that is intended to provide the Fund with a
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<PAGE> 327
temporary source of cash to be used to meet redemption requests from Fund
shareholders in extraordinary or emergency circumstances.
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so by tendering the shares directly to the Fund's Transfer Agent, Financial Data
Services, Inc., P.O. Box 41621, Jacksonville, Florida 32232-1621. Redemption
requests delivered other than by mail should be delivered to Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting redemption. Redemption
requests should not be sent to the Fund. The redemption request in either event
requires the signature(s) of all persons in whose name(s) the shares are
registered, signed exactly as such name(s) appear(s) on the Transfer Agent's
register. The signature(s) on the redemption request may require a guarantee by
an "eligible guarantor institution" as defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications. In the
event a signature guarantee is required, notarized signatures are not
sufficient. In general, signature guarantees are waived on redemptions of less
than $50,000 as long as the following requirements are met: (i) all requests
require the signature(s) of all persons in whose name(s) shares are recorded on
the Transfer Agent's register; (ii) all checks must be mailed to the stencil
address of record on the Transfer Agent's register and (iii) the stencil address
must not have changed within 30 days. Certain rules may apply regarding certain
account types such as but not limited to UGMA/UTMA accounts, Joint Tenancies
with Rights of Survivorship, contra broker transactions and institutional
accounts. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority.
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the Transfer
Agent at 1-800-236-4479. The request must be made by the shareholder of record
and be for an amount less than $50,000. Before telephone requests will be
honored, signature approval from all shareholders of record on the account must
be obtained. The shares being redeemed must have been held for at least 15 days.
Telephone redemption requests will not be honored in the following situations:
the accountholder is deceased, the proceeds are to be sent to someone other than
the shareholder of record, funds are to be wired to the client's bank account, a
systematic withdrawal plan is in effect, the request is by an individual other
than the accountholder of record, the account is held by joint tenants who are
divorced, the address has changed within the last 30 days or share certificates
have been issued on the account.
Since this account feature involves a risk of loss from unauthorized or
fraudulent transactions, the Transfer Agent will take certain precautions to
protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address registered
on the account and the social security number registered on the account. The
Fund or the Transfer Agent may temporarily suspend telephone transactions at any
time.
For shareholders redeeming directly with the Transfer Agent, payments will
be mailed within seven days of receipt of a proper notice of redemption. At
various times the Fund may be requested to redeem shares for which it has not
yet received good payment (e.g., cash, Federal funds or certified check drawn on
a U.S. bank). The Fund may delay or cause to be delayed the mailing of a
redemption check until such time as good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank) has been collected for the purchase of
such Fund shares, which usually will not exceed 10 days. In the event that a
shareholder account held directly with the Transfer Agent contains a fractional
share balance, such fractional share balance will be automatically redeemed by
the Fund.
REPURCHASE
The Fund also will repurchase its shares through a shareholder's listed
selected securities dealer or other financial intermediary. The Fund normally
will accept orders to repurchase shares by wire or telephone from
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<PAGE> 328
dealers for their customers at the net asset value next computed after the order
is placed. Shares will be priced at the net asset value calculated on the day
the request is received, provided that the request for repurchase is submitted
to the selected securities dealer or other financial intermediary prior to the
close of regular trading on the NYSE (generally, regular trading on the NYSE
closes at 4:00 p.m., Eastern time) and such request is received by the Fund from
such selected securities dealer or other financial intermediary not later than
30 minutes after the close of regular trading on the NYSE on the same day.
Selected securities dealers and other financial intermediaries have the
responsibility of submitting such repurchase requests to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to obtain
that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any applicable
deferred sales charge). Securities firms that do not have agreements with the
Distributor, however, may impose a transaction charge on the shareholder for
transmitting the notice of repurchase to the Fund. Certain selected securities
dealers and other financial intermediaries may charge a processing fee to
confirm a repurchase of shares. For example, the fee currently charged by
Merrill Lynch is $5.35. Fees charged by other selected securities dealers may be
higher or lower. Repurchases made through the Transfer Agent, on accounts held
at the Transfer Agent, are not subject to the processing fee. The Fund reserves
the right to reject any order for repurchase, which right of rejection might
adversely affect shareholders seeking redemption through the repurchase
procedure. A shareholder whose order for repurchase is rejected by the Fund,
however, may redeem Fund shares as set forth above.
REINSTATEMENT PRIVILEGE -- CLASS I SHARES
Shareholders of the Fund who have redeemed their Class I shares have a
privilege to reinstate their accounts by purchasing Class I shares of the Fund
at the net asset value without a sales charge up to the dollar amount redeemed.
The reinstatement privilege may be exercised by sending a notice of exercise
along with a check for the amount to be reinstated to the Transfer Agent within
30 days after the date the request for redemption was accepted by the Transfer
Agent or the Distributor. Alternatively, the reinstatement privilege may be
exercised through the investor's financial consultant within 30 days after the
date the request for redemption was accepted by the Transfer Agent or the
Distributor. The reinstatement will be made at the net asset value per share
next determined after the notice of reinstatement is received and cannot exceed
the amount of the redemption proceeds.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "Account Choices -- How Shares are Priced" in the
Prospectus.
The net asset value of the shares of the Fund is determined once daily
Monday through Friday as of the close of regular trading on the NYSE on each day
the NYSE is open for trading based on prices at the time of closing. Regular
trading on the NYSE generally closes at 4:00 p.m., Eastern time. Any assets or
liabilities initially expressed in terms of non-U.S. dollar currencies are
translated into U.S. dollars at the prevailing market rates as quoted by one or
more banks or dealers on the day of valuation. The NYSE is not open for trading
on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Net asset value of the Fund is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Investment Adviser, are accrued daily.
Portfolio securities, including ADRs, EDRs or GDRs, that are traded on
stock exchanges are valued at the last sale price (regular way) on the exchange
on which such securities are traded, as of the close of regular trading on the
day the securities are being valued or, lacking any sales, at the last available
bid price for long
19
<PAGE> 329
positions, and at the last available ask price for short positions. In cases
where securities are traded on more than one exchange, the securities are valued
on the exchange designated by or under the authority of the Board of Trustees as
the primary market. Long positions in securities traded in the OTC market are
valued at the last available bid price in the OTC market prior to the time of
valuation. Short positions in securities traded in the OTC market are valued at
the last available ask price in the OTC market prior to the time of valuation.
Portfolio securities that are traded both in the OTC market and on a stock
exchange are valued according to the broadest and most representative market.
When the Fund writes an option, the amount of the premium received is recorded
on the books of the Fund as an asset and an equivalent liability. The amount of
the liability is subsequently valued to reflect the current market value of the
option written, based upon the last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last ask price.
Options purchased by the Fund are valued at their last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last bid price. Other investments, including financial futures contracts and
related options, are stated at market value. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Trustees.
Such valuations and procedures will be reviewed periodically by the Board of
Trustees.
Generally, trading in non-U.S. securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of regular trading on the NYSE. The values of
such securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of regular trading on the NYSE. Occasionally,
events affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of regular trading
on the NYSE that may not be reflected in the computation of the Fund's net asset
value.
Each investor in the Fund may add to or reduce its investment in the Fund
on each day the NYSE is open for trading. The value of each investor's interest
in the Fund will be determined as of the close of regular trading on the NYSE by
multiplying the net asset value of the Fund by the percentage, effective for
that day, that represents that investor's share of the aggregate interests in
the Fund. The close of regular trading on the NYSE is generally 4:00 p.m.,
Eastern time. Any additions or withdrawals to be effected on that day will then
be effected. The investor's percentage of the aggregate beneficial interests in
the Fund will then be recomputed as the percentage equal to the fraction (i) the
numerator of which is the value of such investor's investment in the Fund as of
the time of determination on such day plus or minus, as the case may be, the
amount of any additions to or withdrawals from the investor's investment in the
Fund effected on such day, and (ii) the denominator of which is the aggregate
net asset value of the Fund as of such time on such day plus or minus, as the
case may be, the amount of the net additions to or withdrawals from the
aggregate investments in the Fund by all investors in the Fund. The percentage
so determined will then be applied to determine the value of the investor's
interest in the Fund after the close of regular trading on the NYSE on the next
determination of net asset value of the Fund.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for shares of the
Fund based on the net asset value of the Fund's shares on June 30, 2000 is as
follows:
<TABLE>
<CAPTION>
CLASS I
-------
<S> <C>
Net Assets.................................................. $
-------
Number of Shares Outstanding................................
-------
Net Asset Value Per Share (net assets divided by number of
shares outstanding)....................................... $
-------
Sales Charge (for Class I Shares; 5.25% of Offering Price;
( % of net amount invested))*.........................
-------
Offering Price.............................................. $
-------
</TABLE>
---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable. No sales charges were imposed as of June 30, 2000.
20
<PAGE> 330
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Subject to policies established by the Board of Trustees, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Fund, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and operational facilities of the firm and the
firm's risk in positioning a block of securities. While the Investment Adviser
generally seeks reasonably competitive commission rates, the Fund does not
necessarily pay the lowest spread or commission available. In addition,
consistent with the Conduct Rules of the NASD and policies established by the
Board of Trustees, the Investment Adviser may consider sales of Fund shares as a
factor in the selection of brokers or dealers to execute portfolio transactions
for the Fund; however, whether or not a particular broker or dealer sells shares
of the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Fund.
Subject to obtaining the best net results, brokers who provide supplemental
investment research to the Investment Adviser may receive orders for
transactions by the Fund. Such supplemental research services ordinarily consist
of assessments and analyses of the business or prospects of a company, industry
or economic sector. Information so received will be in addition to and not in
lieu of the services required to be performed by the Investment Adviser under
the Investment Advisory Agreement and the expenses of the Investment Adviser
will not necessarily be reduced as a result of the receipt of such supplemental
information. If in the judgment of the Investment Adviser the Fund will benefit
from supplemental research services, the Investment Adviser is authorized to pay
brokerage commissions to a broker furnishing such services that are in excess of
commissions that another broker may have charged for effecting the same
transactions. Certain supplemental research services may primarily benefit one
or more other investment companies or other accounts for which the Investment
Adviser exercises investment discretion. Conversely, the Fund may be the primary
beneficiary of the supplemental research services received as a result of
portfolio transactions effected for such other accounts or investment companies.
Foreign equity securities may be held by the Fund in the form of ADRs,
EDRs, GDRs or other securities convertible into foreign equity securities. ADRs,
EDRs and GDRs may be listed on stock exchanges, or traded in over-the-counter
markets in the United States or Europe, as the case may be. ADRs, like other
securities traded in the United States, will be subject to negotiated commission
rates. The Fund's ability and decisions to purchase or sell portfolio securities
of foreign issuers may be affected by laws or regulations relating to the
convertibility and repatriation of assets. Because the shares of the Fund are
redeemable on a daily basis in U.S. dollars, the Fund intends to manage the
portfolio so as to give reasonable assurance that it will be able to obtain U.S.
dollars to the extent necessary to meet anticipated redemptions. Under present
conditions, it is not believed that these considerations will have significant
effect on the Fund's portfolio strategies.
The Fund may invest in certain securities traded in the OTC market and
intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Fund and
persons who are affiliated with such affiliated persons are prohibited from
dealing with the Fund as principal in the purchase and sale of securities unless
a permissive order allowing such transactions is obtained from the Commission.
Since transactions in the OTC market usually involve transactions with the
dealers acting as principal for their own accounts, the Fund will not deal with
affiliated persons, including Merrill Lynch and its affiliates, in connection
with such transactions. However, an affiliated person of the Fund may serve as
its broker in OTC transactions conducted on an agency basis provided that, among
other things, the fee or commission received by such affiliated broker is
reasonable and fair compared to the fee or commission received by non-affiliated
brokers in connection with comparable transactions. In addition, the Fund may
not purchase securities during the existence of any underwriting syndicate for
such securities of which Merrill Lynch or an affiliate is a member or in a
private placement in which Merrill Lynch or an affiliate serves as placement
agent except
21
<PAGE> 331
pursuant to procedures approved by the Board of Trustees that either comply with
rules adopted by the Commission or with interpretations of the Commission staff.
See "Investment Objective and Policies -- Investment Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch or its affiliates acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund. Securities may be held by, or be appropriate
investments for, the Fund as well as other funds or investment advisory clients
of the Investment Adviser or its affiliates.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or its affiliates
when one or more clients of the Investment Adviser or its affiliates are selling
the same security. If purchases or sales of securities arise for consideration
at or about the same time that would involve the Fund or other clients or funds
for which the Investment Adviser or an affiliate acts as investment adviser,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Investment Adviser or
its affiliates during the same period may increase the demand for securities
being purchased or the supply of securities being sold, there may be an adverse
effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below that are
designed to facilitate investment in its shares. Full details as to each such
service and copies of the various plans or how to change options with respect
thereto, can be obtained from the Fund by calling the telephone number on the
cover page hereof, or from the Distributor or your selected securities dealer or
other financial intermediary. Certain of these services are available only to
U.S. investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of dividends. The statements
also will show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
dividends. A shareholder with an account held at the Transfer Agent may make
additions to his or her Investment Account at any time by mailing a check
directly to the Transfer Agent. The Fund does not issue share certificates.
Shareholders considering transferring their Class I shares from a selected
securities dealer to another brokerage firm or financial institution should be
aware that, if the firm to which the Class I shares are to be transferred will
not take delivery of shares of the Fund, a shareholder either must redeem the
shares so that the cash proceeds can be transferred to the account at the new
firm or such shareholder must continue to maintain an Investment Account at the
Transfer Agent for those shares.
Certain shareholder services may not be available for the transferred
shares. After the transfer, the shareholder may purchase additional shares of
funds owned before the transfer, and all future trading of these assets must be
coordinated by the new firm.
22
<PAGE> 332
Shareholders considering transferring a tax-deferred retirement account,
such as an individual retirement account, from a selected securities dealer or
other financial intermediary to another brokerage firm or financial institution
should be aware that, if the firm to which the retirement account is to be
transferred will not take delivery of shares of the Fund, a shareholder must
either redeem the shares so that the cash proceeds can be transferred to the
account at the new firm, or such shareholder must continue to maintain a
retirement account at a selected securities dealer or other financial
intermediary for those shares.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other Mercury mutual funds and Summit, a series of Financial
Institutions Series Trust, which is a Merrill Lynch-sponsored money market fund
specifically designated as available for exchange by holders of Class I shares.
Shares with a net asset value of at least $100 are required to qualify for the
exchange privilege and any shares used in an exchange must have been held by the
shareholder for at least 15 days. Before effecting an exchange, shareholders
should obtain a currently effective prospectus of the fund into which the
exchange is to be made. Exercise of the exchange privilege is treated as a sale
of the exchanged shares and a purchase of the acquired shares for Federal income
tax purposes.
Exchanges of Class I Shares. Under the Fund's pricing system, Class I
shareholders may exchange Class I shares of the Fund for Class I shares of a
second Mercury mutual fund. If the Class I shareholder wants to exchange Class I
shares for shares of a second Mercury mutual fund, but does not hold Class I
shares of the second fund in his or her account at the time of exchange and is
not otherwise eligible to acquire Class I shares of the second fund, the
shareholder will receive Class A shares of the second fund as a result of the
exchange.
Exchanges of Class I shares outstanding ("outstanding Class I shares") for
Class I or Class A shares of another Mercury mutual fund, or for Class A shares
of Summit ("new Class I or Class A shares") are transacted on the basis of
relative net asset value per Class I or Class A share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously paid
on the outstanding Class I shares and the sales charge payable at the time of
the exchange on the new Class I or Class A shares. With respect to outstanding
Class I shares as to which previous exchanges have taken place, the "sales
charge previously paid" shall include the aggregate of the sales charges paid
with respect to such Class I shares in the initial purchase and any subsequent
exchange. Class I shares issued pursuant to dividend reinvestment are sold on a
no-load basis. For purposes of the exchange privilege, Class I shares acquired
through dividend reinvestment shall be deemed to have been sold with a sales
charge equal to the sales charge previously paid on the Class I shares on which
the dividend was paid. Based on this formula, Class I shares of the Fund
generally may be exchanged into the Class I and Class A shares, respectively, of
the other funds with a reduced or without a sales charge.
Exchanges for Shares of a Money Market Fund. Class I shares are
exchangeable for Class A shares of Summit. Class A shares of Summit have an
exchange privilege back into Class I or Class A shares of affiliate-advised
Funds. This exchange privilege does not apply with respect to certain fee-based
programs for which alternative exchange arrangements may exist. Please see your
financial consultant for further information.
Prior to October 12, 1998, exchanges from other affiliate-advised Funds
into a money market fund were directed to certain affiliate-advised money market
funds other than Summit. Shareholders who exchanged affiliate-advised Fund
shares for such other money market funds and subsequently wish to exchange those
money market fund shares for shares of the Fund will be subject to the CDSC
schedule applicable to such Fund shares, if any. The holding period for those
money market fund shares will not count toward satisfaction of the holding
period requirement for reduction of the CDSC imposed on such shares, if any,
and, with respect to Class B shares, toward satisfaction of the Conversion
Period. However, the holding period for Class B or Class C shares of the Fund
received in exchange for such money market fund shares will be aggregated with
the holding period for the fund shares originally exchanged for such money
market fund shares for purposes of reducing the CDSC or satisfying the
Conversion Period.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her financial consultant, who will advise the
relevant Fund of the exchange. Shareholders of the Fund and
23
<PAGE> 333
shareholders of the other funds described above with shares for which
certificates have not been issued may exercise the exchange privilege by wire
through their selected securities dealers or other financial intermediaries. The
Fund reserves the right to require a properly completed Exchange Application.
This exchange privilege may be modified or terminated in accordance with the
rules of the Commission. The Fund reserves the right to limit the number of
times an investor may exercise the exchange privilege. Certain funds may suspend
the continuous offering of their shares to the general public at any time and
may thereafter resume such offering from time to time. The exchange privilege is
available only to U.S. shareholders in states where the exchange legally may be
made. It is contemplated that the exchange privilege may be applicable to other
new mutual funds whose shares may be distributed by the Distributor.
FEE-BASED PROGRAMS
Certain fee-based programs, including pricing alternatives for securities
transactions (each referred to in this paragraph as a "Program"), may permit the
purchase of Class I shares at net asset value. Under specified circumstances,
participants in certain Programs may deposit other classes of shares, which will
be exchanged for Class I shares. Initial or deferred sales charges otherwise due
in connection with such exchanges may be waived or modified. Termination of
participation in certain Programs may result in the redemption of shares held
therein. [In addition, upon termination of participation in a Program, shares
that have been held for less than specified periods within such Program may be
subject to a fee based on the current value of such shares.] These Programs also
generally prohibit such shares from being transferred to another account, to
another broker-dealer or to the Transfer Agent. Additional information regarding
certain specific Programs offered through particular selected securities dealers
or other financial intermediaries (including charges and limitations on
transferability applicable to shares that may be held in such Programs) is
available in each such Program's client agreement and from the Transfer Agent at
1-800-236-4479.
RETIREMENT PLANS
The minimum initial purchase to establish a retirement plan is $100.
Dividends received in retirement plans are exempt from Federal taxation until
distributed from the plans. Different tax rules apply to Roth IRA plans and
educational savings plans. Investors considering participation in any retirement
or education savings plan should review specific tax laws relating thereto and
should consult their attorneys or tax advisers with respect to the establishment
and maintenance of any such plan.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class I shares at the applicable public offering price. These
purchases may be made either through the shareholder's securities dealer or by
mail directly to the Transfer Agent, acting as agent for such securities dealer.
You may also add to your account by automatically investing a specific amount in
the Fund on a periodic basis through your selected securities dealer or other
financial intermediary. The current minimum for such automatic additional
investments is $100. This minimum may be waived or revised under certain
circumstances.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Shareholders may, at any time, by written notification to their selected
securities dealer or other financial intermediary if their account is maintained
with a selected securities dealer or other financial intermediary, or by written
notification or by telephone (1-800-236-4479) to the Transfer Agent, if their
account is maintained with the Transfer Agent, elect to have subsequent
dividends of ordinary income and/or capital gains paid with respect to shares of
the Fund in cash, rather than reinvested in shares of the Fund (provided that,
in the event that a payment on an account maintained at the Transfer Agent would
amount to $10.00 or less, a shareholder will not receive such payment in cash
and such payment will automatically be reinvested in additional shares).
Commencing ten days after the receipt by the Transfer Agent of such notice,
those instructions will be effected. The Fund is not responsible for any failure
of delivery to the shareholder's address of record and no interest will accrue
on amounts represented by uncashed dividend checks. Cash payments can also be
directly deposited to the shareholder's bank account.
24
<PAGE> 334
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals are available for shareholders with
shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed from
those on deposit in the shareholder's account to provide the withdrawal payment
specified by the shareholder. The shareholder may specify the dollar amount to
be redeemed. Redemptions will be made at net asset value as of the close of
regular trading on the NYSE (generally, the NYSE closes at 4:00 p.m., Eastern
time) on the 24th day of each month or the 24th day of the last month of each
quarter, whichever is applicable. If the NYSE is not open for business on such
date, the shares will be redeemed at the net asset value determined after the
close of regular trading on the NYSE on the following business day. The check
for the withdrawal payment will be mailed, or the direct deposit for withdrawal
payment will be made, on the next business day following redemption. When a
shareholder is making systematic withdrawals, dividends on all shares in the
Investment Account are reinvested automatically in Fund shares. A shareholder's
systematic withdrawal plan may be terminated at any time, without a charge or
penalty, by the shareholder, the Fund, the Transfer Agent or the Distributor.
If an investor wishes to change the amount being withdrawn in a systematic
withdrawal plan the investor should contact his or her financial consultant.
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax liabilities.
The Fund will not knowingly accept purchase orders for shares of the Fund from
investors who maintain a systematic withdrawal plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
DIVIDENDS AND TAX STATUS
The Fund has qualified as a regulated investment company. Qualification as
a regulated investment company requires, among other things, that (1) at least
90% of the Fund's annual gross income, without offset for losses from the sale
or other disposition of securities, be derived from payments with respect to
securities loans, interest, dividends and gains from the sale or other
disposition of stock, securities, or foreign currencies or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities, or currencies; and (2) the Fund diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of the Fund's assets is represented by cash, U.S. government securities,
securities of other regulated investment companies, and other securities limited
in respect of any one issuer to an amount not greater than 5% of the Fund's
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. government securities or the securities of other
regulated investment companies). In addition, in order not to be subject to
federal taxation, the Fund must distribute to its shareholders at least 90% of
its investment company taxable income earned in each year.
The Fund is required to pay an excise tax to the extent it does not
distribute to its shareholders during any calendar year at least 98% of its
ordinary income for that calendar year, 98% of the excess of its capital gains
over its capital losses for the one-year period ending October 31 in such
calendar year, and all undistributed ordinary income and capital gains for the
preceding respective one-year period. The Fund intends to meet these
distribution requirements to avoid excise tax liability. The Fund also intends
to continue distributing to shareholders all of the excess of net long-term
capital gain over net short-term capital loss on sales of
25
<PAGE> 335
securities. If the net asset value of shares of the Fund should, by reason of a
distribution of realized capital gains, be reduced below a shareholder's cost,
such distribution would to that extent be a return of capital to that
shareholder even though taxable to the shareholder, and a sale of shares by a
shareholder at net asset value at that time would establish a capital loss for
federal tax purposes.
In determining the extent to which the Fund's dividends may be eligible for
the 70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisers regarding other requirements applicable to the dividends received
deduction.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined in accordance with a formula specified
by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time. The Fund's total return may be
expressed either as a percentage or as a dollar amount in order to illustrate
such total return on a hypothetical $1,000 investment in the Fund at the
beginning of each specified period.
Average annual total returns for the periods ended June 30, 2000 are as
follows:
<TABLE>
<CAPTION>
ONE SINCE
YEAR INCEPTION
----- ---------
<S> <C> <C> <C>
Class I........................................ 10.41% 14.40% (Since 1/2/97)
</TABLE>
In order to reflect the reduced sales charges applicable to certain
investors, as described under "Purchase of Shares" and "Redemption of Shares,"
respectively, the total return data quoted by the Fund in advertisements
directed to such investors may take into account the reduced, and not the
maximum, sales charge and therefore may reflect greater total return since, due
to the reduced sales charges or the waiver of sales charges, a lower amount of
expenses is deducted.
In advertising and sales literature, the Fund may compare its performance
to that of various broad market indexes, including without limitation the Lehman
Brothers Aggregate Bond Index, Standard & Poor's 500 Composite Stock Price Index
and other published indexes. When comparing its performance to a market index,
the Fund may refer to various statistical measures derived from the historic
performance of the Fund and the index, such as standard deviation and beta. In
addition, the Fund may refer in advertising or sales literature to (i) mutual
fund performance ratings, rankings and comparisons (including risk-adjusted
ratings,
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rankings and comparisons), (ii) other comparisons of mutual fund data including
assets, expenses, fees and other data, and (iii) other discussions reported in
or assigned by Barron's, Business Week, CDA Investment Technology, Inc.,
Financial World, Forbes Magazine, Fortune Magazine, Lipper Inc., Money Magazine,
U.S. News & World Report, The Wall Street Journal and other industry
publications. The Fund may also make reference to awards that may be given to
the Investment Adviser. As with other performance data, performance comparisons
should not be considered indicative of the Fund's relative performance for any
future period.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest and to divide or combine
the shares into a greater or lesser number of shares without thereby changing
the proportionate beneficial interest in the Fund. Each share represents an
interest in the Fund proportionately equal to the interest of each other share.
Upon the Trust's liquidation, all shareholders would share pro rata in the net
assets of the Fund available for distribution to shareholders. If they deem it
advisable and in the best interest of shareholders, the Board of Trustees may
create additional classes of shares. The Board of Trustees has created ten
series of shares, and may create additional series in the future, which have
separate assets and liabilities.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a
Fund's shares may advise the Trustees in writing that they wish to communicate
with other shareholders for the purpose of requesting a meeting to remove a
Trustee. The Trustees will then, if requested by the applicants, mail at the
applicants' expense the applicants' communication to all other shareholders.
The Trust or the Fund may be terminated if approved by the vote of a
majority of the Trustees or by the approval of the holders of a majority of the
Trust's outstanding shares, as defined in the 1940 Act. If not so terminated,
the Trust will continue indefinitely.
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Trust or its Trustees. The Declaration of Trust provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for its obligations. While Massachusetts
law permits a shareholder of a trust such as this to be held personally liable
as a partner under certain circumstances, the risk of a shareholder incurring
financial loss on account of shareholder liability is highly unlikely and is
limited to the relatively remote circumstances in which the Trust would be
unable to meet its obligations.
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<PAGE> 337
Common expenses incurred by the Trust are allocated among the portfolios
based upon: (1) relative net assets; (2) as incurred on a specific
identification basis; or (3) evenly among the portfolios, depending on the
nature of the expenditure.
Except for (1) changes which do not adversely affect the rights of Trust
shareholders; (2) a change in the name of the Trust, or a series or class
thereof; (3) authorization of a new series or class; (4) changes to supply any
omission or correct any ambiguous or defective provision; or (5) changes
required by any federal, state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust without the affirmative vote of the holders of at least 67%
of the Trust's outstanding shares at a meeting at which more than 50% of its
outstanding shares are present in person or represented by proxy. The holders of
shares have no preemptive or conversion rights. Shares when issued are fully
paid and non-assessable, except as set forth above.
ISSUANCE OF FUND SHARES FOR SECURITIES
Investors may purchase Fund shares for consideration consisting of
securities rather than cash when, in the judgment of the Investment Adviser, the
securities: (a) meet the investment objective and policies of the Fund, (b) are
liquid and not subject to restrictions on resale, and (c) have a value that is
readily ascertainable via listing on or trading in a recognized United States or
international exchange or market.
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment wholly
in cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of the Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund during
any 90 day period for any one shareholder. Should redemptions by any shareholder
exceed such limitation the Fund will have the option of redeeming the excess in
cash or in kind. If shares are redeemed in kind, the redeeming shareholder would
incur brokerage costs in converting the assets into cash.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202, has been selected as the independent auditors of the Fund. The
independent auditors are responsible for auditing the annual financial
statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109-3661, acts as custodian of the Fund's assets (the "Custodian"). The
Custodian is responsible for safeguarding and controlling the Fund's cash and
securities, handling the receipt and delivery of securities and collecting
interest and dividends on the Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly-owned subsidiary of ML & Co., acts as the
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement. The Transfer Agent is responsible
for the issuance, transfer and redemption of shares and the opening, maintenance
and servicing of shareholder accounts.
LEGAL COUNSEL
Gardner, Carton & Douglas, 321 North Clark Street, Chicago, Illinois 60610,
is counsel for the Fund.
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<PAGE> 338
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio and
other information. An annual report containing financial statements audited by
independent auditors is sent to shareholders each year. After the end of each
year, shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
PRINCIPAL HOLDERS
[to come]
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STATEMENT OF ADDITIONAL INFORMATION
MERCURY HW SMALL CAP VALUE FUND
OF MERCURY HW FUNDS
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017 - Phone No.
(800) 236-4479
------------------------
Mercury HW Small Cap Value Fund (the "Fund") is a fund of the Mercury HW
Funds (the "Trust"). The Trust is a diversified, open-end, management investment
company which is organized as a Massachusetts business trust. The investment
objective of the Fund is to seek capital appreciation. The Fund seeks to achieve
its investment objective by investing primarily in stocks of U.S. companies with
market capitalizations of less than $2 billion. No assurance can be given that
the investment objective of the Fund will be realized. For more information on
the Fund's investment objective and policies, see "Investment Objective and
Policies."
The Fund offers two classes of shares, each with a different combination of
sales charges, ongoing fees and other features. Only certain investors are
eligible to buy Class I shares. See "Purchase of Shares."
------------------------
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus of the Fund, dated October , 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Fund at
1-800-236-4479 or your financial consultant or other financial intermediary, or
by writing to the Fund at Financial Data Services, Inc., P.O. Box 41621,
Jacksonville, Florida 32232-1621. The Prospectus is incorporated by reference
into this Statement of Additional Information, and this Statement of Additional
Information is incorporated by reference into the Prospectus. The Fund's
financial statements are incorporated by reference to its annual report for the
fiscal year ended June 30, 2000. You may request copies of the annual report at
no extra charge by calling 1-800-236-4479 between 8:00 a.m. and 8:00 p.m. on any
business day.
------------------------
MERCURY ADVISORS -- INVESTMENT ADVISER
FAM DISTRIBUTORS, INC. -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is October , 2000
<PAGE> 340
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Trust History............................................... 3
Investment Objective and Policies........................... 3
Investment Restrictions................................... 3
Repurchase Agreements..................................... 4
Bonds..................................................... 4
U.S. Government Securities................................ 4
Corporate Debt Securities................................. 5
Convertible Securities.................................... 5
Derivative Instruments.................................... 5
Foreign Securities........................................ 6
Foreign Investment Risks.................................. 7
Swap Agreements........................................... 8
Illiquid Securities....................................... 8
Borrowing................................................. 9
When-Issued Securities.................................... 9
Real Estate Investment Trusts............................. 10
Shares of Other Investment Companies...................... 10
Limited Partnerships...................................... 10
Short Sales Against-the-Box............................... 10
Corporate Loans........................................... 10
Temporary Defensive Position.............................. 10
Management of the Fund...................................... 10
Advisory Arrangements..................................... 12
Accounting and Administrative Services.................... 13
Code of Ethics............................................ 14
Purchase of Shares.......................................... 14
Initial Sales Charge Alternative -- Class I and Class A
Shares.................................................. 15
Reduced Initial Sales Charges............................. 16
Distribution Plan......................................... 17
Redemption of Shares........................................ 18
Redemption................................................ 19
Repurchase................................................ 19
Reinstatement Privilege -- Class I and Class A Shares..... 20
Pricing of Shares........................................... 20
Determination of Net Asset Value.......................... 20
Computation of Offering Price Per Share................... 22
Portfolio Transactions and Brokerage........................ 22
Transactions in Portfolio Securities...................... 22
Shareholder Services........................................ 23
Investment Account........................................ 23
Exchange Privilege........................................ 24
Fee-Based Programs........................................ 25
Retirement Plans.......................................... 26
Automatic Investment Plans................................ 26
Automatic Dividend Reinvestment Plan...................... 26
Systematic Withdrawal Plans............................... 26
Dividends and Tax Status.................................... 27
Performance Data............................................ 28
General Information......................................... 29
Description of Shares..................................... 29
Issuance of Fund Shares for Securities.................... 30
Redemption in Kind........................................ 30
Independent Auditors...................................... 30
Custodian................................................. 30
Transfer Agent............................................ 30
Legal Counsel............................................. 30
Reports to Shareholders................................... 30
Shareholder Inquiries..................................... 31
Additional Information.................................... 31
Principal Holders......................................... 31
</TABLE>
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<PAGE> 341
TRUST HISTORY
The Trust was organized on August 22, 1984 as a Massachusetts business
trust. Before October 7, 1994, the Trust was called "Olympic Trust," and before
October , 2000, the Trust was called "Hotchkis and Wiley Funds." The Trust is
a diversified, open-end, management investment company currently consisting of
ten separate funds. Prior to October , 2000, the Fund was called the Small Cap
Fund.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek capital appreciation.
Reference is made to the discussion under "How the Fund Invests" and "Investment
Risks" in the Prospectus for information with respect to the Fund's investment
objective and policies.
Mercury Advisors (the "Investment Adviser"), the Fund's investment adviser,
is responsible for the management of the Fund's portfolio.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of the Fund's outstanding
voting securities, as defined in the Investment Company Act of 1940, as amended
(the "1940 Act"). Under the 1940 Act, the vote of the holders of a "majority" of
the Fund's outstanding voting securities means the vote of the holders of the
lesser of (1) 67% of the shares of the Fund represented at a meeting at which
the holders of more than 50% of its outstanding shares are represented or (2)
more than 50% of the outstanding shares.
Except as noted, the Fund may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Fund's total assets (determined at the time of investment) would
then be invested in securities of a single issuer; or (ii) more than
25% of the Fund's total assets (determined at the time of investment)
would be invested in one or more issuers having their principal
business activities in a single industry.
2. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions),
provided that the deposit or payment by the Fund of initial or
maintenance margin in connection with futures or options is not
considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short (short sale
against-the-box), and unless not more than 25% of the Fund's net assets
(taken at current value) is held as collateral for such sales at any
one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Fund may borrow from a bank for temporary or emergency purposes in
amounts not exceeding 10% (taken at the lower of cost or current value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings; the Fund will not purchase any
additional portfolio securities while such borrowings are outstanding.
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would
then hold more than 10% of the outstanding voting securities of an
issuer.
6. Buy or sell commodities or commodity contracts or real estate or
interests in real estate, although it may purchase and sell securities
which are secured by real estate and securities of companies which
3
<PAGE> 342
invest or deal in real estate. (For the purposes of this restriction,
forward foreign currency exchange contracts are not deemed to be
commodities or commodity contracts.)
7. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws.
8. Make investments for the purpose of exercising control or management.
9. Participate on a joint or joint and several basis in any trading
account in securities.
10. Make loans, except through repurchase agreements.
11. Purchase or sell foreign currencies.
Any percentage limitation on the Fund's investments is determined when the
investment is made, unless otherwise noted.
REPURCHASE AGREEMENTS
The Fund may purchase debt securities maturing more than one year from the
date of purchase only if they are purchased subject to repurchase agreements. A
repurchase agreement is an agreement where the seller agrees to repurchase a
security from the Fund at a mutually agreed-upon time and price. The period of
maturity is usually quite short, possibly overnight or a few days, although it
may extend over a number of months. The resale price is more than the purchase
price, reflecting an agreed-upon rate of return effective for the period of time
the Fund's money is invested in the repurchase agreement. The Fund's repurchase
agreements will at all times be fully collateralized in an amount at least equal
to the resale price. The instruments held as collateral are valued daily, and if
the value of instruments declines, the Fund will require additional collateral.
In the event of a default, insolvency or bankruptcy by a seller, the Fund will
promptly seek to liquidate the collateral. In such circumstances, the Fund could
experience a delay or be prevented from disposing of the collateral. To the
extent that the proceeds from any sale of such collateral upon a default in the
obligation to repurchase are less than the repurchase price, the Fund will
suffer a loss.
BONDS
The term "bond" or "bonds" are used in the Prospectus is intended to
include all manner of fixed-income securities, debt securities and other debt
obligations unless specifically defined otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. The Fund will
invest in securities of such instrumentality only when the Investment Adviser is
satisfied that the credit risk with respect to any instrumentality is
acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely, either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such
4
<PAGE> 343
obligations. These obligations may take the form of (1) Treasury obligations
from which the interest coupons have been stripped; (2) the interest coupons
that are stripped; (3) book-entries at a Federal Reserve member bank
representing ownership of Treasury obligation components; or (4) receipts
evidencing the component parts (corpus or coupons) of Treasury obligations that
have not actually been stripped. Such receipts evidence ownership of component
parts of Treasury obligations (corpus or coupons) purchased by a third party
(typically an investment banking firm) and held on behalf of the third party in
physical or book-entry form by a major commercial bank or trust company pursuant
to a custody agreement with the third party. These custodial receipts are known
by various names, including "Treasury Receipts," "Treasury Investment Growth
Receipts" ("TIGRs") and "Certificates of Accrual on Treasury Securities"
("CATS"), and are not issued by the U.S. Treasury; therefore they are not U.S.
Government securities, although the underlying bonds represented by these
receipts are debt obligations of the U.S. Treasury.
CORPORATE DEBT SECURITIES
The Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, are in the Investment Adviser's opinion comparable
in quality to corporate debt securities in which the Fund may invest. The rate
of return or return of principal on some debt obligations may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying common stock.
The price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
DERIVATIVE INSTRUMENTS
As indicated in the prospectus, to the extent consistent with its
investment objective and policies and the investment restrictions listed in this
Statement of Additional Information, the Fund may purchase and write call and
put options on securities and securities indexes and enter into forward
contracts. The Fund also may enter into swap agreements with respect to foreign
currencies, interest rates and securities indexes. The Fund may use these
techniques to hedge against changes in interest rates or securities prices or as
part of its overall investment strategies. The Fund will mark as segregated
cash, U.S. government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily (or, as permitted by applicable
regulation, enter into certain offsetting positions), to cover its obligations
under forward contracts, swap agreements and options to avoid leveraging of the
Fund.
5
<PAGE> 344
Options on Securities and on Securities Indexes. The Fund may purchase put
options on securities to protect holdings in an underlying or related security
against a substantial decline in market value. The Fund may purchase call
options on securities to protect against substantial increases in prices of
securities the Fund intends to purchase pending its ability to invest in such
securities in an orderly manner. The Fund may sell put or call options it has
previously purchased, which could result in a net gain or loss depending on
whether the amount realized on the sale is more or less than the premium and
other transaction costs paid on the put or call option which is sold. The Fund
may write a call or put option only if the option is "covered" by the Fund
holding a position in the underlying securities or by other means which would
permit immediate satisfaction of the Fund's obligation as writer of the option.
Prior to exercise or expiration, an option may be closed out by an offsetting
purchase or sale of an option of the same series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
FOREIGN SECURITIES
The Fund may invest in American Depositary Receipts ("ADRs"), other
securities convertible into securities of issuers based in foreign countries or
other foreign securities that can be purchased and sold in U.S. dollars. ADRs
are receipts, usually issued by a U.S. bank or trust company, evidencing
ownership of the underlying securities; EDRs are European receipts evidencing a
similar arrangement. Generally, ADRs are issued in registered form, denominated
in U.S. dollars, and are designed for use in the U.S. securities markets.
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<PAGE> 345
FOREIGN INVESTMENT RISKS
Foreign Market Risk. The Fund may invest a portion of its assets in foreign
securities. Foreign security investment involves special risks not present in
U.S. investments that can increase the chances that the Fund will lose money.
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of capital, resources, and
balance of payments position. Certain such economies may rely heavily on
particular industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a particular country
or countries, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. Investments in foreign markets may
also be adversely affected by governmental actions such as the imposition of
capital controls, nationalization of companies or industries, expropriation of
assets, or the imposition of punitive taxes. In addition, the governments of
certain countries may prohibit or impose substantial restrictions on foreign
investing in their capital markets or in certain industries. Any of these
actions could severely affect security prices, impair the Fund's ability to
purchase or sell foreign securities or otherwise adversely affect the Fund's
operations. Other foreign market risks include difficulties in pricing
securities, defaults on foreign government securities, difficulties in enforcing
favorable legal judgments in foreign courts, and political and social
instability. Legal remedies available to investors in certain foreign countries
may be less extensive than those available to investors in the United States or
other foreign countries.
EMU. For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU established a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU participants by July 1, 2002. Upon implementation of EMU,
certain securities issued in participating EU countries (beginning with
government and corporate bonds) were redenominated in the euro, and are now
listed, traded, declaring dividends and making other payments only in euros.
No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on the Fund's investments
in Europe generally or in specific countries participating in EMU.
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some countries may not have laws
to protect investors the way that the United States securities laws do.
Accounting
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<PAGE> 346
standards in other countries are not necessarily the same as in the United
States. If the accounting standards in another country do not require as much
disclosure or detail as U.S. accounting standards, it may be harder for the
Fund's portfolio managers to completely and accurately determine a company's
financial condition.
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
SWAP AGREEMENTS.
The Fund may enter into interest rate and index swap agreements for
purposes of attempting to obtain a particular desired return at a lower cost to
the Fund than if the Fund had invested directly in an instrument that yielded
the desired return. Swap agreements are two party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to
more than one year. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized on
particular predetermined investments or instruments. The gross returns to be
exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate or in a "basket" of
securities representing a particular index. The "notional amount" of the swap
agreement is only a fictive basis on which to calculate the obligations which
the parties to a swap agreement have agreed to exchange. The Fund's obligations
(or rights) under a swap agreement will generally be equal only to the net
amount to be paid or received under the agreement based on the relative values
of the positions held by each party to the agreement (the "net amount"). The
Fund's obligations under a swap agreement will be accrued daily (offset against
any amounts owing to the Fund) and any accrued but unpaid net amounts owed to a
swap counter-party will be covered by marking as segregated cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, to avoid any potential leveraging of the Fund's
portfolio. The Fund will not enter into a swap agreement with any single party
if the net amount owed or to be received under existing contracts with that
party would exceed 5% of the Fund's assets.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Investment Adviser's
ability to correctly predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, the Fund bears the risk
of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counter-party.
Restrictions imposed by the Internal Revenue Code may limit the Fund's ability
to use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps market,
including potential government regulation, could adversely affect the Fund's
ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions of
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended ("Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
that have a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Limitations on resale may have an adverse effect on the
marketability of portfolio securities and a mutual fund might be unable to
dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemption within
seven days. The absence of a trading market can make it difficult to ascertain a
market value for illiquid investments. Also market quotations are less readily
available. The judgment of the Investment Adviser may at times play a greater
role in valuing these securities than in the case of unrestricted
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<PAGE> 347
securities. A mutual fund might also have to register such restricted securities
in order to dispose of them resulting in additional expense and delay. Adverse
market conditions could impede such a public offering of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Investment Adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least one nationally recognized statistical
rating organizations ("NRSRO"), or, if unrated, be of comparable quality in the
view of the Investment Adviser; and (2) it must not be in default as to
principal or interest. Investing in Rule 144A securities could have the effect
of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
BORROWING
The Fund may borrow for temporary, emergency or investment purposes in
amounts not exceeding 10% of the Fund's total assets. This borrowing may be
unsecured. The 1940 Act requires the Fund to maintain continuous asset coverage
(that is, total assets including borrowings, less liabilities exclusive of
borrowings) of 300% of the amount borrowed. Borrowing subjects the Fund to
interest costs which may or may not be recovered by appreciation of the
securities purchased, and can exaggerate the effect on net asset value of any
increase or decrease in the market value of the Fund's portfolio. This is the
speculative factor known as leverage.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value
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<PAGE> 348
of the security each day in determining the Fund's net asset value. The Fund
will also mark as segregated with its custodian cash, U.S. government
securities, equity securities or other liquid, unencumbered assets, marked-
to-market daily, equal in value to its obligations for when-issued securities.
REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain Internal Revenue Code requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties, as well as
greater income potential than an investment in common stocks. Like any
investment in real estate, though, a REIT's performance depends on several
factors, such as its ability to find tenants for its properties, to renew leases
and to finance property purchases and renovations.
SHARES OF OTHER INVESTMENT COMPANIES
The Fund can invest in securities of other investment companies except to
the extent prohibited by law. Like all equity investments, these investments may
go up or down in value. They also may not perform in correlation with the Fund's
principal strategies. The Fund will pay additional fees through its investments
in other investment companies.
LIMITED PARTNERSHIPS
The Fund can invest in limited partnership interests.
SHORT SALES AGAINST-THE-BOX
The Fund can borrow and sell "short" securities when it also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund's
total assets can be held as collateral for short sales at any one time.
CORPORATE LOANS
The Fund can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Fund may not
recover its investment, or there might be a delay in the Fund's recovery. By
investing in a corporate loan, the Fund becomes a member of the syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, the Fund may invest
all or part of its assets in short-term investment grade debt obligations of the
U.S. government, its agencies and instrumentalities, bank certificates of
deposit, bankers' acceptances, high quality commercial paper, demand notes and
repurchase agreements.
MANAGEMENT OF THE FUND
The Trustees oversee the actions of the Fund's Investment Adviser and other
service providers and decide upon matters of general policy. The Trustees also
review the actions of the Trust's officers, who conduct and
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supervise the daily business operations of the Trust. The Trustees (* denotes
"interested" Trustee as defined in the 1940 Act, due to the relationship with
the Investment Adviser) and officers of the Trust are:
MICHAEL BAXTER* (37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since 1999);
Managing Director of the Investment Adviser (since 1996); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since 1994); Chairman, Gamma Services Corp.
(venture capital) (since 1968); Principal, Gavin, Dailey & Partners (consulting)
(since 1993); U.S. Ambassador to Mexico (1981 - 1986); Director, Apex Mortgage
Capital, Inc., Atlantic Richfield Co., International Wire Corp. and Krause's
Furniture.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (since 1986); Member of CIEBA's Executive Committee (since
1988) and its Chairman (from 1991 - 1992); Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds (1986 - 1993); Member of the Investment Advisory Committees of
the State of New York Common Retirement Fund and the Howard Hughes Medical
Institute (since 1997); Director, Duke Management Company (since 1992) and Vice
Chairman (since 1998); Director, Kimco Realty Corporation (since 1997);
Director, LaSalle Street Fund (since 1995); Member of the Investment Advisory
Committee of the Virginia Retirement System (since 1998); Director, Montpelier
Foundation (since 1998); Trustee or Director of 31 registered investment
companies (consisting of 47 portfolios) for which the Investment Adviser or an
advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since
1999); Managing Director of the Investment Adviser (since 1998); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (48) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 66 registered investment companies
(consisting of 70 portfolios) for which the Investment Adviser or an advisory
affiliate is the adviser.
NANCY D. CELICK (49) -- President -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Chief Administrative Officer of the Investment
Adviser (since 1998); Chief Financial Officer of the Investment Adviser
(1993 - 1998); Chief Financial Officer of Kennedy-Wilson, Inc. (auction
marketing services) (1992 - 1993); Chief Financial Officer of First National
Corporation (bank holding company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-9011. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services
(since 1999); Vice President of FAM Distributors, Inc. (since 1999); First Vice
President of the Investment Adviser (1990 - 1997).
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<PAGE> 350
ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
GRACIE FERMELIA (38) -- Vice President and Assistant Secretary -- 725 South
Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Director of the
Investment Adviser (since 2000); Vice President of the Investment Adviser
(1997 - 2000); Senior Manager, Price Waterhouse (1985 - 1994).
The Trust does not pay salaries to any of its officers or fees to any of
its Trustees affiliated with the Investment Adviser. The following table sets
forth the aggregate compensation paid to the Trustees during the Trust's fiscal
year ended June 30, 2000 and the aggregate compensation paid to the Trustees for
service on the Trust's Board and that of any other fund for which the Investment
Adviser serves as investment adviser or which has an investment adviser that is
an affiliated person of the Investment Adviser ("Fund Complex") for the year
ended December 31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $ $ 34,000
John A. G. Gavin................................... $ $ 25,000
Joe Grills......................................... $ $232,333
Nigel Hurst-Brown.................................. $ -0- $ -0-
Robert B. Hutchinson**............................. $ $ 34,000
Madeleine A. Kleiner............................... $ $ 18,000
Merle T. Welshans**................................ $ $ 34,000
Richard R. West.................................... $ $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of Mercury HW Variable Trust, Fund
Asset Management Master Trust and Merrill Lynch Investment Managers Funds,
Inc. Messrs. Grills and West also serve on the boards of other investment
companies advised by the Investment Adviser or its advisory affiliates.
** Messrs. Hutchinson and Welshans retired on November 12, 1999.
The Trustees may be eligible for reduced sales charges on purchases of
Class I shares. See "Reduced Initial Sales Charges -- Purchase Privileges of
Certain Persons."
For information as to ownership of shares, see "General
Information -- Principal Holders."
ADVISORY ARRANGEMENTS
Investment Advisory Services and Fee. The Trust on behalf of the Fund has
entered into an investment advisory agreement (the "Advisory Agreement") with
the Investment Adviser as investment adviser. Subject to the supervision of the
Trustees, the Investment Adviser is responsible for the actual management of the
Fund and constantly reviews the Fund's holdings in light of its own research
analysis and that from other relevant sources. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser. The Investment Adviser performs certain of the other administrative
services and provides all office space, facilities, equipment and necessary
personnel for management of the Fund. The Investment Adviser receives for its
services to the Fund a monthly fee at an annual rate of 0.75% of the Fund's
average daily net assets. For purposes of this calculation, average daily net
assets is determined at the end of each month on the basis of the average net
assets of the Fund for each day during the month.
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<PAGE> 351
Prior to October , 2000, the Fund was party to an investment advisory
agreement under which it paid Merrill Lynch Investment Managers, L.P., an
affiliate of the Investment Adviser, a fee at the annual rate of 0.75% of its
average daily net assets. For the fiscal years ended June 30, 2000, 1999 and
1998, the Fund paid Merrill Lynch Investment Managers, L.P. $ ,
$357,779 and $491,489, respectively.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients of the Investment Adviser or an affiliate when one or more clients of
the Investment Adviser or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Payment of Fund Expenses. The Advisory Agreement obligates the Investment
Adviser to provide investment advisory services and to pay, or cause an
affiliate to pay, for maintaining its staff and personnel and to provide office
space, facilities and necessary personnel for the Fund. The Investment Adviser
is also obligated to pay, or cause an affiliate to pay, the fees of all officers
and Trustees who are affiliated persons of the Investment Adviser or any
sub-adviser or of an affiliate of the Investment Adviser or any sub-adviser. The
Fund pays, or causes to be paid, all other expenses incurred in the operation of
the Fund (except to the extent paid by FAM Distributors, Inc. (the
"Distributor")), including, among other things, taxes, expenses for legal and
auditing services, costs of printing proxies, shareholder reports, copies of the
Registration Statement, charges of the custodian, any sub-custodian and the
transfer agent, expenses of portfolio transactions, expenses of redemption of
shares, Commission fees, expenses of registering the shares under Federal, state
or non-U.S. laws, fees and actual out-of-pocket expenses of non-interested
Trustees, accounting and pricing costs (including the daily calculation of net
asset value), insurance, interest, brokerage costs, litigation and other
extraordinary or non-recurring expenses, and other expenses properly payable by
the Fund. Accounting services are provided to the Fund by the Investment Adviser
or an affiliate of the Investment Adviser, and the Fund reimburses the
Investment Adviser or an affiliate of the Investment Adviser for its costs in
connection with such services.
Organization of the Investment Adviser. The Investment Adviser is a limited
partnership, the partners of which are Merrill Lynch & Co., Inc. ("ML & Co."), a
financial services holding company and the parent of Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"), and Princeton Services, Inc. ML &
Co. and Princeton Services, Inc. are "controlling persons" of the Investment
Adviser as defined under the 1940 Act because of their ownership of its voting
securities and their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Advisory Agreement will remain in effect from year to year if approved annually
(a) by the Board of Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees of the Trust who are
not parties to the Advisory Agreement or interested persons (as defined in the
1940 Act) of any such party. The Advisory Agreement is not assignable and will
automatically terminate in the event of its assignment. In addition, such
contract may be terminated by the vote of a majority of the outstanding voting
securities of the Fund or by the Investment Adviser without penalty on 60 days'
written notice to the other party.
ACCOUNTING AND ADMINISTRATIVE SERVICES
The Trust has entered into a Fund Accounting and Administration Servicing
Agreement (the "Fund Accounting Agreement") with the Investment Adviser acting
as service provider. The Fund Accounting Agreement obligates the Investment
Adviser to provide certain accounting and administrative services to the Trust.
The Trust reimburses the Investment Adviser for its costs in connection with
such services.
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<PAGE> 352
Transfer Agency Services. The Transfer Agent, a subsidiary of ML & Co.,
acts as the Fund's Transfer Agent pursuant to a Transfer Agency, Dividend
Disbursing Agency and Shareholder Servicing Agency Agreement (the "Transfer
Agency Agreement"). Pursuant to the Transfer Agency Agreement, the Transfer
Agent is responsible for the issuance, transfer and redemption of shares and the
opening and maintenance of shareholder accounts. Pursuant to the Transfer Agency
Agreement, the Transfer Agent receives a fee ranging from $16.00 to $20.00 per
account (depending on the level of services required) and certain other fees
relating to special processing of sub-transfer agency relationships. The
Transfer Agent is entitled to reimbursement for certain transaction charges and
out-of-pocket expenses incurred by the Transfer Agent under the Transfer Agency
Agreement. For purposes of the Transfer Agency Agreement, the term "account"
includes a shareholder account maintained directly by the Transfer Agent and any
other account representing the beneficial interest of a person in the relevant
share class on a recordkeeping system.
Distribution Expenses. The Fund has entered into a distribution agreement
with the Distributor in connection with the continuous offering of shares of the
Fund (the "Distribution Agreement"). The Distribution Agreement obligates the
Distributor to pay certain expenses in connection with the offering of the
shares of the Fund. After the prospectuses, statements of additional information
and periodic reports have been prepared, set in type and mailed to shareholders,
the Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to dealers and investors. The Distributor also pays
for other supplementary sales literature and advertising costs. The Distribution
Agreement is subject to the same renewal requirements and termination provisions
as the Advisory Agreement described above.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act that covers the Trust, the Investment Adviser and the
Distributor (the "Code of Ethics"). The Code of Ethics significantly restricts
the personal investing activities of all employees of the Investment Adviser and
the Distributor and, as described below, imposes additional more onerous
restrictions on fund investment personnel.
The Code of Ethics requires that all employees of the Investment Adviser
and the Distributor pre-clear any personal securities investments (with limited
exceptions, such as mutual funds, high-quality short-term securities and direct
obligations of the U.S. government). The pre-clearance requirement and
associated procedures are designed to identify any substantive prohibition or
limitation applicable to the proposed investment. The substantive restrictions
applicable to all employees of the Investment Adviser and the Distributor
include a ban on acquiring any securities in a "hot" initial public offering. In
addition, investment personnel are prohibited from profiting on short-term
trading in securities. No employee may purchase or sell any security that at the
time is being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Investment Adviser. Furthermore, the Code of Ethics provides for trading
"blackout periods" which prohibit trading by investment personnel of the Fund
within seven calendar days, before or after, of trading by the Fund in the same
or equivalent security.
PURCHASE OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus for certain information as to the purchase of
Fund shares.
The Fund issues two classes of shares: Class I and Class A. Each Class I
and Class A share of the Fund represents an identical interest in the investment
portfolio of the Fund, and has the same rights, except that Class A shares bear
the expenses of the ongoing account maintenance fees (also known as service
fees). The account maintenance fees that are imposed on Class A shares are
imposed directly against the class and not against all assets of the Fund, and,
accordingly, such charges do not affect the net asset value of the other class.
Dividends paid by the Fund for each class of shares are calculated in the same
manner at the same time and differ only to the extent that account maintenance
fees are borne exclusively by that class. Class A shares have exclusive voting
rights with respect to the Rule 12b-1 distribution plan adopted with respect to
such class
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<PAGE> 353
pursuant to which the account maintenance fees are paid. Each class has
different exchange privileges. See "Shareholder Services -- Exchange Privilege."
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share plus any sales charge applicable to the
class of shares selected by the investor. The applicable offering price for
purchase orders is based upon the net asset value of the Fund next determined
after receipt of the purchase order by the Distributor. As to purchase orders
received by selected securities dealers or other financial intermediaries prior
to the close of regular trading on the New York Stock Exchange (the "NYSE")
(generally 4:00 p.m., Eastern time) which includes orders received after the
determination of net asset value on the previous day, the applicable offering
price will be based on the net asset value on the day the order is placed with
the Distributor, provided that the orders are received by the Distributor prior
to 30 minutes after the close of regular trading on the NYSE on that day. If the
purchase orders are not received prior to 30 minutes after the close of regular
trading on the NYSE on that day, such orders shall be deemed received on the
next business day. Selected securities dealers or other financial intermediaries
have the responsibility of submitting purchase orders to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to purchase
shares at that day's offering price.
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Any order may be rejected by the Fund or the Distributor. Neither
the Distributor nor the selected securities dealers or other financial
intermediaries are permitted to withhold placing orders to benefit themselves by
a price change. Certain selected securities dealers or other financial
intermediaries may charge a processing fee to confirm a sale of shares. For
example, the fee currently charged by Merrill Lynch is $5.35. Purchases made
directly through the Transfer Agent are not subject to the processing fee.
INITIAL SALES CHARGE ALTERNATIVE -- CLASS I AND CLASS A SHARES
Investors may elect to purchase Class A shares or, if an eligible investor,
Class I shares.
Investors who are eligible to purchase Class I shares should purchase Class
I shares rather than Class A shares, because there is an account maintenance fee
imposed on Class A shares.
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class I and Class A
shares of the Fund, refers to a single purchase by an individual or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his or her spouse and their children under
the age of 21 years purchasing shares for his, her or their own account and to
single purchases by a trustee or other fiduciary purchasing shares for a single
trust estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company," as that
term is defined in the 1940 Act, but does not include purchases by any such
company that has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
Class I shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class I shares. Investors
who owned Investor Class shares or who currently own Class I shares of the Fund
in a shareholder account are entitled to purchase additional Class I shares of
the Fund in that account. Certain employer-sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class I shares at net asset
value provided such plans meet the required minimum number of eligible employees
or required amount of assets advised by the Investment Adviser or any of its
affiliates. Also eligible to purchase Class I shares at net asset value are
participants in certain investment programs including certain managed accounts
for which a trust institution, thrift or bank trust department provides
discretionary trustee services, certain collective investment trusts for which a
trust institution, thrift, or bank trust department serves as trustee, certain
purchases made in connection with certain fee-based programs and certain
purchases made through certain financial advisers that meet and adhere to
standards established by the
15
<PAGE> 354
Investment Adviser. Class I shares are available at net asset value to corporate
warranty insurance reserve fund programs and U.S. branches of foreign banking
institutions, provided that the participant has $3 million or more initially
invested in affiliate-advised investment companies. In addition, Class I shares
are offered at net asset value to ML & Co. and its subsidiaries and their
directors and employees, to members of the Boards of investment companies
advised by the Investment Adviser or its affiliates, including the Fund, and to
employees of certain selected securities dealers or other financial
intermediaries. Class I shares may also be offered at net asset value to certain
accounts over which the Investment Adviser or an affiliate exercises investment
discretion. Although some investors who previously purchased Class I shares may
no longer be eligible to purchase Class I shares of other affiliate-advised
funds, those previously purchased Class I shares, together with Class A share
holdings, will count toward a right of accumulation which may qualify the
investor for a reduced initial sales charge on new initial sales charge
purchases. The ongoing Class A account maintenance fees will cause Class A
shares to have a higher expense ratio, pay lower dividends and have a lower
total return than Class I shares.
The Distributor may reallow discounts to selected securities dealers or
other financial intermediaries and retain the balance over such discounts. At
times the Distributor may reallow the entire sales charge to such selected
securities dealers or other financial intermediaries. Since selected securities
dealers or other financial intermediaries selling Class I and Class A shares of
the Fund will receive a concession equal to most of the sales charge, they may
be deemed to be underwriters under the Securities Act.
REDUCED INITIAL SALES CHARGES
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
to obtain such investments.
Reinvested Dividends. No initial sales charges are imposed upon Class I and
Class A shares issued as a result of the automatic reinvestment of dividends.
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other Mercury mutual funds. For any such right of accumulation to be
made available, the Distributor must be provided at the time of purchase, by the
purchaser or the purchaser's selected securities dealer or other financial
intermediary, with sufficient information to permit confirmation of
qualification. Acceptance of the purchase order is subject to such confirmation.
The right of accumulation may be amended or terminated at any time. Shares held
in the name of a nominee or custodian under pension, profit-sharing, or other
employee benefit plans may not be combined with other shares to qualify for the
right of accumulation.
Letter of Intent. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class I or Class A shares of the Fund or any
other Mercury mutual funds made within a 13-month period starting with the first
purchase pursuant to the Letter of Intent. The Letter of Intent is available
only to investors whose accounts are established and maintained at the Fund's
Transfer Agent. The Letter of Intent is not available to employee benefit plans
for which affiliates of the Investment Adviser provide plan participant
record-keeping services. The Letter of Intent is not a binding obligation to
purchase any amount of Class I or Class A shares; however, its execution will
result in the purchaser paying a lower sales charge at the appropriate quantity
purchase level. A purchase not originally made pursuant to a Letter of Intent
may be included under a subsequent Letter of Intent executed within 90 days of
such purchase if the Distributor is informed in writing of this intent within
such 90-day period. The value of Class I and Class A shares of the Fund and of
other Mercury mutual funds presently held, at cost or maximum offering price
(whichever is higher), on the date of the first purchase under the Letter of
Intent, may be included as a credit toward the completion of such Letter, but
the reduced sales charge applicable to the amount covered by such Letter will be
applied only to new purchases. If the total amount of shares does not equal the
amount stated in the Letter of Intent (minimum of $25,000), the investor will be
notified and must pay, within 20 days of the execution of
16
<PAGE> 355
such Letter, the difference between the sales charge on the Class I or Class A
shares purchased at the reduced rate and the sales charge applicable to the
shares actually purchased through the Letter. Class I or Class A shares equal to
5.0% of the intended amount will be held in escrow during the 13-month period
(while remaining registered in the name of the purchaser) for this purpose. The
first purchase under the Letter of Intent must be at least 5.0% of the dollar
amount of such Letter. If a purchase during the term of such Letter would
otherwise be subject to a further reduced sales charge based on the right of
accumulation, the purchaser will be entitled on that purchase and subsequent
purchases to that further reduced percentage sales charge but there will be no
retroactive reduction of the sales charges on any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intent will be deducted from
the total purchases made under such Letter. An exchange from the Summit Cash
Reserves Fund ("Summit") into the Fund that creates a sales charge will count
toward completing a new or existing Letter of Intent from the Fund.
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and certain
other arrangements may purchase Class I or Class A shares at net asset value,
based on the number of employees or number of employees eligible to participate
in the plan and/or the aggregate amount invested by the plan in specified
investments. Minimum purchase requirements may be waived or varied for such
plans. For additional information regarding purchases by employer-sponsored
retirement or savings plans and certain other arrangements, call your plan
administrator or your selected securities dealer or other financial
intermediary.
Managed Trusts. Class I shares are offered at net asset value to certain
trusts to which trust institutions, thrifts, and bank trust departments provide
discretionary trustee services.
Purchase Privileges of Certain Persons. Trustees of the Trust and of other
investment companies advised by the Investment Adviser or its affiliates,
directors and employees of ML & Co. and its subsidiaries (the term
"subsidiaries," when used herein with respect to ML & Co., includes the
Investment Adviser, Merrill Lynch Investment Managers, L.P., Merrill Lynch
Investment Managers International Limited and certain other entities directly or
indirectly wholly-owned and controlled by ML & Co.), employees of certain
selected securities dealers, and any trust, pension, profit-sharing or other
benefit plan for such persons, may purchase Class I shares of the Fund at net
asset value. The Fund realizes economies of scale and reduction of sales-
related expenses by virtue of the familiarity of these persons with the Fund.
Employees and Trustees wishing to purchase shares of the Fund must satisfy the
Fund's suitability standards.
Class I and Class A shares are also offered at net asset value to certain
accounts over which the Investment Adviser or an affiliate exercises investment
discretion.
Acquisition of Certain Investment Companies. Class A shares may be offered
at net asset value in connection with the acquisition of the assets of or merger
or consolidation with a personal holding company or a public or private
investment company.
Purchases Through Certain Financial Intermediaries. Reduced sales charges
may be applicable for purchases of Class I or Class A shares of the Fund through
certain financial advisers, selected securities dealers and other financial
intermediaries that meet and adhere to standards established by the Investment
Adviser from time to time.
A waived sales charge on a purchase of Class I shares will apply to current
beneficial shareholders who were also beneficial shareholders of the Fund as of
the opening of business of the Fund on October , 2000.
DISTRIBUTION PLAN
Reference is made to "Account Choices -- Pricing of Shares" in the
Prospectus for certain information with respect to the distribution plan for
Class A shares pursuant to Rule 12b-1 under the 1940 Act (the "Distribution
Plan") with respect to the account maintenance fees paid by the Fund to the
Distributor with respect to such class.
17
<PAGE> 356
The Distribution Plan of the Class A shares provides that the Fund pays the
Distributor an account maintenance fee relating to the shares of the relevant
class, accrued daily and paid monthly, at the annual rate of 0.25% of the
average daily net assets of the Fund in order to compensate the Distributor and
selected securities dealers or other financial intermediaries (pursuant to
sub-agreements) in connection with account maintenance activities with respect
to Class A shares. Holders of Class A shares have exclusive voting rights with
respect to the Distribution Plan adopted with respect to such class pursuant to
which account maintenance fees are paid.
The Fund's Distribution Plan is subject to the provisions of Rule 12b-1
under the 1940 Act. In their consideration of the Distribution Plan, the
Trustees must consider all factors they deem relevant, including information as
to the benefits of the Distribution Plan to the Fund and the related class of
shareholders. The Distribution Plan further provides that, so long as the
Distribution Plan remains in effect, the selection and nomination of
non-interested Trustees shall be committed to the discretion of the
non-interested Trustees then in office. In approving the Distribution Plan in
accordance with Rule 12b-1, the non-interested Trustees concluded that there is
a reasonable likelihood that such Distribution Plan will benefit the Fund and
its related class of shareholders. The Distribution Plan can be terminated at
any time, without penalty, by the vote of a majority of the non-interested
Trustees or by the vote of the holders of a majority of the outstanding Class A
shares of the Fund. The Distribution Plan cannot be amended to increase
materially the amount to be spent by the Fund without the approval of the Class
A shareholders, and all material amendments are required to be approved by the
vote of Trustees, including a majority of the non-interested Trustees who have
no direct or indirect financial interest in such Distribution Plan, cast in
person at a meeting called for that purpose. Rule 12b-1 further requires that
the Fund preserve copies of the Distribution Plan and any report made pursuant
to such plan for a period of not less than six years from the date of such
Distribution Plan or such report, the first two years in an easily accessible
place.
Among other things, the Distribution Plan provides that the Distributor
shall provide and the Trustees shall review quarterly reports of the
disbursement of the account maintenance fees paid to the Distributor. Payments
under the Distribution Plan are based on a percentage of average daily net
assets attributable to the shares regardless of the amount of expenses incurred.
For the fiscal year ended June 30, 2000, the Fund made no payments to the
Distributor under the Rule 12b-1 Plan for the Distributor Class shares (which
were redesignated as Class A shares).
REDEMPTION OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Except for any CDSC that may be applicable, there will be no charge
for redemption if the redemption request is sent directly to the Transfer Agent.
Shareholders liquidating their holdings will receive upon redemption all
dividends reinvested through the date of redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists, as defined by the
Commission, as a result of which disposal of portfolio securities or
determination of the net asset value of the Fund is not reasonably practicable,
and for such other periods as the Commission may by order permit for the
protection of shareholders of the Fund.
The value of shares of the Fund at the time of redemption may be more or
less than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
The Trust has entered into a joint committed line of credit with other
investment companies advised by the Investment Adviser and its affiliates and a
syndicate of banks that is intended to provide the Fund with a
18
<PAGE> 357
temporary source of cash to be used to meet redemption requests from Fund
shareholders in extraordinary or emergency circumstances.
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so by tendering the shares directly to the Fund's Transfer Agent, Financial Data
Services, Inc., P.O. Box 41621, Jacksonville, Florida 32232-1621. Redemption
requests delivered other than by mail should be delivered to Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting redemption. Redemption
requests should not be sent to the Fund. The redemption request in either event
requires the signature(s) of all persons in whose name(s) the shares are
registered, signed exactly as such name(s) appear(s) on the Transfer Agent's
register. The signature(s) on the redemption request may require a guarantee by
an "eligible guarantor institution" as defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications. In the
event a signature guarantee is required, notarized signatures are not
sufficient. In general, signature guarantees are waived on redemptions of less
than $50,000 as long as the following requirements are met: (i) all requests
require the signature(s) of all persons in whose name(s) shares are recorded on
the Transfer Agent's register; (ii) all checks must be mailed to the stencil
address of record on the Transfer Agent's register and (iii) the stencil address
must not have changed within 30 days. Certain rules may apply regarding certain
account types such as but not limited to UGMA/UTMA accounts, Joint Tenancies
with Rights of Survivorship, contra broker transactions and institutional
accounts. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority.
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the Transfer
Agent at 1-800-236-4479. The request must be made by the shareholder of record
and be for an amount less than $50,000. Before telephone requests will be
honored, signature approval from all shareholders of record on the account must
be obtained. The shares being redeemed must have been held for at least 15 days.
Telephone redemption requests will not be honored in the following situations:
the accountholder is deceased, the proceeds are to be sent to someone other than
the shareholder of record, funds are to be wired to the client's bank account, a
systematic withdrawal plan is in effect, the request is by an individual other
than the accountholder of record, the account is held by joint tenants who are
divorced, the address has changed within the last 30 days or share certificates
have been issued on the account.
Since this account feature involves a risk of loss from unauthorized or
fraudulent transactions, the Transfer Agent will take certain precautions to
protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address registered
on the account and the social security number registered on the account. The
Fund or the Transfer Agent may temporarily suspend telephone transactions at any
time.
For shareholders redeeming directly with the Transfer Agent, payments will
be mailed within seven days of receipt of a proper notice of redemption. At
various times the Fund may be requested to redeem shares for which it has not
yet received good payment (e.g., cash, Federal funds or certified check drawn on
a U.S. bank). The Fund may delay or cause to be delayed the mailing of a
redemption check until such time as good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank) has been collected for the purchase of
such Fund shares, which usually will not exceed 10 days. In the event that a
shareholder account held directly with the Transfer Agent contains a fractional
share balance, such fractional share balance will be automatically redeemed by
the Fund.
REPURCHASE
The Fund also will repurchase its shares through a shareholder's listed
selected securities dealer or other financial intermediary. The Fund normally
will accept orders to repurchase shares by wire or telephone from
19
<PAGE> 358
dealers for their customers at the net asset value next computed after the order
is placed. Shares will be priced at the net asset value calculated on the day
the request is received, provided that the request for repurchase is submitted
to the selected securities dealer or other financial intermediary prior to the
close of regular trading on the NYSE (generally, regular trading on the NYSE
closes at 4:00 p.m., Eastern time) and such request is received by the Fund from
such selected securities dealer or other financial intermediary not later than
30 minutes after the close of regular trading on the NYSE on the same day.
Selected securities dealers and other financial intermediaries have the
responsibility of submitting such repurchase requests to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to obtain
that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any applicable
CDSC). Securities firms that do not have agreements with the Distributor,
however, may impose a transaction charge on the shareholder for transmitting the
notice of repurchase to the Fund. Certain selected securities dealers and other
financial intermediaries may charge a processing fee to confirm a repurchase of
shares. For example, the fee currently charged by Merrill Lynch is $5.35. Fees
charged by other selected securities dealers may be higher or lower. Repurchases
made through the Transfer Agent, on accounts held at the Transfer Agent, are not
subject to the processing fee. The Fund reserves the right to reject any order
for repurchase, which right of rejection might adversely affect shareholders
seeking redemption through the repurchase procedure. A shareholder whose order
for repurchase is rejected by the Fund, however, may redeem Fund shares as set
forth above.
REINSTATEMENT PRIVILEGE -- CLASS I AND CLASS A SHARES
Shareholders of the Fund who have redeemed their Class I and Class A shares
have a privilege to reinstate their accounts by purchasing Class I or Class A
shares of the Fund, as the case may be, at the net asset value without a sales
charge up to the dollar amount redeemed. The reinstatement privilege may be
exercised by sending a notice of exercise along with a check for the amount to
be reinstated to the Transfer Agent within 30 days after the date the request
for redemption was accepted by the Transfer Agent or the Distributor.
Alternatively, the reinstatement privilege may be exercised through the
investor's financial consultant within 30 days after the date the request for
redemption was accepted by the Transfer Agent or the Distributor. The
reinstatement will be made at the net asset value per share next determined
after the notice of reinstatement is received and cannot exceed the amount of
the redemption proceeds.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "Account Choices -- How Shares are Priced" in the
Prospectus.
The net asset value of the shares of all classes of the Fund is determined
once daily Monday through Friday as of the close of regular trading on the NYSE
on each day the NYSE is open for trading based on prices at the time of closing.
Regular trading on the NYSE generally closes at 4:00 p.m., Eastern time. Any
assets or liabilities initially expressed in terms of non-U.S. dollar currencies
are translated into U.S. dollars at the prevailing market rates as quoted by one
or more banks or dealers on the day of valuation. The NYSE is not open for
trading on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
Net asset value of the Fund is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Administrator and Distributor, are accrued daily.
The per share net asset value of Class A shares generally will be lower
than the per share net asset value of Class I shares, reflecting the daily
expense accruals of the account maintenance fees applicable with respect to
Class A shares. It is expected, however, that the per share net asset value of
the two classes of the Fund will
20
<PAGE> 359
tend to converge (although not necessarily meet) immediately after the payment
of dividends which will differ by approximately the amount of the expense
accrual differentials between the classes.
Portfolio securities, including ADRs, EDRs or GDRs, that are traded on
stock exchanges are valued at the last sale price (regular way) on the exchange
on which such securities are traded, as of the close of regular trading on the
day the securities are being valued or, lacking any sales, at the last available
bid price for long positions, and at the last available ask price for short
positions. In cases where securities are traded on more than one exchange, the
securities are valued on the exchange designated by or under the authority of
the Board of Trustees as the primary market. Long positions in securities traded
in the OTC market are valued at the last available bid price in the OTC market
prior to the time of valuation. Short positions in securities traded in the OTC
market are valued at the last available ask price in the OTC market prior to the
time of valuation. Portfolio securities that are traded both in the OTC market
and on a stock exchange are valued according to the broadest and most
representative market. When the Fund writes an option, the amount of the premium
received is recorded on the books of the Fund as an asset and an equivalent
liability. The amount of the liability is subsequently valued to reflect the
current market value of the option written, based upon the last sale price in
the case of exchange-traded options or, in the case of options traded in the OTC
market, the last ask price. Options purchased by the Fund are valued at their
last sale price in the case of exchange-traded options or, in the case of
options traded in the OTC market, the last bid price. Other investments,
including financial futures contracts and related options, are stated at market
value. Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Trustees. Such valuations and procedures will be
reviewed periodically by the Board of Trustees.
Generally, trading in non-U.S. securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of regular trading on the NYSE. The values of
such securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of regular trading on the NYSE. Occasionally,
events affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of regular trading
on the NYSE that may not be reflected in the computation of the Fund's net asset
value.
Each investor in the Fund may add to or reduce its investment in the Fund
on each day the NYSE is open for trading. The value of each investor's interest
in the Fund will be determined as of the close of regular trading on the NYSE by
multiplying the net asset value of the Fund by the percentage, effective for
that day, that represents that investor's share of the aggregate interests in
the Fund. The close of regular trading on the NYSE is generally 4:00 p.m.,
Eastern time. Any additions or withdrawals to be effected on that day will then
be effected. The investor's percentage of the aggregate beneficial interests in
the Fund will then be recomputed as the percentage equal to the fraction (i) the
numerator of which is the value of such investor's investment in the Fund as of
the time of determination on such day plus or minus, as the case may be, the
amount of any additions to or withdrawals from the investor's investment in the
Fund effected on such day, and (ii) the denominator of which is the aggregate
net asset value of the Fund as of such time on such day plus or minus, as the
case may be, the amount of the net additions to or withdrawals from the
aggregate investments in the Fund by all investors in the Fund. The percentage
so determined will then be applied to determine the value of the investor's
interest in the Fund after the close of regular trading on the NYSE on the next
determination of net asset value of the Fund.
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<PAGE> 360
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class I and
Class A shares of the Fund based on the net asset value of the Fund's shares on
June 30, 2000 is as follows:
<TABLE>
<CAPTION>
CLASS I CLASS A
------- -------
<S> <C> <C>
Net Assets.................................................. $ $
------- -------
Number of Shares Outstanding................................
------- -------
Net Asset Value Per Share (net assets divided by number of
shares outstanding)....................................... $ $
------- -------
Sales Charge (for Class I and Class A Shares; 5.25% of
Offering Price; ( % of net amount invested))*.........
------- -------
Offering Price.............................................. $ $
------- -------
</TABLE>
---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable. No Class A shares were outstanding on June 30, 2000.
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Subject to policies established by the Board of Trustees, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Fund, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and operational facilities of the firm and the
firm's risk in positioning a block of securities. While the Investment Adviser
generally seeks reasonably competitive commission rates, the Fund does not
necessarily pay the lowest spread or commission available. In addition,
consistent with the Conduct Rules of the NASD and policies established by the
Board of Trustees, the Investment Adviser may consider sales of Fund shares as a
factor in the selection of brokers or dealers to execute portfolio transactions
for the Fund; however, whether or not a particular broker or dealer sells shares
of the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Fund.
Subject to obtaining the best net results, brokers who provide supplemental
investment research to the Investment Adviser may receive orders for
transactions by the Fund. Such supplemental research services ordinarily consist
of assessments and analyses of the business or prospects of a company, industry
or economic sector. Information so received will be in addition to and not in
lieu of the services required to be performed by the Investment Adviser under
the Investment Advisory Agreement and the expenses of the Investment Adviser
will not necessarily be reduced as a result of the receipt of such supplemental
information. If in the judgment of the Investment Adviser the Fund will benefit
from supplemental research services, the Investment Adviser is authorized to pay
brokerage commissions to a broker furnishing such services that are in excess of
commissions that another broker may have charged for effecting the same
transactions. Certain supplemental research services may primarily benefit one
or more other investment companies or other accounts for which the Investment
Adviser exercises investment discretion. Conversely, the Fund may be the primary
beneficiary of the supplemental research services received as a result of
portfolio transactions effected for such other accounts or investment companies.
Foreign equity securities may be held by the Fund in the form of ADRs,
EDRs, GDRs or other securities convertible into foreign equity securities. ADRs,
EDRs and GDRs may be listed on stock exchanges, or traded in over-the-counter
markets in the United States or Europe, as the case may be. ADRs, like other
securities traded in the United States, will be subject to negotiated commission
rates. The Fund's ability and decisions to purchase or sell portfolio securities
of foreign issuers may be affected by laws or regulations relating to the
convertibility and repatriation of assets. Because the shares of the Fund are
redeemable on a daily basis in
22
<PAGE> 361
U.S. dollars, the Fund intends to manage the portfolio so as to give reasonable
assurance that it will be able to obtain U.S. dollars to the extent necessary to
meet anticipated redemptions. Under present conditions, it is not believed that
these considerations will have significant effect on the Fund's portfolio
strategies.
The Fund may invest in certain securities traded in the OTC market and
intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Fund and
persons who are affiliated with such affiliated persons are prohibited from
dealing with the Fund as principal in the purchase and sale of securities unless
a permissive order allowing such transactions is obtained from the Commission.
Since transactions in the OTC market usually involve transactions with the
dealers acting as principal for their own accounts, the Fund will not deal with
affiliated persons, including Merrill Lynch and its affiliates, in connection
with such transactions. However, an affiliated person of the Fund may serve as
its broker in OTC transactions conducted on an agency basis provided that, among
other things, the fee or commission received by such affiliated broker is
reasonable and fair compared to the fee or commission received by non-affiliated
brokers in connection with comparable transactions. In addition, the Fund may
not purchase securities during the existence of any underwriting syndicate for
such securities of which Merrill Lynch or an affiliate is a member or in a
private placement in which Merrill Lynch or an affiliate serves as placement
agent except pursuant to procedures approved by the Board of Trustees that
either comply with rules adopted by the Commission or with interpretations of
the Commission staff. See "Investment Objective and Policies -- Investment
Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch or its affiliates acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund. Securities may be held by, or be appropriate
investments for, the Fund as well as other funds or investment advisory clients
of the Investment Adviser or its affiliates.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or its affiliates
when one or more clients of the Investment Adviser or its affiliates are selling
the same security. If purchases or sales of securities arise for consideration
at or about the same time that would involve the Fund or other clients or funds
for which the Investment Adviser or an affiliate acts as investment adviser,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Investment Adviser or
its affiliates during the same period may increase the demand for securities
being purchased or the supply of securities being sold, there may be an adverse
effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below that are
designed to facilitate investment in its shares. Full details as to each such
service and copies of the various plans or how to change options with respect
thereto, can be obtained from the Fund by calling the telephone number on the
cover page hereof, or from the Distributor or your selected securities dealer or
other financial intermediary. Certain of these services are available only to
U.S. investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction
23
<PAGE> 362
confirmations for automatic investment purchases and the reinvestment of
dividends. The statements also will show any other activity in the account since
the preceding statement. Shareholders also will receive separate confirmations
for each purchase or sale transaction other than automatic investment purchases
and the reinvestment of dividends. A shareholder with an account held at the
Transfer Agent may make additions to his or her Investment Account at any time
by mailing a check directly to the Transfer Agent. The Fund does not issue share
certificates.
Shareholders considering transferring their Class I or Class A shares from
a selected securities dealer or other financial intermediary to another
brokerage firm or financial institution should be aware that, if the firm to
which the Class I or Class A shares are to be transferred will not take delivery
of shares of the Fund, a shareholder either must redeem the Class I or Class A
shares so that the cash proceeds can be transferred to the account at the new
firm or such shareholder must continue to maintain an Investment Account at the
Transfer Agent for those Class I or Class A shares.
Certain shareholder services may not be available for the transferred
shares. After the transfer, the shareholder may purchase additional shares of
funds owned before the transfer, and all future trading of these assets must be
coordinated by the new firm.
Shareholders considering transferring a tax-deferred retirement account,
such as an individual retirement account, from a selected securities dealer or
other financial intermediary to another brokerage firm or financial institution
should be aware that, if the firm to which the retirement account is to be
transferred will not take delivery of shares of the Fund, a shareholder must
either redeem the shares (paying any applicable CDSC) so that the cash proceeds
can be transferred to the account at the new firm, or such shareholder must
continue to maintain a retirement account at a selected securities dealer or
other financial intermediary for those shares.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other Mercury mutual funds and Summit, a series of Financial
Institutions Series Trust, which is a Merrill Lynch-sponsored money market fund
specifically designated as available for exchange by holders of Class I and
Class A shares. Shares with a net asset value of at least $100 are required to
qualify for the exchange privilege and any shares used in an exchange must have
been held by the shareholder for at least 15 days. Before effecting an exchange,
shareholders should obtain a currently effective prospectus of the fund into
which the exchange is to be made. Exercise of the exchange privilege is treated
as a sale of the exchanged shares and a purchase of the acquired shares for
Federal income tax purposes.
Exchanges of Class I and Class A Shares. Under the Fund's pricing system,
Class I shareholders may exchange Class I shares of the Fund for Class I shares
of a second Mercury mutual fund. If the Class I shareholder wants to exchange
Class I shares for shares of a second Mercury mutual fund, but does not hold
Class I shares of the second fund in his or her account at the time of exchange
and is not otherwise eligible to acquire Class I shares of the second fund, the
shareholder will receive Class A shares of the second fund as a result of the
exchange. Class A shares also may be exchanged for Class I shares of a second
Mercury mutual fund at any time as long as, at the time of the exchange, the
shareholder is eligible to acquire Class I shares of any Mercury mutual fund.
Exchanges of Class I or Class A shares outstanding ("outstanding Class I or
Class A shares") for Class I or Class A shares of another Mercury mutual fund,
or for Class A shares of Summit ("new Class I or Class A shares") are transacted
on the basis of relative net asset value per Class I or Class A share,
respectively, plus an amount equal to the difference, if any, between the sales
charge previously paid on the outstanding Class I or Class A shares and the
sales charge payable at the time of the exchange on the new Class I or Class A
shares. With respect to outstanding Class I or Class A shares as to which
previous exchanges have taken place, the "sales charge previously paid" shall
include the aggregate of the sales charges paid with respect to such Class I or
Class A shares in the initial purchase and any subsequent exchange. Class I or
Class A shares issued pursuant to dividend reinvestment are sold on a no-load
basis. For purposes of the exchange privilege, Class I and Class A shares
acquired through dividend reinvestment shall be deemed to have been sold with a
sales charge equal to the sales charge previously paid on the Class I or Class A
shares on which the dividend was
24
<PAGE> 363
paid. Based on this formula, Class I and Class A shares of the Fund generally
may be exchanged into the Class I and Class A shares, respectively, of the other
funds with a reduced or without a sales charge.
Exchanges for Shares of a Money Market Fund. Class I and Class A shares are
exchangeable for Class A shares of Summit. Class A shares of Summit have an
exchange privilege back into Class I or Class A shares of affiliate-advised
Funds. This exchange privilege does not apply with respect to certain fee-based
programs for which alternative exchange arrangements may exist. Please see your
financial consultant for further information.
Prior to October 12, 1998, exchanges from other affiliate-advised Funds
into a money market fund were directed to certain affiliate-advised money market
funds other than Summit. Shareholders who exchanged affiliate-advised Fund
shares for such other money market funds and subsequently wish to exchange those
money market fund shares for shares of the Fund will be subject to the CDSC
schedule applicable to such Fund shares, if any. The holding period for those
money market fund shares will not count toward satisfaction of the holding
period requirement for reduction of the CDSC imposed on such shares, if any,
and, with respect to Class B shares, toward satisfaction of the Conversion
Period. However, the holding period for Class B or Class C shares of the Fund
received in exchange for such money market fund shares will be aggregated with
the holding period for the fund shares originally exchanged for such money
market fund shares for purposes of reducing the CDSC or satisfying the
Conversion Period.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her financial consultant, who will advise the
relevant Fund of the exchange. Shareholders of the Fund and shareholders of the
other funds described above with shares for which certificates have not been
issued may exercise the exchange privilege by wire through their selected
securities dealers or other financial intermediaries. The Fund reserves the
right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated in accordance with the rules of the
Commission. The Fund reserves the right to limit the number of times an investor
may exercise the exchange privilege. Certain funds may suspend the continuous
offering of their shares to the general public at any time and may thereafter
resume such offering from time to time. The exchange privilege is available only
to U.S. shareholders in states where the exchange legally may be made. It is
contemplated that the exchange privilege may be applicable to other new mutual
funds whose shares may be distributed by the Distributor.
FEE-BASED PROGRAMS
Certain fee-based programs, including pricing alternatives for securities
transactions (each referred to in this paragraph as a "Program"), may permit the
purchase of Class I shares at net asset value. Under specified circumstances,
participants in certain Programs may deposit other classes of shares, which will
be exchanged for Class I shares. Initial or deferred sales charges otherwise due
in connection with such exchanges may be waived or modified, as may the
Conversion Period applicable to the deposited shares. Termination of
participation in certain Programs may result in the redemption of shares held
therein or the automatic exchange thereof to another class at net asset value.
In addition, upon termination of participation in a Program, shares that have
been held for less than specified periods within such Program may be subject to
a fee based on the current value of such shares. These Programs also generally
prohibit such shares from being transferred to another account, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and account maintenance fees) in order for the
investment not to be subject to Program fees. Additional information regarding
certain specific Programs offered through particular selected securities dealers
or other financial intermediaries (including charges and limitations on
transferability applicable to shares that may be held in such Programs) is
available in each such Program's client agreement and from the Transfer Agent at
1-800-236-4479.
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<PAGE> 364
RETIREMENT PLANS
The minimum initial purchase to establish a retirement plan is $100.
Dividends received in retirement plans are exempt from Federal taxation until
distributed from the plans. Different tax rules apply to Roth IRA plans and
educational savings plans. Investors considering participation in any retirement
or education savings plan should review specific tax laws relating thereto and
should consult their attorneys or tax advisers with respect to the establishment
and maintenance of any such plan.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class I shares (if he or she is an eligible Class I investor) or
Class A shares at the applicable public offering price. These purchases may be
made either through the shareholder's securities dealer or by mail directly to
the Transfer Agent, acting as agent for such securities dealer. You may also add
to your account by automatically investing a specific amount in the Fund on a
periodic basis through your selected securities dealer or other financial
intermediary. The current minimum for such automatic additional investments is
$100. This minimum may be waived or revised under certain circumstances.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Shareholders may, at any time, by written notification to their selected
securities dealer or other financial intermediary if their account is maintained
with a selected securities dealer or other financial intermediary, or by written
notification or by telephone (1-800-236-4479) to the Transfer Agent, if their
account is maintained with the Transfer Agent, elect to have subsequent
dividends of ordinary income and/or capital gains paid with respect to shares of
the Fund in cash, rather than reinvested in shares of the Fund (provided that,
in the event that a payment on an account maintained at the Transfer Agent would
amount to $10.00 or less, a shareholder will not receive such payment in cash
and such payment will automatically be reinvested in additional shares).
Commencing ten days after the receipt by the Transfer Agent of such notice,
those instructions will be effected. The Fund is not responsible for any failure
of delivery to the shareholder's address of record and no interest will accrue
on amounts represented by uncashed dividend checks. Cash payments can also be
directly deposited to the shareholder's bank account.
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals are available for shareholders with
shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed from
those on deposit in the shareholder's account to provide the withdrawal payment
specified by the shareholder. The shareholder may specify the dollar amount and
class of shares to be redeemed. Redemptions will be made at net asset value as
of the close of regular trading on the NYSE (generally, the NYSE closes at 4:00
p.m., Eastern time) on the 24th day of each month or the 24th day of the last
month of each quarter, whichever is applicable. If the NYSE is not open for
business on such date, the shares will be redeemed at the net asset value
determined after the close of regular trading on the NYSE on the following
business day. The check for the withdrawal payment will be mailed, or the direct
deposit for withdrawal payment will be made, on the next business day following
redemption. When a shareholder is making systematic withdrawals, dividends on
all shares in the Investment Account are reinvested automatically in Fund
shares. A shareholder's systematic withdrawal plan may be terminated at any
time, without a charge or penalty, by the shareholder, the Fund, the Transfer
Agent or the Distributor.
If an investor wishes to change the amount being withdrawn in a systematic
withdrawal plan the investor should contact his or her financial consultant.
26
<PAGE> 365
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax liabilities.
The Fund will not knowingly accept purchase orders for shares of the Fund from
investors who maintain a systematic withdrawal plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
DIVIDENDS AND TAX STATUS
The Fund has qualified as a regulated investment company. Qualification as
a regulated investment company requires, among other things, that (1) at least
90% of the Fund's annual gross income, without offset for losses from the sale
or other disposition of securities, be derived from payments with respect to
securities loans, interest, dividends and gains from the sale or other
disposition of stock, securities, or foreign currencies or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities, or currencies; and (2) the Fund diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of the Fund's assets is represented by cash, U.S. Government securities,
securities of other regulated investment companies, and other securities limited
in respect of any one issuer to an amount not greater than 5% of the Fund's
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. Government securities or the securities of other
regulated investment companies). In addition, in order not to be subject to
federal taxation, the Fund must distribute to its shareholders at least 90% of
its investment company taxable income earned in each year.
The Fund is required to pay an excise tax to the extent it does not
distribute to its shareholders during any calendar year at least 98% of its
ordinary income for that calendar year, 98% of the excess of its capital gains
over its capital losses for the one-year period ending October 31 in such
calendar year, and all undistributed ordinary income and capital gains for the
preceding respective one-year period. The Fund intends to meet these
distribution requirements to avoid excise tax liability. The Fund also intends
to continue distributing to shareholders all of the excess of net long-term
capital gain over net short-term capital loss on sales of securities. If the net
asset value of shares of the Fund should, by reason of a distribution of
realized capital gains, be reduced below a shareholder's cost, such distribution
would to that extent be a return of capital to that shareholder even though
taxable to the shareholder, and a sale of shares by a shareholder at net asset
value at that time would establish a capital loss for federal tax purposes.
In determining the extent to which the Fund's dividends may be eligible for
the 70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisors regarding other requirements applicable to the dividends received
deduction.
Any loss realized on a sale, redemption or exchange of shares of the Fund
by a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by the Fund constitute a
replacement of shares.
The per share dividends on Class A shares will be lower than the per share
dividends on Class I shares as a result of the account maintenance fees
applicable with respect to the Class A shares. See "Pricing of
Shares -- Determination of Net Asset Value."
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<PAGE> 366
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined separately for Class I and Class A
shares in accordance with a formula specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class I and Class A
shares. Dividends paid by the Fund with respect to all shares, to the extent any
dividends are paid, will be calculated in the same manner at the same time on
the same day and will be in the same amount, except that account maintenance
charges will be borne exclusively by Class A.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time. The Fund's total return may be
expressed either as a percentage or as a dollar amount in order to illustrate
such total return on a hypothetical $1,000 investment in the Fund at the
beginning of each specified period.
Average annual total returns for the periods ended June 30, 2000 are as
follows:
<TABLE>
<CAPTION>
ONE FIVE TEN SINCE
YEAR YEARS YEARS INCEPTION
------ ----- ----- ---------
<S> <C> <C> <C> <C> <C>
Class I..................... -18.60% 4.81% 8.54% 9.73% (Since 9/20/85)
(Since /99)
Class A..................... N/A N/A N/A N/A
</TABLE>
In order to reflect the reduced sales charges in the case of Class I or
Class A shares applicable to certain investors, as described under "Purchase of
Shares" and "Redemption of Shares," respectively, the total return data quoted
by the Fund in advertisements directed to such investors may take into account
the reduced, and not the maximum, sales charge and therefore may reflect greater
total return since, due to the reduced sales charges or the waiver of sales
charges, a lower amount of expenses is deducted.
In advertising and sales literature, the Fund may compare its performance
to that of various broad market indexes, including without limitation the
Russell 2000 Index, Standard & Poor's 500 Composite Stock Price Index and other
published indexes. When comparing its performance to a market index, the Fund
may refer to various statistical measures derived from the historic performance
of the Fund and the index, such as standard deviation and beta. In addition, the
Fund may refer in advertising or sales literature to (i) mutual fund performance
ratings, rankings and comparisons (including risk-adjusted ratings, rankings and
comparisons), (ii) other comparisons of mutual fund data including assets,
expenses, fees and other data, and (iii) other discussions reported in or
assigned by Barron's, Business Week, CDA Investment Technology, Inc., Financial
World, Forbes Magazine, Fortune Magazine, Lipper Inc., Money Magazine, U.S. News
& World Report, The Wall Street Journal and other industry publications. The
Fund may also make reference to awards that may be given to the Investment
Adviser. As with other performance data, performance comparisons should not be
considered indicative of the Fund's relative performance for any future period.
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<PAGE> 367
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest and to divide or combine
the shares into a greater or lesser number of shares without thereby changing
the proportionate beneficial interest in the Fund. Each share represents an
interest in a Fund proportionately equal to the interest of each other share,
except that the Class A shares are subject to account maintenance fees payable
under the Plan of Distribution. Upon the Trust's liquidation, all shareholders
would share pro rata in the net assets of the Fund in question available for
distribution to shareholders. If they deem it advisable and in the best interest
of shareholders, the Board of Trustees may create additional classes of shares.
The Board of Trustees has created ten series of shares, and may create
additional series in the future, which have separate assets and liabilities.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a
Fund's shares may advise the Trustees in writing that they wish to communicate
with other shareholders for the purpose of requesting a meeting to remove a
Trustee. The Trustees will then, if requested by the applicants, mail at the
applicants' expense the applicants' communication to all other shareholders.
The Trust or the Fund may be terminated if approved by the vote of a
majority of the Trustees or by the approval of the holders of a majority of the
Trust's outstanding shares, as defined in the 1940 Act. If not so terminated,
the Trust will continue indefinitely.
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Trust or its Trustees. The Declaration of Trust provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for its obligations. While Massachusetts
law permits a shareholder of a trust such as this to be held personally liable
as a partner under certain circumstances, the risk of a shareholder incurring
financial loss on account of shareholder liability is highly unlikely and is
limited to the relatively remote circumstances in which the Trust would be
unable to meet its obligations.
Common expenses incurred by the Trust are allocated among the portfolios
based upon: (1) relative net assets; (2) as incurred on a specific
identification basis; or (3) evenly among the portfolios, depending on the
nature of the expenditure.
Except for (1) changes which do not adversely affect the rights of Trust
shareholders; (2) a change in the name of the Trust, or a series or class
thereof; (3) authorization of a new series or class; (4) changes to supply any
omission or correct any ambiguous or defective provision; or (5) changes
required by any federal, state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust
29
<PAGE> 368
without the affirmative vote of the holders of at least 67% of the Trust's
outstanding shares at a meeting at which more than 50% of its outstanding shares
are present in person or represented by proxy. The holders of shares have no
preemptive or conversion rights. Shares when issued are fully paid and
non-assessable, except as set forth above.
ISSUANCE OF FUND SHARES FOR SECURITIES
Investors may purchase Fund shares for consideration consisting of
securities rather than cash when, in the judgment of the Investment Adviser, the
securities: (a) meet the investment objective and policies of the Fund, (b) are
liquid and not subject to restrictions on resale, and (c) have a value that is
readily ascertainable via listing on or trading in a recognized United States or
international exchange or market.
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment wholly
in cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of the Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund during
any 90 day period for any one shareholder. Should redemptions by any shareholder
exceed such limitation the Fund will have the option of redeeming the excess in
cash or in kind. If shares are redeemed in kind, the redeeming shareholder would
incur brokerage costs in converting the assets into cash.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202 has been selected as the independent auditors of the Fund. The independent
auditors are responsible for auditing the annual financial statements of the
Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109-3661 acts as custodian of the Fund's assets (the "Custodian"). Under its
contract with the Trust, the Custodian is authorized to establish separate
accounts in foreign currencies and to cause foreign securities owned by the
Trust to be held in its offices outside the United States and with certain
foreign banks and securities depositories. The Custodian is responsible for
safeguarding and controlling the Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and dividends on the
Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly-owned subsidiary of ML & Co., acts as the
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement (the "Transfer Agency Agreement").
The Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts.
LEGAL COUNSEL
Gardner, Carton & Douglas, 321 North Clark Street, Chicago, Illinois 60610,
is counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio and
other information. An annual report containing financial statements audited by
independent auditors is sent to shareholders each year. After the end of each
30
<PAGE> 369
year, shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
PRINCIPAL HOLDERS
[to come]
31
<PAGE> 370
STATEMENT OF ADDITIONAL INFORMATION
MERCURY HW INTERNATIONAL VALUE FUND
OF MERCURY HW FUNDS
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017
Phone No. (800) 236-4479
------------------------
Mercury HW International Value Fund (the "Fund") is a series of Mercury HW
Funds (the "Trust"). The Trust is a diversified, open-end, management investment
company which is organized as a Massachusetts business trust. The investment
objective of the Fund is to seek to provide current income and long term growth
of income, accompanied by growth of capital. The Fund seeks to achieve its
investment objective by investing primarily in international stocks. No
assurance can be given that the investment objective of the Fund will be
realized. For more information on the Fund's investment objective and policies,
see "Investment Objective and Policies."
The Fund offers four classes of shares, each with a different combination
of sales charges, ongoing fees and other features. These alternatives permit an
investor to choose the method of purchasing shares that the investor believes is
most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances. See
"Purchase of Shares."
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This Statement of Additional Information is not a prospectus and should be
read in conjunction with the prospectus of the Fund, dated October , 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Fund at
1-800-236-4479 or your financial consultant or other financial intermediary, or
by writing to the Fund at Financial Data Services, Inc., P.O. Box 41621,
Jacksonville, Florida 32232-1621. The Prospectus is incorporated by reference
into this Statement of Additional Information, and this Statement of Additional
Information is incorporated by reference into the Prospectus. The Fund's
financial statements are incorporated by reference to its annual report for the
fiscal year ended June 30, 2000. You may request copies of the annual report at
no charge by calling 1-800-236-4479 between 8:00 a.m. and 8:00 p.m. on any
business day.
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MERCURY ADVISORS -- INVESTMENT ADVISER
FAM DISTRIBUTORS, INC. -- DISTRIBUTOR
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The date of this Statement of Additional Information is October , 2000
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TABLE OF CONTENTS
<TABLE>
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PAGE
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Trust History............................................... 3
Investment Objective and Policies........................... 3
Investment Restrictions................................... 3
Repurchase Agreements..................................... 4
Bonds..................................................... 4
U.S. Government Securities................................ 4
Corporate Debt Securities................................. 5
Convertible Securities.................................... 5
Derivative Instruments.................................... 5
Foreign Securities........................................ 6
Foreign Currency Options and Related Risks................ 7
Forward Foreign Currency Exchange Contracts............... 7
Foreign Investment Risks.................................. 9
Swap Agreements........................................... 10
Illiquid Securities....................................... 11
Borrowing................................................. 12
When-Issued Securities.................................... 12
Real Estate Investment Trusts............................. 12
Shares of Other Investment Companies...................... 13
Limited Partnerships...................................... 13
Short Sales Against-the-Box............................... 13
Corporate Loans........................................... 13
Temporary Defensive Position.............................. 13
Management of the Fund...................................... 13
Management and Advisory Arrangements...................... 15
Accounting and Administrative Services.................... 16
Code of Ethics............................................ 17
Purchase of Shares.......................................... 17
Initial Sales Charge Alternatives -- Class I and Class A
Shares.................................................. 18
Reduced Initial Sales Charges............................. 19
Deferred Sales Charge Alternatives -- Class B and Class C
Shares.................................................. 21
Distribution Plans........................................ 23
Limitations on the Payment of Deferred Sales Charges...... 24
Redemption of Shares........................................ 25
Redemption................................................ 25
Repurchase................................................ 26
Reinstatement Privilege -- Class I and Class A Shares..... 26
Pricing of Shares........................................... 27
Determination of Net Asset Value.......................... 27
Computation of Offering Price Per Share................... 28
Portfolio Transactions and Brokerage........................ 29
Transactions in Portfolio Securities...................... 29
Shareholder Services........................................ 30
Investment Account........................................ 30
Exchange Privilege........................................ 31
Fee-Based Programs........................................ 33
Retirement Plans.......................................... 33
Automatic Investment Plans................................ 33
Automatic Dividend Reinvestment Plan...................... 33
Systematic Withdrawal Plans............................... 34
Dividends and Tax Status.................................... 34
Performance Data............................................ 36
General Information......................................... 37
Description of Shares..................................... 37
Issuance of Fund Shares for Securities.................... 38
Redemption in Kind........................................ 38
Independent Auditors...................................... 38
Custodian................................................. 38
Transfer Agent............................................ 38
Legal Counsel............................................. 39
Reports to Shareholders................................... 39
Shareholder Inquiries..................................... 39
Additional Information.................................... 39
Principal Holders......................................... 39
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TRUST HISTORY
The Trust was organized on August 22, 1984 as a Massachusetts business
trust. Before October 7, 1994, the Trust was called "Olympic Trust," and before
October , 2000, the Trust was called "Hotchkis and Wiley Funds." The Trust is
a diversified, open-end, management investment company currently consisting of
ten separate funds. Prior to October , 2000, the Fund was called the
International Fund.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to maximize long-term total return.
Reference is made to the discussion under "How the Fund Invests" and "Investment
Risks" in the Prospectus for information with respect to the Fund's investment
objective and policies.
Mercury Advisors (the "Investment Adviser"), the Fund's investment adviser,
is responsible for the management of the Fund's portfolio.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of the Fund's outstanding
voting securities, as defined in the Investment Company Act of 1940, as amended
(the "1940 Act"). Under the 1940 Act, the vote of the holders of a "majority" of
the Fund's outstanding voting securities means the vote of the holders of the
lesser of (1) 67% of the shares of the Fund represented at a meeting at which
the holders of more than 50% of its outstanding shares are represented or (2)
more than 50% of the outstanding shares.
Except as noted, the Fund may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Fund's total assets (determined at the time of investment) would
then be invested in securities of a single issuer; or (ii) more than
25% of the Fund's total assets (determined at the time of investment)
would be invested in one or more issuers having their principal
business activities in a single industry.
2. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions),
provided that the deposit or payment by the Fund of initial or
maintenance margin in connection with futures or options is not
considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short (short sale
against-the-box), and unless not more than 25% of the Fund's net assets
(taken at current value) is held as collateral for such sales at any
one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Fund may borrow from a bank for temporary or emergency purposes in
amounts not exceeding 10% (taken at the lower of cost or current value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings; the Fund will not purchase any
additional portfolio securities while such borrowings are outstanding.
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would
then hold more than 10% of the outstanding voting securities of an
issuer.
6. Buy or sell commodities or commodity contracts or real estate or
interests in real estate, although it may purchase and sell securities
which are secured by real estate and securities of companies which
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invest or deal in real estate. (For the purposes of this restriction,
forward foreign currency exchange contracts are not deemed to be
commodities or commodity contracts.)
7. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws.
8. Make investments for the purpose of exercising control or management.
9. Participate on a joint or joint and several basis in any trading
account in securities.
10. Make loans, except through repurchase agreements.
Any percentage limitation on the Fund's investments is determined when the
investment is made, unless otherwise noted.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement where the seller agrees to
repurchase a security from the Fund at a mutually agreed-upon time and price.
The period of maturity is usually quite short, possibly overnight or a few days,
although it may extend over a number of months. The resale price is more than
the purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Fund's money is invested in the repurchase agreement. The
Fund's repurchase agreements will at all times be fully collateralized in an
amount at least equal to the resale price. The instruments held as collateral
are valued daily, and if the value of instruments declines, the Fund will
require additional collateral. In the event of a default, insolvency or
bankruptcy by a seller, the Fund will promptly seek to liquidate the collateral.
In such circumstances, the Fund could experience a delay or be prevented from
disposing of the collateral. To the extent that the proceeds from any sale of
such collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
BONDS
The term "bond" or "bonds" as used in the Prospectus is intended to include
all manner of fixed-income securities, debt securities and other debt
obligations unless specifically defined otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. The Fund will
invest in securities of such instrumentality only when the Investment Adviser is
satisfied that the credit risk with respect to any instrumentality is
acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely, either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (1) Treasury obligations from which the interest coupons
have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member bank representing ownership of Treasury obligation
components; or (4) receipts evidencing the component parts (corpus or coupons)
of Treasury obligations that have not actually been stripped. Such receipts
evidence ownership of component parts of Treasury obligations (corpus or
coupons) purchased by a third party
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(typically an investment banking firm) and held on behalf of the third party in
physical or book-entry form by a major commercial bank or trust company pursuant
to a custody agreement with the third party. These custodial receipts are known
by various names, including "Treasury Receipts," "Treasury Investment Growth
Receipts" ("TIGRs") and "Certificates of Accrual on Treasury Securities"
("CATS"), and are not issued by the U.S. Treasury; therefore they are not U.S.
Government securities, although the underlying bonds represented by these
receipts are debt obligations of the U.S. Treasury.
CORPORATE DEBT SECURITIES
The Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, are in the Investment Adviser's opinion comparable
in quality to corporate debt securities in which the Fund may invest. The rate
of return or return of principal on some debt obligations may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying common stock.
The price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
DERIVATIVE INSTRUMENTS
As indicated in the prospectus, to the extent consistent with its
investment objective and policies and the investment restrictions listed in this
Statement of Additional Information, the Fund may purchase and write call and
put options on securities, securities indexes and foreign currencies and enter
into forward contracts. The Fund also may enter into swap agreements with
respect to foreign currencies, interest rates and securities indexes. The Fund
may use these techniques to hedge against changes in interest rates, foreign
currency exchange rates, or securities prices or as part of its overall
investment strategies. The Fund may also purchase and sell options relating to
foreign currencies for the purpose of increasing exposure to a foreign currency
or to shift exposure to foreign currency fluctuations from one country to
another. The Fund will mark as segregated cash, U.S. government securities,
equity securities or other liquid, unencumbered assets, marked-to-market daily
(or, as permitted by applicable regulation, enter into certain offsetting
positions), to cover its obligations under forward contracts, swap agreements
and options to avoid leveraging of the Fund.
Options on Securities and on Securities Indexes. The Fund may purchase put
options on securities to protect holdings in an underlying or related security
against a substantial decline in market value. The Fund may purchase call
options on securities to protect against substantial increases in prices of
securities the Fund
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intends to purchase pending its ability to invest in such securities in an
orderly manner. The Fund may sell put or call options it has previously
purchased, which could result in a net gain or loss depending on whether the
amount realized on the sale is more or less than the premium and other
transaction costs paid on the put or call option which is sold. The Fund may
write a call or put option only if the option is "covered" by the Fund holding a
position in the underlying securities or by other means which would permit
immediate satisfaction of the Fund's obligation as writer of the option. Prior
to exercise or expiration, an option may be closed out by an offsetting purchase
or sale of an option of the same series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
FOREIGN SECURITIES
The Fund may invest in American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") or other securities convertible into securities of
issuers based in foreign countries. These securities may not necessarily be
denominated in the same currency as the securities into which they may be
converted. ADRs are receipts, usually issued by a U.S. bank or trust company,
evidencing ownership of the underlying securities; EDRs are European receipts
evidencing a similar arrangement. Generally, ADRs are issued in registered form,
denominated in U.S. dollars, and are designed for use in the U.S. securities
markets; EDRs are issued in bearer form, denominated in other currencies, and
are designed for use in European securities markets.
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FOREIGN CURRENCY OPTIONS AND RELATED RISKS
The Fund may take positions in options on foreign currencies to hedge
against the risk that foreign exchange rate fluctuations will affect the value
of foreign securities the Fund holds in its portfolio or intends to purchase.
For example, if the Fund were to enter into a contract to purchase securities
denominated in a foreign currency, it could effectively fix the maximum U.S.
dollar cost of the securities by purchasing call options on that foreign
currency. Similarly, if the Fund held securities denominated in a foreign
currency and anticipated a decline in the value of that currency against the
U.S. dollar, it could hedge against such a decline by purchasing a put option on
the currency involved. The markets in foreign currency options are relatively
new, and the Fund's ability to establish and close out positions in such options
is subject to the maintenance of a liquid secondary market. There can be no
assurance that a liquid secondary market will exist for a particular option at
any specific time. In addition, options on foreign currencies are affected by
all of those factors that influence foreign exchange rates and investments
generally.
The quantities of currencies underlying option contracts represent odd lots
in a market dominated by transactions between banks, and as a result extra
transaction costs may be incurred upon exercise of an option.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations be firm or revised on a
timely basis. Quotation information is generally representative of very large
transactions in the interbank market and may not reflect smaller transactions
where rates may be less favorable. Option markets may be closed while
round-the-clock interbank currency markets are open, and this can create price
and rate discrepancies.
Risks of Options Trading. The Fund may effectively terminate its rights or
obligations under options by entering into closing transactions. Closing
transactions permit the Fund to realize profits or limit losses on its options
positions prior to the exercise or expiration of the option. The value of a
foreign currency option depends on the value of the underlying currency relative
to the U.S. dollar. Other factors affecting the value of an option are the time
remaining until expiration, the relationship of the exercise price to market
price, the historical price volatility of the underlying currency and general
market conditions. As a result, changes in the value of an option position may
have no relationship to the investment merit of a foreign security. Whether a
profit or loss is realized on a closing transaction depends on the price
movement of the underlying currency and the market value of the option.
Options normally have expiration dates of up to nine months. The exercise
price may be below, equal to or above the current market value of the underlying
currency. Options that expire unexercised have no value, and the Fund will
realize a loss of any premium paid and any transaction costs. Closing
transactions may be effected only by negotiating directly with the other party
to the option contract, unless a secondary market for the options develops.
Although the Fund intends to enter into foreign currency options only with
dealers which agree to enter into, and which are expected to be capable of
entering into, closing transactions with the Fund, there can be no assurance
that the Fund will be able to liquidate an option at a favorable price at any
time prior to expiration. In the event of insolvency of the counter-party, the
Fund may be unable to liquidate a foreign currency option. Accordingly, it may
not be possible to effect closing transactions with respect to certain options,
with the result that the Fund would have to exercise those options that it had
purchased in order to realize any profit.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may use forward contracts to protect against uncertainty in the
level of future exchange rates. The Fund will not speculate with forward
contracts or foreign currency exchange rates.
The Fund may enter into forward contracts with respect to specific
transactions. For example, when the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, or when the Fund
anticipates the receipt in a foreign currency of dividend or interest payments
on a security that it holds, the Fund may desire to "lock in" the U.S. dollar
price of the security or the U.S. dollar equivalent of the payment, by entering
into a forward contract for the purchase or sale, for a fixed amount of U.S.
dollars or foreign currency, of the amount of foreign currency involved in the
underlying transaction. The Fund will
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thereby be able to protect itself against a possible loss resulting from an
adverse change in the relationship between the currency exchange rates during
the period between the date on which the security is purchased or sold, or on
which the payment is declared, and the date on which such payments are made or
received.
The Fund also may use forward contracts in connection with portfolio
positions to lock in the U.S. dollar value of those positions, to increase the
Fund's exposure to foreign currencies that the Investment Adviser believes may
rise in value relative to the U.S. dollar or to shift the Fund's exposure to
foreign currency fluctuations from one country to another. For example, when the
Investment Adviser believes that the currency of a particular foreign country
may suffer a substantial decline relative to the U.S. dollar or another
currency, it may enter into a forward contract to sell the amount of the former
foreign currency approximating the value of some or all of the Fund's portfolio
securities denominated in such foreign currency. This investment practice
generally is referred to as "cross-hedging" when another foreign currency is
used.
The precise matching of the forward contract amounts and the value of the
securities involved will not generally be possible because the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Accordingly, it may be necessary for
the Fund to purchase additional foreign currency on the spot (that is, cash)
market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Fund is obligated to
deliver and if a decision is made to sell the security and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio security if
its market value exceeds the amount of foreign currency the Fund is obligated to
deliver. The projection of short-term currency market movements is extremely
difficult, and the successful execution of a short-term hedging strategy is
highly uncertain. Forward contracts involve the risk that anticipated currency
movements will not be accurately predicted, causing the Fund to sustain losses
on these contracts and transaction costs. The Fund may enter into forward
contracts or maintain a net exposure to such contracts only if (1) the
consummation of the contracts would not obligate the Fund to deliver an amount
of foreign currency in excess of the value of the Fund's portfolio securities or
other assets denominated in that currency, or (2) the Fund maintains in a
segregated account cash, U.S. Government securities, equity securities or other
liquid, unencumbered assets, marked-to-market daily, in an amount not less than
the value of the Fund's total assets committed to the consummation of the
contracts. Under normal circumstances, consideration of the prospect for
currency parities will be incorporated into the longer term investment decisions
made with regard to overall diversification strategies. However, the Investment
Adviser believes it is important to have the flexibility to enter into such
forward contracts when it determines that the best interests of the Fund will be
served.
At or before the maturity date of a forward contract that requires the Fund
to sell a currency, the Fund may either sell a portfolio security and use the
sale proceeds to 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 that it is obligated to deliver. Similarly, the Fund
may close out a forward contract requiring it to purchase a specified currency
by entering into a second contract entitling it to sell the same amount of the
same currency on the maturity date of the first contract. The Fund would realize
a gain or loss as a result of entering into such an offsetting forward contract
under either circumstance to the extent the exchange rate between the currencies
involved moved between the execution dates of the first and second contracts.
The cost to the Fund of engaging in forward contracts varies with factors
such as the currencies involved, the length of the contract period and the
market conditions then prevailing. Because forward contracts are usually entered
into on a principal basis, no fees or commissions are involved. The use of
forward contracts does not eliminate fluctuations in the prices of the
underlying securities the Fund owns or intends to acquire, but it does fix a
rate of exchange in advance. In addition, although forward contracts limit the
risk of loss due to a decline in the value of the hedged currencies, at the same
time they limit any potential gain that might result should the value of the
currencies increase.
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend to convert holdings of foreign currencies into U.S. dollars on a
daily basis. The Fund may convert foreign currency from time to time,
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and investors should be aware of the costs of currency conversion. Although
foreign exchange dealers do not charge a fee for conversion, they do realize a
profit based on the difference between the prices at which they are buying and
selling various currencies. Thus, a dealer may offer to sell a foreign currency
to the Fund at one rate, while offering a lesser rate of exchange should the
Fund desire to resell that currency to the dealer.
FOREIGN INVESTMENT RISKS
Foreign Market Risk. Because the Fund may invest in foreign securities, the
Fund offers you more diversification than an investment only in the United
States since prices of securities traded on foreign markets have often, though
not always, moved counter to prices in the United States. Foreign security
investment, however, involves special risks not present in U.S. investments that
can increase the chances that the Fund will lose money. In particular, the Fund
is subject to the risk that because there are generally fewer investors on
foreign exchanges and a smaller number of shares traded each day, it may be
difficult for the Fund to buy and sell securities on those exchanges. In
addition, prices of foreign securities may fluctuate more than prices of
securities traded in the United States.
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of capital, resources, and
balance of payments position. Certain such economies may rely heavily on
particular industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a particular country
or countries, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. Investments in foreign markets may
also be adversely affected by governmental actions such as the imposition of
capital controls, nationalization of companies or industries, expropriation of
assets, or the imposition of punitive taxes. In addition, the governments of
certain countries may prohibit or impose substantial restrictions on foreign
investing in their capital markets or in certain industries. Any of these
actions could severely affect security prices, impair the Fund's ability to
purchase or sell foreign securities or transfer the Fund's assets or income back
into the United States, or otherwise adversely affect the Fund's operations.
Other foreign market risks include foreign exchange controls, difficulties in
pricing securities, defaults on foreign government securities, difficulties in
enforcing favorable legal judgments in foreign courts, and political and social
instability. Legal remedies available to investors in certain foreign countries
may be less extensive than those available to investors in the United States or
other foreign countries.
Currency Risk and Exchange Risk. Securities in which the Fund invests may
be denominated or quoted in currencies other than the U.S. dollar. Changes in
foreign currency exchange rates will affect the value of the securities of the
Fund. Generally, when the U.S. dollar rises in value against a foreign currency,
your investment in a security denominated in that currency loses value because
the currency is worth fewer U.S. dollars. Similarly when the U.S. dollar
decreases in value against a foreign currency, your investment in a security
denominated in that currency gains value because the currency is worth more U.S.
dollars. This risk is generally known as "currency risk" which is the
possibility that a stronger U.S. dollar will reduce returns for U.S. investors
investing overseas and a weak U.S. dollar will increase returns for U.S.
investors investing overseas.
For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU established a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU participants by July 1, 2002. Upon implementation of EMU,
certain securities issued in participating EU countries (beginning with
government and corporate bonds) were redenominated in the euro, and are now
listed, traded, declaring dividends and making other payments only in euros.
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No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on the Fund's investments
in Europe generally or in specific countries participating in EMU.
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some countries may not have laws
to protect investors the way that the United States securities laws do.
Accounting standards in other countries are not necessarily the same as in the
United States. If the accounting standards in another country do not require as
much disclosure or detail as U.S. accounting standards, it may be harder for the
Fund's portfolio managers to completely and accurately determine a company's
financial condition.
Certain Risks of Holding Fund Assets Outside the United States. The Fund
generally holds the foreign securities in which it invests outside the United
States in foreign banks and securities depositories. These foreign banks and
securities depositories may be recently organized or new to the foreign custody
business. They may also have operations subject to limited or no regulatory
oversight. Also, the laws of certain countries may put limits on the Fund's
ability to recover its assets if a foreign bank or depository or issuer of a
security or any of their agents goes bankrupt. In addition, it can be expected
that it will be more expensive for the Fund to buy, sell and hold securities in
certain foreign markets than it is in the U.S. market due to higher brokerage,
transaction, custody and/or other costs. The increased expense of investing in
foreign markets reduces the amount the Fund can earn on its investments.
Settlement and clearance procedures in certain foreign markets differ
significantly from those in the United States. Foreign settlement and clearance
procedures and trade regulations also may involve certain risks (such as delays
in payment for or delivery of securities) not typically involved with the
settlement of U.S. investments. Communications between the United States and
emerging market countries may be unreliable, increasing the risk of delayed
settlements or losses of security certificates. Settlements in certain foreign
countries at times have not kept pace with the number of securities
transactions. These problems may make it difficult for a Fund to carry out
transactions. If the Fund cannot settle or is delayed in settling a purchase of
securities, it may miss attractive investment opportunities and certain of its
assets may be uninvested with no return earned thereon for some period. If the
Fund cannot settle or is delayed in settling a sale of securities, it may lose
money if the value of the security then declines or, if it has contracted to
sell the security to another party, the Fund could be liable to that party for
any losses incurred.
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
SWAP AGREEMENTS.
The Fund may enter into interest rate, index and currency exchange rate
swap agreements for purposes of attempting to obtain a particular desired return
at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded the desired return. Swap agreements are two party
contracts entered into primarily by institutional investors for periods ranging
from a few weeks to more than one year. In a standard "swap" transaction, two
parties agree to exchange the returns (or differentials in rates of return)
earned or
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realized on particular predetermined investments or instruments. The gross
returns to be exchanged or "swapped" between the parties are calculated with
respect to a "notional amount," i.e., the return on or increase in value of a
particular dollar amount invested at a particular interest rate, in a particular
foreign currency, or in a "basket" of securities representing a particular
index. The "notional amount" of the swap agreement is only a fictive basis on
which to calculate the obligations which the parties to a swap agreement have
agreed to exchange. The Fund's obligations (or rights) under a swap agreement
will generally be equal only to the net amount to be paid or received under the
agreement based on the relative values of the positions held by each party to
the agreement (the "net amount"). The Fund's obligations under a swap agreement
will be accrued daily (offset against any amounts owing to the Fund) and any
accrued but unpaid net amounts owed to a swap counter-party will be covered by
marking as segregated cash, U.S. government securities, equity securities or
other liquid, unencumbered assets, marked-to-market daily, to avoid any
potential leveraging of the Fund's portfolio. The Fund will not enter into a
swap agreement with any single party if the net amount owed or to be received
under existing contracts with that party would exceed 5% of the Fund's assets.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Investment Adviser's
ability to correctly predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, the Fund bears the risk
of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counter-party.
Restrictions imposed by the Internal Revenue Code may limit the Fund's ability
to use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps market,
including potential government regulation, could adversely affect the Fund's
ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions of
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended ("Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
that have a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Limitations on resale may have an adverse effect on the
marketability of portfolio securities and a mutual fund might be unable to
dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemption within
seven days. The absence of a trading market can make it difficult to ascertain a
market value for illiquid investments. Also market quotations are less readily
available. The judgment of the Investment Adviser may at times play a greater
role in valuing these securities than in the case of unrestricted securities. A
mutual fund might also have to register such restricted securities in order to
dispose of them resulting in additional expense and delay. Adverse market
conditions could impede such a public offering of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the
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registration requirements of the Securities Act for resales of certain
securities to qualified institutional buyers. The Investment Adviser anticipates
that the market for certain restricted securities such as institutional
commercial paper and foreign securities will expand further as a result of this
regulation and the development of automated systems for the trading, clearance
and settlement of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least one nationally recognized statistical
rating organizations ("NRSRO") or, if unrated, be of comparable quality in the
view of the Investment Adviser; and (2) it must not be in default as to
principal or interest. Investing in Rule 144A securities could have the effect
of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
BORROWING
The Fund may borrow for temporary, emergency or investment purposes in
amounts not exceeding 10% of the Fund's total assets. This borrowing may be
unsecured. The 1940 Act requires the Fund to maintain continuous asset coverage
(that is, total assets including borrowings, less liabilities exclusive of
borrowings) of 300% of the amount borrowed. Borrowing subjects the Fund to
interest costs which may or may not be recovered by appreciation of the
securities purchased, and can exaggerate the effect on net asset value of any
increase or decrease in the market value of the Fund's portfolio. This is the
speculative factor known as leverage.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value of the security each day in determining the Fund's net asset
value. The Fund will also mark as segregated with its custodian cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, equal in value to its obligations for when-issued
securities.
REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain Internal Revenue Code requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties, as well as
greater income potential than an investment in common stocks. Like any
investment in real estate, though, a REIT's performance depends on several
factors, such as its ability to find tenants for its properties, to renew leases
and to finance property purchases and renovations.
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<PAGE> 382
SHARES OF OTHER INVESTMENT COMPANIES
The Fund can invest in securities of other investment companies except to
the extent prohibited by law. Like all equity investments, these investments may
go up or down in value. They also may not perform in correlation with the Fund's
principal strategies. The Fund will pay additional fees through its investments
in other investment companies.
LIMITED PARTNERSHIPS
The Fund can invest in limited partnership interests.
SHORT SALES AGAINST-THE-BOX
The Fund can borrow and sell "short" securities when it also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund's
total assets can be held as collateral for short sales at any one time.
CORPORATE LOANS
The Fund can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Fund may not
recover its investment, or there might be a delay in the Fund's recovery. By
investing in a corporate loan, the Fund becomes a member of the syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, the Fund may invest
all or part of its assets in short-term investment grade debt obligations of the
U.S. government, its agencies and instrumentalities, bank certificates of
deposit, bankers' acceptances, high quality commercial paper, demand notes and
repurchase agreements.
MANAGEMENT OF THE FUND
The Trustees oversee the actions of the Fund's Investment Adviser and other
service providers and decide upon matters of general policy. The Trustees also
review the actions of the Trust's officers, who conduct and supervise the daily
business operations of the Trust. The Trustees (* denotes "interested" Trustee
as defined in the 1940 Act, due to the relationship with the Investment Adviser)
and officers of the Trust are:
MICHAEL BAXTER* (37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since 1999);
Managing Director of the Investment Adviser (since 1996); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since
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1994); Chairman, Gamma Services Corp. (venture capital) (since 1968); Principal,
Gavin, Dailey & Partners (consulting) (since 1993); U.S. Ambassador to Mexico
(1981 - 1986); Director, Apex Mortgage Capital, Inc., Atlantic Richfield Co.,
International Wire Corp. and Krause's Furniture.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (since 1986); Member of CIEBA's Executive Committee (since
1988) and its Chairman (from 1991 - 1992); Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds (1986 - 1993); Member of the Investment Advisory Committees of
the State of New York Common Retirement Fund and the Howard Hughes Medical
Institute (since 1997); Director, Duke Management Company (since 1992) and Vice
Chairman (since 1998); Director, Kimco Realty Corporation (since 1997);
Director, LaSalle Street Fund (since 1995); Member of the Investment Advisory
Committee of the Virginia Retirement System (since 1998); Director, Montpelier
Foundation (since 1998); Trustee or Director of 31 registered investment
companies (consisting of 47 portfolios) for which the Investment Adviser or an
advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since
1999); Managing Director of the Investment Adviser (since 1998); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (49) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 66 registered investment companies
(consisting of 71 portfolios) for which the Investment Adviser or an advisory
affiliate is the adviser.
NANCY D. CELICK (49) -- President and Principal Executive Officer -- 725
South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Chief
Administrative Officer of the Investment Adviser (since 1998); Chief Financial
Officer of the Investment Adviser (1993 - 1998); Chief Financial Officer of
Kennedy-Wilson, Inc. (auction marketing services) (1992 - 1993); Chief Financial
Officer of First National Corporation (bank holding company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-9011. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services,
Inc. (since 1999); Vice President of FAM Distributors, Inc. (since 1999); First
Vice President of the Investment Adviser (1990 - 1997).
ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
GRACIE FERMELIA (38) -- Vice President and Assistant Secretary -- 725 South
Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Director of the
Investment Adviser (since 2000); Vice President of the Investment Adviser
(1994-2000); Senior Manager, Price Waterhouse (1985 - 1994).
The Trust does not pay salaries to any of its officers or fees to any of
its Trustees affiliated with the Investment Adviser. The following table sets
forth the aggregate compensation paid to the Trustees during the Trust's fiscal
year ended June 30, 2000 and the aggregate compensation paid to the Trustees for
service on the
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Trust's Board and that of any other fund for which the Investment Adviser serves
as investment adviser or which has an investment adviser that is an affiliated
person of the Investment Adviser ("Fund Complex") for the year ended December
31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $ $ 34,000
John A. G. Gavin................................... $ $ 25,000
Joe Grills......................................... $ $232,333
Nigel Hurst-Brown.................................. $ -0- $ -0-
Robert B. Hutchinson**............................. $ $ 34,000
Madeleine A. Kleiner............................... $ $ 18,000
Merle T. Welshans**................................ $ $ 34,000
Richard R. West.................................... $ $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of Mercury HW Variable Trust, Fund
Asset Management Master Trust and Merrill Lynch Investment Managers Funds,
Inc. Messrs. Grills and West also serve on the boards of other investment
companies advised by the Investment Adviser and its advisory affiliates.
** Messrs. Hutchinson and Welshans retired on November 12, 1999.
The Trustees may be eligible for reduced sales charges on purchases of
Class I shares. See "Reduced Initial Sales Charges -- Purchase Privileges of
Certain Persons."
For information as to ownership of shares, see "General
Information -- Principal Holders."
MANAGEMENT AND ADVISORY ARRANGEMENTS
Investment Advisory Services and Fee. The Trust on behalf of the Fund has
entered into an investment advisory agreement (the "Advisory Agreement") with
the Investment Adviser as investment adviser. Subject to the supervision of the
Trustees, the Investment Adviser is responsible for the actual management of the
Fund and constantly reviews the Fund's holdings in light of its own research
analysis and that from other relevant sources. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser. The Investment Adviser performs certain of the other administrative
services and provides all office space, facilities, equipment and necessary
personnel for management of the Fund. The Investment Adviser receives for its
services to the Fund a monthly fee at an annual rate of 0.75% of the Fund's
average daily net assets. For purposes of this calculation, average daily net
assets is determined at the end of each month on the basis of the average net
assets of the Fund for each day during the month.
Prior to October , 2000, the Fund was party to an investment advisory
agreement under which it paid Merrill Lynch Investment Managers, L.P., an
affiliate of the Investment Adviser a fee at the annual rate of 0.75% of its
average daily net assets. For the fiscal years ended June 30, 2000, 1999 and
1998, the Fund paid Merrill Lynch Investment Managers, L.P. $ ,
$10,084,942 and $8,732,479, respectively.
Subadvisers. The Investment Adviser has entered into subadvisory agreements
with Merrill Lynch Investment Managers International Limited and Merrill Lynch
Asset Management U.K. Limited, affiliated investment advisers that are indirect
subsidiaries of Merrill Lynch & Co., Inc. The subadvisory arrangements are for
investment research, recommendations and other investment-related services to be
provided to the Fund at rates of compensation as may be agreed by the parties.
There is no increase in the aggregate fees paid by the Fund for such services.
For the fiscal years ended June 30, 2000, 1999 and 1998, the Fund paid no
advisory fees and Merrill Lynch Investment Managers, L.P. reimbursed the Fund in
the amounts of $ , $16,239 and $67,175 respectively.
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<PAGE> 385
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients of the Investment Adviser or an affiliate when one or more clients of
the Investment Adviser or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Payment of Fund Expenses. The Advisory Agreement obligates the Investment
Adviser to provide investment advisory services and to pay, or cause an
affiliate to pay, for maintaining its staff and personnel and to provide office
space, facilities and necessary personnel for the Fund. The Investment Adviser
is also obligated to pay, or cause an affiliate to pay, the fees of all officers
and Trustees who are affiliated persons of the Investment Adviser or any
sub-adviser or of an affiliate of the Investment Adviser or any sub-adviser. The
Fund pays, or causes to be paid, all other expenses incurred in the operation of
the Fund (except to the extent paid by FAM Distributors, Inc. (the
"Distributor")), including, among other things, taxes, expenses for legal and
auditing services, costs of printing proxies, shareholder reports, copies of the
Registration Statement, charges of the custodian, any sub-custodian and the
transfer agent, expenses of portfolio transactions, expenses of redemption of
shares, commission fees, expenses of registering the shares under Federal, state
or non-U.S. laws, fees and actual out-of-pocket expenses of non-interested
Trustees, accounting and pricing costs (including the daily calculation of net
asset value), insurance, interest, brokerage costs, litigation and other
extraordinary or non-recurring expenses, and other expenses properly payable by
the Fund. Accounting services are provided to the Fund by the Investment Adviser
or an affiliate of the Investment Adviser, and the Fund reimburses the
Investment Adviser or an affiliate of the Investment Adviser for its costs in
connection with such services.
Organization of the Investment Adviser. The Investment Adviser is a limited
partnership, the partners of which are Merrill Lynch & Co., Inc. ("ML & Co."), a
financial services holding company and the parent of Merrill Lynch, Pierce,
Fenner & Smith Incorporated (" Merrill Lynch"), and Princeton Services, Inc. ML
& Co. and Princeton Services, Inc. are "controlling persons" of the Investment
Adviser as defined under the 1940 Act because of their ownership of its voting
securities and their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Advisory Agreement will remain in effect from year to year if approved annually
(a) by the Board of Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees of the Trust who are
not parties to the Advisory Agreement or interested persons (as defined in the
1940 Act) of any such party. The Advisory Agreement is not assignable and will
automatically terminate in the event of its assignment. In addition, such
contract may be terminated by the vote of a majority of the outstanding voting
securities of the Fund or by the Investment Adviser without penalty on 60 days'
written notice to the other party.
ACCOUNTING AND ADMINISTRATIVE SERVICES
The Trust has entered into a Fund Accounting and Administration Servicing
Agreement (the "Fund Accounting Agreement") with the Investment Adviser acting
as service provider. The Fund Accounting Agreement obligates the Investment
Adviser to provide certain accounting and administrative services to the Trust.
The Trust reimburses the Investment Adviser for its costs in connection with
such services.
Transfer Agency Services. The Transfer Agent, a subsidiary of ML & Co.,
acts as the Fund's Transfer Agent pursuant to a Transfer Agency, Dividend
Disbursing Agency and Shareholder Servicing Agency Agreement (the "Transfer
Agency Agreement"). Pursuant to the Transfer Agency Agreement, the Transfer
Agent is responsible for the issuance, transfer and redemption of shares and the
opening and maintenance of shareholder accounts. Pursuant to the Transfer Agency
Agreement, the Transfer Agent receives a fee ranging
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<PAGE> 386
from $16.00 to $20.00 per account (depending on the level of services required)
and certain other fees relating to special processing of sub-transfer agency
relationships. The Transfer Agent is entitled to reimbursement for certain
transaction charges and out-of-pocket expenses incurred by the Transfer Agent
under the Transfer Agency Agreement. For purposes of the Transfer Agency
Agreement, the term "account" includes a shareholder account maintained directly
by the Transfer Agent and any other account representing the beneficial interest
of a person in the relevant share class on a recordkeeping system.
Distribution Expenses. The Fund has entered into a distribution agreement
with the Distributor in connection with the continuous offering of shares of the
Fund (the "Distribution Agreement"). The Distribution Agreement obligates the
Distributor to pay certain expenses in connection with the offering of the
shares of the Fund. After the prospectuses, statements of additional information
and periodic reports have been prepared, set in type and mailed to shareholders,
the Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to dealers and investors. The Distributor also pays
for other supplementary sales literature and advertising costs. The Distribution
Agreement is subject to the same renewal requirements and termination provisions
as the Advisory Agreement described above.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act that covers the Trust, the Investment Adviser and the
Distributor (the "Code of Ethics"). The Code of Ethics significantly restricts
the personal investing activities of all employees of the Investment Adviser and
the Distributor and, as described below, imposes additional more onerous
restrictions on fund investment personnel.
The Code of Ethics requires that all employees of the Investment Adviser
and the Distributor pre-clear any personal securities investments (with limited
exceptions, such as mutual funds, high-quality short-term securities and direct
obligations of the U.S. government). The pre-clearance requirement and
associated procedures are designed to identify any substantive prohibition or
limitation applicable to the proposed investment. The substantive restrictions
applicable to all employees of the Investment Adviser and the Distributor
include a ban on acquiring any securities in a "hot" initial public offering. In
addition, investment personnel are prohibited from profiting on short-term
trading in securities. No employee may purchase or sell any security that at the
time is being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Investment Adviser. Furthermore, the Code of Ethics provides for trading
"blackout periods" which prohibit trading by investment personnel of the Fund
within seven calendar days, before or after, of trading by the Fund in the same
or equivalent security.
PURCHASE OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus for certain information as to the purchase of
Fund shares.
The Fund issues four classes of shares: shares of Class I and Class A are
sold to investors choosing the initial sales charge alternatives and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. Each Class I, Class A, Class B and Class C share of the Fund
represents an identical interest in the investment portfolio of the Fund, and
has the same rights, except that Class A, Class B and Class C shares bear the
expenses of the ongoing account maintenance fees (also known as service fees)
and Class B and Class C shares bear the expenses of the ongoing distribution
fees and the additional incremental transfer agency costs resulting from the
deferred sales charge arrangements. The contingent deferred sales charges
("CDSCs"), distribution fees and account maintenance fees that are imposed on
Class B and Class C shares, as well as the account maintenance fees that are
imposed on Class A shares, are imposed directly against those classes and not
against all assets of the Fund, and, accordingly, such charges do not affect the
net asset value of any other class or have any impact on investors choosing
another sales charge option. Dividends paid by the Fund for each class of shares
are calculated in the same manner at the same time and differ only to the extent
that account maintenance and distribution fees and any incremental transfer
agency costs in
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<PAGE> 387
relation to a particular class are borne exclusively by that class. Class A,
Class B and Class C shares each have exclusive voting rights with respect to the
Rule 12b-1 distribution plan adopted with respect to such class pursuant to
which the account maintenance and/or distribution fees are paid (except that
Class B shareholders may vote upon any material changes to expenses charged
under the Distribution Plan for Class A shares). Each class has different
exchange privileges. See "Shareholder Services -- Exchange Privilege."
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class I and Class A shares are the same as
those of the CDSCs and distribution fees with respect to the Class B and Class C
shares in that the sales charges and distribution fees applicable to each class
provide for the financing of the distribution of the shares of the Fund. The
distribution-related revenues paid with respect to a class will not be used to
finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share plus any sales charge applicable to the
class of shares selected by the investor. The applicable offering price for
purchase orders is based upon the net asset value of the Fund next determined
after receipt of the purchase order by the Distributor. As to purchase orders
received by selected securities dealers or other financial intermediaries prior
to the close of regular trading on the New York Stock Exchange (the "NYSE")
(generally 4:00 p.m., Eastern time) which includes orders received after the
determination of net asset value on the previous day, the applicable offering
price will be based on the net asset value on the day the order is placed with
the Distributor, provided that the orders are received by the Distributor prior
to 30 minutes after the close of regular trading on the NYSE on that day. If the
purchase orders are not received prior to 30 minutes after the close of regular
trading on the NYSE on that day, such orders shall be deemed received on the
next business day. Selected securities dealers or other financial intermediaries
have the responsibility of submitting purchase orders to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to purchase
shares at that day's offering price.
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Any order may be rejected by the Fund or the Distributor. Neither
the Distributor nor the selected securities dealers or other financial
intermediaries are permitted to withhold placing orders to benefit themselves by
a price change. Certain selected securities dealers or other financial
intermediaries may charge a processing fee to confirm a sale of shares. For
example, the fee currently charged by Merrill Lynch is $5.35. Purchases made
directly through the Transfer Agent are not subject to the processing fee.
INITIAL SALES CHARGE ALTERNATIVES -- CLASS I AND CLASS A SHARES
Investors who prefer an initial sales charge alternative may elect to
purchase Class A shares or, if an eligible investor, Class I shares.
Investors choosing the initial sales charge alternative who are eligible to
purchase Class I shares should purchase Class I shares rather than Class A
shares, because there is an account maintenance fee imposed on Class A shares.
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class I and Class A
shares of the Fund, refers to a single purchase by an individual or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his or her spouse and their children under
the age of 21 years purchasing shares for his, her or their own account and to
single purchases by a trustee or other fiduciary purchasing shares for a single
trust estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company," as that
term is defined in the 1940 Act, but does not include purchases by any such
company that has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
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<PAGE> 388
Class I shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class I shares. Investors
who owned Investor Class shares or who currently own Class I shares of the Fund
in a shareholder account are entitled to purchase additional Class I shares of
the Fund in that account. Certain employer-sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class I shares at net asset
value provided such plans meet the required minimum number of eligible employees
or required amount of assets advised by the Investment Adviser or any of its
affiliates. Also eligible to purchase Class I shares at net asset value are
participants in certain investment programs including certain managed accounts
for which a trust institution, thrift or bank trust department provides
discretionary trustee services, certain collective investment trusts for which a
trust institution, thrift, or bank trust department serves as trustee, certain
purchases made in connection with certain fee-based programs and certain
purchases made through certain financial advisers that meet and adhere to
standards established by the Investment Adviser. Class I shares are available at
net asset value to corporate warranty insurance reserve fund programs and U.S.
branches of foreign banking institutions, provided that the participant has $3
million or more initially invested in affiliate-advised investment companies. In
addition, Class I shares are offered at net asset value to ML & Co. and its
subsidiaries and their directors and employees, to members of the Boards of
investment companies advised by the Investment Adviser or its affiliates,
including the Fund, and to employees of certain selected securities dealers or
other financial intermediaries. Class I shares may also be offered at net asset
value to certain accounts over which the Investment Adviser or an affiliate
exercises investment discretion. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative particularly
attractive, because similar sales charge reductions are not available with
respect to the deferred sales charges imposed in connection with purchases of
Class B or Class C shares. Investors not qualifying for reduced initial sales
charges who expect to maintain their investment for an extended period of time
also may elect to purchase Class I or Class A shares, because over time the
accumulated ongoing account maintenance and distribution fees on Class B or
Class C shares may exceed the initial sales charges, and, in the case of Class A
shares, the account maintenance fee. Although some investors who previously
purchased Class I shares may no longer be eligible to purchase Class I shares of
other affiliate-advised funds, those previously purchased Class I shares,
together with Class A, Class B and Class C share holdings, will count toward a
right of accumulation which may qualify the investor for a reduced initial sales
charge on new initial sales charge purchases. In addition, the ongoing Class B
and Class C account maintenance and distribution fees will cause Class B and
Class C shares to have higher expense ratios, pay lower dividends and have lower
total returns than the initial sales charge shares. The ongoing Class A account
maintenance fees will cause Class A shares to have a higher expense ratio, pay
lower dividends and have a lower total return than Class I shares.
The Distributor may reallow discounts to selected securities dealers or
other financial intermediaries and retain the balance over such discounts. At
times the Distributor may reallow the entire sales charge to such selected
securities dealers or other financial intermediaries. Since selected securities
dealers or other financial intermediaries selling Class I and Class A shares of
the Fund will receive a concession equal to most of the sales charge, they may
be deemed to be underwriters under the Securities Act.
REDUCED INITIAL SALES CHARGES
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
to obtain such investments.
Reinvested Dividends. No initial sales charges are imposed upon Class I and
Class A shares issued as a result of the automatic reinvestment of dividends.
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other Mercury mutual funds. For any such right of accumulation to be
made available, the Distributor must be provided at the time of purchase, by the
purchaser or the purchaser's selected securities dealer or other financial
intermediary, with sufficient
19
<PAGE> 389
information to permit confirmation of qualification. Acceptance of the purchase
order is subject to such confirmation. The right of accumulation may be amended
or terminated at any time. Shares held in the name of a nominee or custodian
under pension, profit-sharing, or other employee benefit plans may not be
combined with other shares to qualify for the right of accumulation.
Letter of Intent. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class I or Class A shares of the Fund or any
other Mercury mutual funds made within a 13-month period starting with the first
purchase pursuant to the Letter of Intent. The Letter of Intent is available
only to investors whose accounts are established and maintained at the Fund's
Transfer Agent. The Letter of Intent is not available to employee benefit plans
for which affiliates of the Investment Adviser provide plan participant
record-keeping services. The Letter of Intent is not a binding obligation to
purchase any amount of Class I or Class A shares; however, its execution will
result in the purchaser paying a lower sales charge at the appropriate quantity
purchase level. A purchase not originally made pursuant to a Letter of Intent
may be included under a subsequent Letter of Intent executed within 90 days of
such purchase if the Distributor is informed in writing of this intent within
such 90-day period. The value of Class I and Class A shares of the Fund and of
other Mercury mutual funds presently held, at cost or maximum offering price
(whichever is higher), on the date of the first purchase under the Letter of
Intent, may be included as a credit toward the completion of such Letter, but
the reduced sales charge applicable to the amount covered by such Letter will be
applied only to new purchases. If the total amount of shares does not equal the
amount stated in the Letter of Intent (minimum of $25,000), the investor will be
notified and must pay, within 20 days of the execution of such Letter, the
difference between the sales charge on the Class I or Class A shares purchased
at the reduced rate and the sales charge applicable to the shares actually
purchased through the Letter. Class I or Class A shares equal to 5.0% of the
intended amount will be held in escrow during the 13-month period (while
remaining registered in the name of the purchaser) for this purpose. The first
purchase under the Letter of Intent must be at least 5.0% of the dollar amount
of such Letter. If a purchase during the term of such Letter would otherwise be
subject to a further reduced sales charge based on the right of accumulation,
the purchaser will be entitled on that purchase and subsequent purchases to that
further reduced percentage sales charge but there will be no retroactive
reduction of the sales charges on any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intent will be deducted from
the total purchases made under such Letter. An exchange from the Summit Cash
Reserves Fund ("Summit") into the Fund that creates a sales charge will count
toward completing a new or existing Letter of Intent from the Fund.
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and certain
other arrangements may purchase Class I or Class A shares at net asset value,
based on the number of employees or number of employees eligible to participate
in the plan and/or the aggregate amount invested by the plan in specified
investments. Certain other plans may purchase Class B shares with a waiver of
the CDSC upon redemption, based on similar criteria. Such Class B shares will
convert into Class A shares approximately ten years after the plan purchases the
first share of any Mercury mutual fund. Minimum purchase requirements may be
waived or varied for such plans. For additional information regarding purchases
by employer-sponsored retirement or savings plans and certain other
arrangements, call your plan administrator or your selected securities dealer or
other financial intermediary.
Managed Trusts. Class I shares are offered at net asset value to certain
trusts to which trust institutions, thrifts, and bank trust departments provide
discretionary trustee services.
Purchase Privileges of Certain Persons. Trustees of the Trust and of other
investment companies advised by the Investment Adviser or its affiliates,
directors and employees of ML & Co. and its subsidiaries (the term
"subsidiaries," when used herein with respect to ML & Co., includes the
Investment Adviser, Merrill Lynch Investment Managers, L.P., Merrill Lynch
Investment Managers International, Limited and certain other entities directly
or indirectly wholly owned and controlled by ML & Co.), employees of certain
selected securities dealers, and any trust, pension, profit-sharing or other
benefit plan for such persons, may purchase Class I shares of the Fund at net
asset value. The Fund realizes economies of scale and reduction of sales-
20
<PAGE> 390
related expenses by virtue of the familiarity of these persons with the Fund.
Employees and Trustees wishing to purchase shares of the Fund must satisfy the
Fund's suitability standards.
Class I and Class A shares are also offered at net asset value to certain
accounts over which the Investment Adviser or an affiliate exercises investment
discretion.
Acquisition of Certain Investment Companies. Class A shares may be offered
at net asset value in connection with the acquisition of the assets of or merger
or consolidation with a personal holding company or a public or private
investment company.
Purchases Through Certain Financial Intermediaries. Reduced sales charges
may be applicable for purchases of Class I or Class A shares of the Fund through
certain financial advisers, selected securities dealers and other financial
intermediaries that meet and adhere to standards established by the Investment
Adviser from time to time.
A waived sales charge on a purchase of Class I shares will apply to current
beneficial shareholders who were also beneficial shareholders of the Fund as of
the opening of business of the Fund on October , 2000.
DEFERRED SALES CHARGE ALTERNATIVES -- CLASS B AND CLASS C SHARES
Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in Mercury mutual funds.
Because no initial sales charges are deducted at the time of the purchase,
Class B and Class C shares provide the benefit of putting all of the investor's
dollars to work from the time the investment is made. The deferred sales charge
alternatives may be particularly appealing to investors that do not qualify for
the reduction in initial sales charges. Both Class B and Class C shares are
subject to ongoing account maintenance fees and distribution fees; however, the
ongoing account maintenance and distribution fees potentially may be offset to
the extent any return is realized on the additional funds initially invested in
Class B or Class C shares. In addition, Class B shares will be converted into
Class A shares of the Fund after a conversion period of approximately eight
years, and thereafter investors will be subject to lower ongoing fees.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net asset
value per share without the imposition of a sales charge at the time of
purchase. See "Pricing of Shares -- Determination of Net Asset Value" below.
Class B shares that are redeemed within six years of purchase may be
subject to a CDSC at the rates set forth below charged as a percentage of the
dollar amount subject thereto. In determining whether a CDSC is applicable to a
redemption, the calculation will be determined in the manner that results in the
lowest applicable rate being charged. The charge will be assessed on an amount
equal to the lesser of the proceeds of redemption or the cost of the shares
being redeemed. Accordingly, no CDSC will be imposed on increases in net asset
value above the initial purchase price. In addition, no CDSC will be assessed on
shares derived from reinvestment of dividends. It will be assumed that the
redemption is first of shares held for over six years or shares acquired
pursuant to reinvestment of dividends and then of shares held longest during the
six-year period. A transfer of shares from a shareholder's account to another
account will be assumed to be made in the same order as a redemption.
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<PAGE> 391
The following table sets forth the Class B CDSC:
<TABLE>
<CAPTION>
CDSC AS A PERCENTAGE
OF DOLLAR AMOUNT
YEAR SINCE PURCHASE PAYMENT MADE SUBJECT TO CHARGE
-------------------------------- --------------------
<S> <C>
0-1....................................... 4.0%
1-2....................................... 4.0%
2-3....................................... 3.0%
3-4....................................... 3.0%
4-5....................................... 2.0%
5-6....................................... 1.0%
6 and thereafter.......................... None
</TABLE>
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired 10
additional shares upon dividend reinvestment. If at such time the investor makes
his or her first redemption of 50 shares (proceeds of $600), 10 shares will not
be subject to a CDSC because of dividend reinvestment. With respect to the
remaining 40 shares, the charge is applied only to the original cost of $10 per
share and not to the increase in net asset value of $2 per share. Therefore,
$400 of the $600 redemption proceeds will be charged at a rate of 3.0% (the
applicable rate in the third year after purchase).
As discussed in the Prospectus under "Account Choices -- Pricing of
Shares -- Class B and C Shares -- Deferred Sales Charge Options," while Class B
shares redeemed within six years of purchase are subject to a CDSC under most
circumstances, the charge may be reduced or waived in certain instances. These
include certain post-retirement withdrawals from an individual retirement
account ("IRA") or other retirement plan or redemption of Class B shares in
certain circumstances following the death of a Class B shareholder. In the case
of such withdrawal, the reduction or waiver applies to: (a) any partial or
complete redemption in connection with a distribution following retirement under
a tax-deferred retirement plan on attaining age 59 1/2 in the case of an IRA or
other retirement plan, or part of a series of equal periodic payments (not less
frequently than annually) made for life (or life expectancy) or any redemption
resulting from the tax-free return of an excess contribution to an IRA (certain
legal documentation may be required at the time of liquidation establishing
eligibility for qualified distribution); or (b) any partial or complete
redemption following the death or disability (as defined in the Internal Revenue
Code of 1986, as amended (the "Code")) of a Class B shareholder (including one
who owns the Class B shares as joint tenant with his or her spouse), provided
the redemption is requested within one year of the death or initial
determination of disability, or if later, reasonably promptly following
completion of probate or in connection with involuntary termination of an
account in which Fund shares are held (certain legal documentation may be
required at the time of liquidation establishing eligibility for qualified
distribution).
The charge may also be reduced or waived in other instances, such as: (a)
redemptions by certain eligible 401(a) and 401(k) plans and certain retirement
plan rollovers; (b) redemptions in connection with participation in certain
fee-based programs of the Investment Adviser or its affiliates; (c) redemptions
in connection with participation in certain fee-based programs of selected
securities dealers and other financial intermediaries that have agreements with
the Investment Adviser or Distributor; or (d) withdrawals through the Systematic
Withdrawal Plan of up to 10% per year of your account value at the time the plan
is established. See "Shareholder Services -- Fee-Based Programs" and
"-- Systematic Withdrawal Plan."
Conversion of Class B Shares to Class A Shares. After approximately eight
years (the "Conversion Period"), Class B shares of the Fund will be converted
automatically into Class A shares of the Fund. Class A shares are subject to an
ongoing account maintenance fee of 0.25% of the average daily net assets of the
Fund but are not subject to the distribution fee that is borne by Class B
shares. Automatic conversion of Class B shares into Class A shares will occur at
least once each month (on the "Conversion Date") on the basis of the relative
net asset value of the shares of the two classes on the Conversion Date, without
the imposition of any sales load, fee or other charge. Conversion of Class B
shares to Class A shares will not be deemed a purchase or sale of the shares for
Federal income tax purposes.
22
<PAGE> 392
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class A shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at the Conversion Date the conversion of Class B shares to Class
A shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class A shares
of the Fund.
The Conversion Period may be modified for investors that participate in
certain fee-based programs. See "Shareholder Services -- Fee-Based Programs."
Class B shareholders of the Fund exercising the exchange privilege
described under "Shareholder Services -- Exchange Privilege" will continue to be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares acquired as a result of the exchange.
Class C shares that are redeemed within one year of purchase may be subject
to a 1.0% CDSC charged as a percentage of the dollar amount subject thereto. In
determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. The charge will be assessed on an amount equal to the lesser
of the proceeds of redemption or the cost of the shares being redeemed.
Accordingly, no Class C CDSC will be imposed on increases in net asset value
above the initial purchase price. In addition, no Class C CDSC will be assessed
on shares derived from reinvestment of dividends. It will be assumed that the
redemption is first of shares held for over one year or shares acquired pursuant
to reinvestment of dividends and then of shares held longest during the one-year
period. A transfer of shares from a shareholder's account to another account
will be assumed to be made in the same order as a redemption. The Class C CDSC
may be waived in connection with involuntary termination of an account in which
Fund shares are held and withdrawals through the Systematic Withdrawal Plans.
See "Shareholder Services -- Systematic Withdrawal Plan."
Proceeds from the CDSC and the distribution fee are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers (including Merrill Lynch) related to providing distribution-related
services to the Fund in connection with the sale of the Class B and Class C
shares, such as the payment of compensation to financial consultants for selling
Class B and Class C shares from the dealer's own funds. The combination of the
CDSC and the ongoing distribution fee facilitates the ability of the Fund to
sell the Class B and Class C shares without a sales charge being deducted at the
time of purchase. See "Distribution Plans" below. Imposition of the CDSC and the
distribution fee on Class B and Class C shares is limited by the National
Association of Securities Dealers, Inc. (the "NASD") asset-based sales charge
rule. See "Limitations on the Payment of Deferred Sales Charges" below.
DISTRIBUTION PLANS
Reference is made to "Account Choices -- Pricing of Shares" in the
Prospectus for certain information with respect to separate distribution plans
for Class A, Class B, and Class C shares pursuant to Rule 12b-1 under the 1940
Act (each a "Distribution Plan") with respect to the account maintenance and/or
distribution fees paid by the Fund to the Distributor with respect to such
classes.
The Distribution Plans for each of the Class A, Class B and Class C shares
provide that the Fund pays the Distributor an account maintenance fee relating
to the shares of the relevant class, accrued daily and paid monthly, at the
annual rate of 0.25% of the average daily net assets of the Fund attributable to
shares of the relevant class in order to compensate the Distributor and selected
securities dealers or other financial intermediaries (pursuant to
sub-agreements) in connection with account maintenance activities with respect
to Class A, Class B and Class C shares. Each of those classes has exclusive
voting rights with respect to the Distribution Plan adopted with respect to such
class pursuant to which account maintenance and/or distribution fees are paid
(except that Class B shareholders may vote on any material changes to expenses
charged under the Class A Distribution Plan).
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<PAGE> 393
The Distribution Plans for each of the Class B and Class C shares provide
that the Fund also pays the Distributor a distribution fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual rate
of 0.75% of the average daily net assets of the Fund attributable to the shares
of the relevant class in order to compensate the Distributor and selected
securities dealers or other financial intermediaries (pursuant to
sub-agreements) for providing shareholder and distribution services, and bearing
certain distribution-related expenses of the Fund, including payments to
securities dealers and other financial intermediaries for selling Class B and
Class C shares of the Fund. The Distribution Plans relating to Class B and Class
C shares are designed to permit an investor to purchase Class B and Class C
shares through securities dealers and other financial intermediaries without the
assessment of an initial sales charge and at the same time permit the
Distributor to compensate securities dealers and other financial intermediaries
in connection with the sale of the Class B and Class C shares. In this regard,
the purpose and function of the ongoing distribution fees and the CDSC are the
same as those of the initial sales charge with respect to the Class I and Class
A shares of the Fund in that the ongoing distribution fees and deferred sales
charges provide for the financing of the distribution of the Fund's Class B and
Class C shares.
The Fund's Distribution Plans are subject to the provisions of Rule 12b-1
under the 1940 Act. In their consideration of each Distribution Plan, the
Trustees must consider all factors they deem relevant, including information as
to the benefits of each Distribution Plan to the Fund and the related class of
shareholders. Each Distribution Plan further provides that, so long as the
Distribution Plan remains in effect, the selection and nomination of
non-interested Trustees shall be committed to the discretion of the
non-interested Trustees then in office. In approving each Distribution Plan in
accordance with Rule 12b-1, the non-interested Trustees concluded that there is
a reasonable likelihood that such Distribution Plan will benefit the Fund and
its related class of shareholders. Each Distribution Plan can be terminated at
any time, without penalty, by the vote of a majority of the non-interested
Trustees or by the vote of the holders of a majority of the outstanding related
class of voting securities of the Fund. A Distribution Plan cannot be amended to
increase materially the amount to be spent by the Fund without the approval of
the related class of shareholders, and all material amendments are required to
be approved by the vote of Trustees, including a majority of the non-interested
Trustees who have no direct or indirect financial interest in such Distribution
Plan, cast in person at a meeting called for that purpose. Rule 12b-1 further
requires that the Fund preserve copies of its Distribution Plans and any report
made pursuant to such plan for a period of not less than six years from the date
of such Distribution Plan or such report, the first two years in an easily
accessible place.
Among other things, each Distribution Plan provides that the Distributor
shall provide and the Trustees shall review quarterly reports of the
disbursement of the account maintenance and/or distribution fees paid to the
Distributor. Payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred and, accordingly, distribution-related revenues from each
Distribution Plan may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Trustees for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. This information will be presented annually as of December 31 of each
year on a "fully allocated accrual" basis and quarterly on a "direct expense and
revenue/cash" basis. On the fully allocated basis, revenues consist of the
account maintenance fees, the distribution fees, the CDSCs and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and marketing expenses, corporate
overhead and interest expense. On the direct expense and revenue/cash basis,
revenues consist of the account maintenance fees, the distribution fees and
CDSCs and the expenses consist of financial consultant compensation.
For the fiscal year ended June 30, 2000, the Fund made payments of
$ to the Distributor under the Rule 12b-1 Plan for the Distributor
Class shares (which were redesignated as Class A shares).
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee and
the CDSC borne by the Class B and Class C shares,
24
<PAGE> 394
but not the account maintenance fee. The maximum sales charge rule is applied
separately to each class. As applicable to the Fund, the maximum sales charge
rule limits the aggregate of distribution fee payments and CDSCs payable by the
Fund to (1) 6.25% of eligible gross sales of Class B shares and Class C shares,
computed separately (defined to exclude shares issued pursuant to dividend
reinvestments and exchanges), plus (2) interest on the unpaid balance for the
respective class, computed separately, at the prime rate plus 1% (the unpaid
balance being the maximum amount payable minus amounts received from the payment
of the distribution fee and the CDSC).
REDEMPTION OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Except for any CDSC that may be applicable, there will be no charge
for redemption if the redemption request is sent directly to the Transfer Agent.
Shareholders liquidating their holdings will receive upon redemption all
dividends reinvested through the date of redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists, as defined by the
Commission, as a result of which disposal of portfolio securities or
determination of the net asset value of the Fund is not reasonably practicable,
and for such other periods as the Commission may by order permit for the
protection of shareholders of the Fund.
The value of shares of the Fund at the time of redemption may be more or
less than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
The Trust has entered into a joint committed line of credit with other
investment companies advised by the Investment Adviser and its affiliates and a
syndicate of banks that is intended to provide the Fund with a temporary source
of cash to be used to meet redemption requests from Fund shareholders in
extraordinary or emergency circumstances.
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so by tendering the shares directly to the Fund's Transfer Agent, Financial Data
Services, Inc., P.O. Box 41621, Jacksonville, Florida 32232-1621. Redemption
requests delivered other than by mail should be delivered to Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting redemption. Redemption
requests should not be sent to the Fund. The redemption request in either event
requires the signature(s) of all persons in whose name(s) the shares are
registered, signed exactly as such name(s) appear(s) on the Transfer Agent's
register. The signature(s) on the redemption request may require a guarantee by
an "eligible guarantor institution" as defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications. In the
event a signature guarantee is required, notarized signatures are not
sufficient. In general, signature guarantees are waived on redemptions of less
than $50,000 as long as the following requirements are met: (i) all requests
require the signature(s) of all persons in whose name(s) shares are recorded on
the Transfer Agent's register; (ii) all checks must be mailed to the stencil
address of record on the Transfer Agent's register and (iii) the stencil address
must not have changed within 30 days. Certain rules may apply regarding certain
account types such as but not limited to UGMA/UTMA accounts, Joint Tenancies
with Rights of Survivorship, contra broker transactions and institutional
accounts. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority.
25
<PAGE> 395
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the Transfer
Agent at 1-800-236-4479. The request must be made by the shareholder of record
and be for an amount less than $50,000. Before telephone requests will be
honored, signature approval from all shareholders of record on the account must
be obtained. The shares being redeemed must have been held for at least 15 days.
Telephone redemption requests will not be honored in the following situations:
the accountholder is deceased, the proceeds are to be sent to someone other than
the shareholder of record, funds are to be wired to the client's bank account, a
systematic withdrawal plan is in effect, the request is by an individual other
than the accountholder of record, the account is held by joint tenants who are
divorced, the address has changed within the last 30 days or share certificates
have been issued on the account.
Since this account feature involves a risk of loss from unauthorized or
fraudulent transactions, the Transfer Agent will take certain precautions to
protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address registered
on the account and the social security number registered on the account. The
Fund or the Transfer Agent may temporarily suspend telephone transactions at any
time.
For shareholders redeeming directly with the Transfer Agent, payments will
be mailed within seven days of receipt of a proper notice of redemption. At
various times the Fund may be requested to redeem shares for which it has not
yet received good payment (e.g., cash, Federal funds or certified check drawn on
a U.S. bank). The Fund may delay or cause to be delayed the mailing of a
redemption check until such time as good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank) has been collected for the purchase of
such Fund shares, which usually will not exceed 10 days. In the event that a
shareholder account held directly with the Transfer Agent contains a fractional
share balance, such fractional share balance will be automatically redeemed by
the Fund.
REPURCHASE
The Fund also will repurchase its shares through a shareholder's listed
selected securities dealer or other financial intermediary. The Fund normally
will accept orders to repurchase shares by wire or telephone from dealers for
their customers at the net asset value next computed after the order is placed.
Shares will be priced at the net asset value calculated on the day the request
is received, provided that the request for repurchase is submitted to the
selected securities dealer or other financial intermediary prior to the close of
regular trading on the NYSE (generally, regular trading on the NYSE closes at
4:00 p.m., Eastern time) and such request is received by the Fund from such
selected securities dealer or other financial intermediary not later than 30
minutes after the close of regular trading on the NYSE on the same day.
Selected securities dealers and other financial intermediaries have the
responsibility of submitting such repurchase requests to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to obtain
that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any applicable
CDSC). Securities firms that do not have agreements with the Distributor,
however, may impose a transaction charge on the shareholder for transmitting the
notice of repurchase to the Fund. Certain selected securities dealers and other
financial intermediaries may charge a processing fee to confirm a repurchase of
shares. For example, the fee currently charged by Merrill Lynch is $5.35. Fees
charged by other selected securities dealers may be higher or lower. Repurchases
made through the Transfer Agent, on accounts held at the Transfer Agent, are not
subject to the processing fee. The Fund reserves the right to reject any order
for repurchase, which right of rejection might adversely affect shareholders
seeking redemption through the repurchase procedure. A shareholder whose order
for repurchase is rejected by the Fund, however, may redeem Fund shares as set
forth above.
REINSTATEMENT PRIVILEGE -- CLASS I AND CLASS A SHARES
Shareholders of the Fund who have redeemed their Class I and Class A shares
have a privilege to reinstate their accounts by purchasing Class I or Class A
shares of the Fund, as the case may be, at the net
26
<PAGE> 396
asset value without a sales charge up to the dollar amount redeemed. The
reinstatement privilege may be exercised by sending a notice of exercise along
with a check for the amount to be reinstated to the Transfer Agent within 30
days after the date the request for redemption was accepted by the Transfer
Agent or the Distributor. Alternatively, the reinstatement privilege may be
exercised through the investor's financial consultant within 30 days after the
date the request for redemption was accepted by the Transfer Agent or the
Distributor. The reinstatement will be made at the net asset value per share
next determined after the notice of reinstatement is received and cannot exceed
the amount of the redemption proceeds.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "Account Choices -- How Shares are Priced" in the
Prospectus.
The net asset value of the shares of all classes of the Fund is determined
once daily Monday through Friday as of the close of regular trading on the NYSE
on each day the NYSE is open for trading based on prices at the time of closing.
Regular trading on the NYSE generally closes at 4:00 p.m., Eastern time. Any
assets or liabilities initially expressed in terms of non-U.S. dollar currencies
are translated into U.S. dollars at the prevailing market rates as quoted by one
or more banks or dealers on the day of valuation. The NYSE is not open for
trading on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
Net asset value of the Fund is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Distributor, are accrued daily.
The principal assets of the Fund will normally be its interest in the
underlying Portfolio, which will be valued at its net asset value. Net asset
value of the Portfolio is computed by dividing the value of the securities held
by the Portfolio plus any cash or other assets (including interest and dividends
accrued but not yet received) minus all liabilities (including accrued expenses)
by the total number of shares outstanding at such time. Expenses, including the
investment advisory fees, are accrued daily.
The per share net asset value of Class A, Class B and Class C shares
generally will be lower than the per share net asset value of Class I shares,
reflecting the daily expense accruals of the account maintenance, distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares, and the daily expense accruals of the account maintenance fees
applicable with respect to Class A shares. Moreover, the per share net asset
value of the Class B and Class C shares of the Fund generally will be lower than
the per share net asset value of Class A shares of the Fund, reflecting the
daily expense accruals of the distribution fees and higher transfer agency fees
applicable with respect to Class B and Class C shares of the Fund. It is
expected, however, that the per share net asset value of the four classes of the
Fund will tend to converge (although not necessarily meet) immediately after the
payment of dividends which will differ by approximately the amount of the
expense accrual differentials between the classes.
Portfolio securities, including ADRs, EDRs or GDRs, that are traded on
stock exchanges are valued at the last sale price (regular way) on the exchange
on which such securities are traded, as of the close of regular trading on the
day the securities are being valued or, lacking any sales, at the last available
bid price for long positions, and at the last available ask price for short
positions. In cases where securities are traded on more than one exchange, the
securities are valued on the exchange designated by or under the authority of
the Board of Trustees as the primary market. Long positions in securities traded
in the OTC market are valued at the last available bid price in the OTC market
prior to the time of valuation. Short positions in securities traded in the OTC
market are valued at the last available ask price in the OTC market prior to the
time of valuation. Portfolio securities that are traded both in the OTC market
and on a stock exchange are valued according to the broadest and most
representative market. When the Fund writes an option, the amount of the premium
received is recorded on the books of the Fund as an asset and an equivalent
liability. The amount of
27
<PAGE> 397
the liability is subsequently valued to reflect the current market value of the
option written, based upon the last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last ask price.
Options purchased by the Fund are valued at their last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last bid price. Other investments, including financial futures contracts and
related options, are stated at market value. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Trustees.
Such valuations and procedures will be reviewed periodically by the Board of
Trustees.
Generally, trading in non-U.S. securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of regular trading on the NYSE. The values of
such securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of regular trading on the NYSE. Occasionally,
events affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of regular trading
on the NYSE that may not be reflected in the computation of the Fund's net asset
value.
Each investor in the Fund may add to or reduce its investment in the Fund
on each day the NYSE is open for trading. The value of each investor's
(including the Fund's) interest in the Fund will be determined as of the close
of regular trading on the NYSE by multiplying the net asset value of the Fund by
the percentage, effective for that day, that represents that investor's share of
the aggregate interests in the Fund. The close of regular trading on the NYSE is
generally 4:00 p.m., Eastern time. Any additions or withdrawals to be effected
on that day will then be effected. The investor's percentage of the aggregate
beneficial interests in the Fund will then be recomputed as the percentage equal
to the fraction (i) the numerator of which is the value of such investor's
investment in the Fund as of the time of determination on such day plus or
minus, as the case may be, the amount of any additions to or withdrawals from
the investor's investment in the Fund effected on such day, and (ii) the
denominator of which is the aggregate net asset value of the Fund as of such
time on such day plus or minus, as the case may be, the amount of the net
additions to or withdrawals from the aggregate investments in the Fund by all
investors in the Fund. The percentage so determined will then be applied to
determine the value of the investor's interest in the Fund after the close of
regular trading on the NYSE on the next determination of net asset value of the
Fund.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class I, Class
A, Class B and Class C shares of the Fund based on the net asset value of the
Fund's shares on June 30, 2000 is as follows:
<TABLE>
<CAPTION>
CLASS I CLASS A CLASS B CLASS C
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net Assets................................................ $ $ $ $
------- ------- ------- -------
Number of Shares Outstanding..............................
------- ------- ------- -------
Net Asset Value Per Share (net assets divided by number of
shares outstanding)..................................... $ $ $ $
------- ------- ------- -------
Sales Charge (for Class I and Class A Shares; 5.25% of
Offering Price; ( % of net amount invested))*....... ** **
------- ------- ------- -------
Offering Price............................................ $ $ $ $
------- ------- ------- -------
</TABLE>
---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
** Class B and Class C shares are not subject to an initial sales charge but may
be subject to a CDSC on redemption. See "Purchase of Shares -- Deferred Sales
Charge Alternatives -- Class B and Class C Shares" herein. No Class B and
Class C shares were outstanding on June 30, 2000.
28
<PAGE> 398
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Subject to policies established by the Board of Trustees, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Fund, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and operational facilities of the firm and the
firm's risk in positioning a block of securities. While the Investment Adviser
generally seeks reasonably competitive commission rates, the Fund does not
necessarily pay the lowest spread or commission available. In addition,
consistent with the Conduct Rules of the NASD and policies established by the
Board of Trustees, the Investment Adviser may consider sales of Fund shares as a
factor in the selection of brokers or dealers to execute portfolio transactions
for the Fund; however, whether or not a particular broker or dealer sells shares
of the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Fund.
Subject to obtaining the best net results, brokers who provide supplemental
investment research to the Investment Adviser may receive orders for
transactions by the Fund. Such supplemental research services ordinarily consist
of assessments and analyses of the business or prospects of a company, industry
or economic sector. Information so received will be in addition to and not in
lieu of the services required to be performed by the Investment Adviser under
the Investment Advisory Agreement and the expenses of the Investment Adviser
will not necessarily be reduced as a result of the receipt of such supplemental
information. If in the judgment of the Investment Adviser the Fund will benefit
from supplemental research services, the Investment Adviser is authorized to pay
brokerage commissions to a broker furnishing such services that are in excess of
commissions that another broker may have charged for effecting the same
transactions. Certain supplemental research services may primarily benefit one
or more other investment companies or other accounts for which the Investment
Adviser exercises investment discretion. Conversely, the Fund may be the primary
beneficiary of the supplemental research services received as a result of
portfolio transactions effected for such other accounts or investment companies.
The Fund anticipates that its brokerage transactions involving securities
of issuers domiciled in countries other than the United States generally will be
conducted primarily on the principal stock exchanges of such countries.
Brokerage commissions and other transaction costs on foreign stock exchange
transactions generally are higher than in the United States, although the Fund
will endeavor to achieve the best net results in effecting its portfolio
transactions. There generally is less governmental supervision and regulation of
foreign stock exchanges and brokers than in the United States.
Foreign equity securities may be held by the Fund in the form of ADRs,
EDRs, GDRs or other securities convertible into foreign equity securities. ADRs,
EDRs and GDRs may be listed on stock exchanges, or traded in over-the-counter
markets in the United States or Europe, as the case may be. ADRs, like other
securities traded in the United States, will be subject to negotiated commission
rates. The Fund's ability and decisions to purchase or sell portfolio securities
of foreign issuers may be affected by laws or regulations relating to the
convertibility and repatriation of assets. Because the shares of the Fund are
redeemable on a daily basis in U.S. dollars, the Fund intends to manage the
portfolio so as to give reasonable assurance that it will be able to obtain U.S.
dollars to the extent necessary to meet anticipated redemptions. Under present
conditions, it is not believed that these considerations will have significant
effect on the Fund's portfolio strategies.
The Fund may invest in certain securities traded in the OTC market and
intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Fund and
persons who are affiliated with such affiliated persons are prohibited from
dealing with the Fund as principal in the purchase and sale of securities unless
a permissive order allowing such transactions is obtained from the Commission.
Since transactions in the OTC market usually involve transactions with the
dealers acting as principal for their
29
<PAGE> 399
own accounts, the Fund will not deal with affiliated persons, including Merrill
Lynch and its affiliates, in connection with such transactions. However, an
affiliated person of the Fund may serve as its broker in OTC transactions
conducted on an agency basis provided that, among other things, the fee or
commission received by such affiliated broker is reasonable and fair compared to
the fee or commission received by non-affiliated brokers in connection with
comparable transactions. In addition, the Fund may not purchase securities
during the existence of any underwriting syndicate for such securities of which
Merrill Lynch or an affiliate is a member or in a private placement in which
Merrill Lynch or an affiliate serves as placement agent except pursuant to
procedures approved by the Board of Trustees that either comply with rules
adopted by the Commission or with interpretations of the Commission staff. See
"Investment Objective and Policies -- Investment Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch or its affiliates acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund. Securities may be held by, or be appropriate
investments for, the Fund as well as other funds or investment advisory clients
of the Investment Adviser or its affiliates.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or its affiliates
when one or more clients of the Investment Adviser or its affiliates are selling
the same security. If purchases or sales of securities arise for consideration
at or about the same time that would involve the Fund or other clients or funds
for which the Investment Adviser or an affiliate acts as investment adviser,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Investment Adviser or
its affiliates during the same period may increase the demand for securities
being purchased or the supply of securities being sold, there may be an adverse
effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below that are
designed to facilitate investment in its shares. Full details as to each such
service and copies of the various plans or how to change options with respect
thereto, can be obtained from the Fund by calling the telephone number on the
cover page hereof, or from the Distributor or your selected securities dealer or
other financial intermediary. Certain of these services are available only to
U.S. investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of dividends. The statements
also will show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
dividends. A shareholder with an account held at the Transfer Agent may make
additions to his or her Investment Account at any time by mailing a check
directly to the Transfer Agent. The Fund does not issue share certificates.
Shareholders considering transferring their Class I or Class A shares from
a selected securities dealer or other financial intermediary to another
brokerage firm or financial institution should be aware that, if the firm to
which the Class I or Class A shares are to be transferred will not take delivery
of shares of the Fund, a
30
<PAGE> 400
shareholder either must redeem the Class I or Class A shares so that the cash
proceeds can be transferred to the account at the new firm or such shareholder
must continue to maintain an Investment Account at the Transfer Agent for those
Class I or Class A shares.
Shareholders interested in transferring their Class B or Class C shares
from a selected securities dealer or other financial intermediary and who do not
wish to have an Investment Account maintained for such shares at the Transfer
Agent may request their new brokerage firm to maintain such shares in an account
registered in the name of the brokerage firm for the benefit of the shareholder
at the Transfer Agent.
Certain shareholder services may not be available for the transferred
shares. After the transfer, the shareholder may purchase additional shares of
funds owned before the transfer, and all future trading of these assets must be
coordinated by the new firm.
Shareholders considering transferring a tax-deferred retirement account,
such as an individual retirement account, from a selected securities dealer or
other financial intermediary to another brokerage firm or financial institution
should be aware that, if the firm to which the retirement account is to be
transferred will not take delivery of shares of the Fund, a shareholder must
either redeem the shares (paying any applicable CDSC) so that the cash proceeds
can be transferred to the account at the new firm, or such shareholder must
continue to maintain a retirement account at a selected securities dealer or
other financial intermediary for those shares.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other Mercury mutual funds and Summit, a series of Financial
Institutions Series Trust, which is a Merrill Lynch-sponsored money market fund
specifically designated as available for exchange by holders of Class I, Class
A, Class B and Class C shares. Shares with a net asset value of at least $100
are required to qualify for the exchange privilege and any shares used in an
exchange must have been held by the shareholder for at least 15 days. Before
effecting an exchange, shareholders should obtain a currently effective
prospectus of the fund into which the exchange is to be made. Exercise of the
exchange privilege is treated as a sale of the exchanged shares and a purchase
of the acquired shares for Federal income tax purposes.
Exchanges of Class I and Class A Shares. Under the Fund's pricing system,
Class I shareholders may exchange Class I shares of the Fund for Class I shares
of a second Mercury mutual fund. If the Class I shareholder wants to exchange
Class I shares for shares of a second Mercury mutual fund, but does not hold
Class I shares of the second fund in his or her account at the time of exchange
and is not otherwise eligible to acquire Class I shares of the second fund, the
shareholder will receive Class A shares of the second fund as a result of the
exchange. Class A shares also may be exchanged for Class I shares of a second
Mercury mutual fund at any time as long as, at the time of the exchange, the
shareholder is eligible to acquire Class I shares of any Mercury mutual fund.
Exchanges of Class I or Class A shares outstanding ("outstanding Class I or
Class A shares") for Class I or Class A shares of another Mercury mutual fund,
or for Class A shares of Summit ("new Class I or Class A shares") are transacted
on the basis of relative net asset value per Class I or Class A share,
respectively, plus an amount equal to the difference, if any, between the sales
charge previously paid on the outstanding Class I or Class A shares and the
sales charge payable at the time of the exchange on the new Class I or Class A
shares. With respect to outstanding Class I or Class A shares as to which
previous exchanges have taken place, the "sales charge previously paid" shall
include the aggregate of the sales charges paid with respect to such Class I or
Class A shares in the initial purchase and any subsequent exchange. Class I or
Class A shares issued pursuant to dividend reinvestment are sold on a no-load
basis. For purposes of the exchange privilege, Class I and Class A shares
acquired through dividend reinvestment shall be deemed to have been sold with a
sales charge equal to the sales charge previously paid on the Class I or Class A
shares on which the dividend was paid. Based on this formula, Class I and Class
A shares of the Fund generally may be exchanged into the Class I and Class A
shares, respectively, of the other funds with a reduced or without a sales
charge.
Exchanges of Class B and Class C Shares. In addition, the funds with Class
B or Class C shares outstanding ("outstanding Class B or Class C shares") offer
to exchange their Class B or Class C shares for
31
<PAGE> 401
Class B or Class C shares, respectively, of another Mercury mutual fund or for
Class B shares of Summit ("new Class B or Class C shares") on the basis of
relative net asset value per Class B or Class C share, without the payment of
any CDSC that might otherwise be due on redemption of the outstanding shares.
Class B shareholders of the Fund exercising the exchange privilege will continue
to be subject to the Fund's CDSC schedule if such schedule is higher than the
CDSC schedule relating to the new Class B shares acquired through use of the
exchange privilege. In addition, Class B shares of the Fund acquired through use
of the exchange privilege will be subject to the Fund's CDSC schedule if such
schedule is higher than the CDSC schedule relating to the Class B shares of the
fund from which the exchange was made. For purposes of computing the CDSC that
may be payable on a disposition of the new Class B or Class C shares, the
holding period for the outstanding Class B shares is "tacked" to the holding
period of the new Class B or Class C shares. For example, an investor may
exchange Class B shares of the Fund for those of another Mercury fund ("new
Mercury Fund") after having held the Fund's Class B shares for two-and-a-half
years. The 3% CDSC that generally would apply to a redemption would not apply to
the exchange. Four years later the investor may decide to redeem the Class B
shares of new Mercury Fund and receive cash. There will be no CDSC due on this
redemption since by "tacking" the two-and-a-half-year holding period of the
Fund's Class B shares to the four-year holding period for the new Mercury Fund
Class B shares, the investor will be deemed to have held the new Mercury Fund
Class B shares for more than six years.
Exchanges for Shares of a Money Market Fund. Class I and Class A shares are
exchangeable for Class A shares of Summit and Class B and Class C shares are
exchangeable for Class B shares of Summit. Class A shares of Summit have an
exchange privilege back into Class I or Class A shares of affiliate-advised
Funds; Class B shares of Summit have an exchange privilege back into Class B or
Class C shares of affiliate-advised Funds and, in the event of such an exchange,
the period of time that Class B shares of Summit are held will count toward
satisfaction of the holding period requirement for purposes of reducing any CDSC
and toward satisfaction of any Conversion Period with respect to Class B shares.
Class B shares of Summit will be subject to a distribution fee at an annual rate
of 0.50% of average daily net assets of such Class B shares. This exchange
privilege does not apply with respect to certain fee-based programs for which
alternative exchange arrangements may exist. Please see your financial
consultant for further information.
Prior to October 12, 1998, exchanges from other affiliate-advised Funds
into a money market fund were directed to certain affiliate-advised money market
funds other than Summit. Shareholders who exchanged affiliate-advised Fund
shares for such other money market funds and subsequently wish to exchange those
money market fund shares for shares of the Fund will be subject to the CDSC
schedule applicable to such Fund shares, if any. The holding period for those
money market fund shares will not count toward satisfaction of the holding
period requirement for reduction of the CDSC imposed on such shares, if any,
and, with respect to Class B shares, toward satisfaction of the Conversion
Period. However, the holding period for Class B or Class C shares of the Fund
received in exchange for such money market fund shares will be aggregated with
the holding period for the fund shares originally exchanged for such money
market fund shares for purposes of reducing the CDSC or satisfying the
Conversion Period.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her financial consultant, who will advise the
relevant Fund of the exchange. Shareholders of the Fund and shareholders of the
other funds described above with shares for which certificates have not been
issued may exercise the exchange privilege by wire through their selected
securities dealers or other financial intermediaries. The Fund reserves the
right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated in accordance with the rules of the
Commission. The Fund reserves the right to limit the number of times an investor
may exercise the exchange privilege. Certain funds may suspend the continuous
offering of their shares to the general public at any time and may thereafter
resume such offering from time to time. The exchange privilege is available only
to U.S. shareholders in states where the exchange legally may be made. It is
contemplated that the exchange privilege may be applicable to other new mutual
funds whose shares may be distributed by the Distributor.
32
<PAGE> 402
FEE-BASED PROGRAMS
Certain fee-based programs, including pricing alternatives for securities
transactions (each referred to in this paragraph as a "Program"), may permit the
purchase of Class I shares at net asset value. Under specified circumstances,
participants in certain Programs may deposit other classes of shares, which will
be exchanged for Class I shares. Initial or deferred sales charges otherwise due
in connection with such exchanges may be waived or modified, as may the
Conversion Period applicable to the deposited shares. Termination of
participation in certain Programs may result in the redemption of shares held
therein or the automatic exchange thereof to another class at net asset value.
In addition, upon termination of participation in a Program, shares that have
been held for less than specified periods within such Program may be subject to
a fee based on the current value of such shares. These Programs also generally
prohibit such shares from being transferred to another account, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and distribution and account maintenance fees)
in order for the investment not to be subject to Program fees. Additional
information regarding certain specific Programs offered through particular
selected securities dealers or other financial intermediaries (including charges
and limitations on transferability applicable to shares that may be held in such
Programs) is available in each such Program's client agreement and from the
Transfer Agent at 1-800-236-4479.
RETIREMENT PLANS
The minimum initial purchase to establish a retirement plan is $100.
Dividends received in retirement plans are exempt from Federal taxation until
distributed from the plans. Different tax rules apply to Roth IRA plans and
educational savings plans. Investors considering participation in any retirement
or education savings plan should review specific tax laws relating thereto and
should consult their attorneys or tax advisers with respect to the establishment
and maintenance of any such plan.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class I shares (if he or she is an eligible Class I investor) or
Class A, Class B or Class C shares at the applicable public offering price.
These purchases may be made either through the shareholder's securities dealer
or by mail directly to the Transfer Agent, acting as agent for such securities
dealer. You may also add to your account by automatically investing a specific
amount in the Fund on a periodic basis through your selected securities dealer
or other financial intermediary. The current minimum for such automatic
additional investments is $100. This minimum may be waived or revised under
certain circumstances.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Shareholders may, at any time, by written notification to their selected
securities dealer or other financial intermediary if their account is maintained
with a selected securities dealer or other financial intermediary, or by written
notification or by telephone (1-800-236-4479) to the Transfer Agent, if their
account is maintained with the Transfer Agent, elect to have subsequent
dividends of ordinary income and/or capital gains paid with respect to shares of
the Fund in cash, rather than reinvested in shares of the Fund (provided that,
in the event that a payment on an account maintained at the Transfer Agent would
amount to $10.00 or less, a shareholder will not receive such payment in cash
and such payment will automatically be reinvested in additional shares).
Commencing ten days after the receipt by the Transfer Agent of such notice,
those instructions will be effected. The Fund is not responsible for any failure
of delivery to the shareholder's address of record and no interest will accrue
on amounts represented by uncashed dividend checks. Cash payments can also be
directly deposited to the shareholder's bank account.
33
<PAGE> 403
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals are available for shareholders with
shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed from
those on deposit in the shareholder's account to provide the withdrawal payment
specified by the shareholder. The shareholder may specify the dollar amount and
class of shares to be redeemed. Redemptions will be made at net asset value as
of the close of regular trading on the NYSE (generally, the NYSE closes at 4:00
p.m., Eastern time) on the 24th day of each month or the 24th day of the last
month of each quarter, whichever is applicable. If the NYSE is not open for
business on such date, the shares will be redeemed at the net asset value
determined after the close of regular trading on the NYSE on the following
business day. The check for the withdrawal payment will be mailed, or the direct
deposit for withdrawal payment will be made, on the next business day following
redemption. When a shareholder is making systematic withdrawals, dividends on
all shares in the Investment Account are reinvested automatically in Fund
shares. A shareholder's systematic withdrawal plan may be terminated at any
time, without a charge or penalty, by the shareholder, the Fund, the Transfer
Agent or the Distributor.
With respect to redemptions of Class B and Class C shares pursuant to a
systematic withdrawal plan, the maximum number of Class B or Class C shares that
can be redeemed from an account annually shall not exceed 10% of the value of
shares of such class in that account at the time the election to join the
systematic withdrawal plan was made. Any CDSC that otherwise might be due on
such redemption of Class B or Class C shares will be waived. Shares redeemed
pursuant to a systematic withdrawal plan will be redeemed in the same order as
Class B or Class C shares are otherwise redeemed. See "Purchase of
Shares -- Deferred Sales Charge Alternatives -- Class B and C Shares." Where the
systematic withdrawal plan is applied to Class B shares, upon conversion of the
last Class B shares in an account to Class A shares, a shareholder must make a
new election to join the systematic withdrawal program with respect to the Class
A shares. If an investor wishes to change the amount being withdrawn in a
systematic withdrawal plan the investor should contact his or her financial
consultant.
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax liabilities.
The Fund will not knowingly accept purchase orders for shares of the Fund from
investors who maintain a systematic withdrawal plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
DIVIDENDS AND TAX STATUS
The Fund has qualified as a regulated investment company. Qualification as
a regulated investment company requires, among other things, that (1) at least
90% of the Fund's annual gross income, without offset for losses from the sale
or other disposition of securities, be derived from payments with respect to
securities loans, interest, dividends and gains from the sale or other
disposition of stock, securities, or foreign currencies or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities, or currencies; and (2) the Fund diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of the Fund's assets is represented by cash, U.S. government securities,
securities of other regulated investment companies, and other securities limited
in respect of any one issuer to an amount not greater than 5% of the Fund's
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. government securities or the
34
<PAGE> 404
securities of other regulated investment companies). In addition, in order not
to be subject to federal taxation, the Fund must distribute to its shareholders
at least 90% of its investment company taxable income earned in each year.
The Fund is required to pay an excise tax to the extent it does not
distribute to its shareholders during any calendar year at least 98% of its
ordinary income for that calendar year, 98% of the excess of its capital gains
over its capital losses for the one-year period ending October 31 in such
calendar year, and all undistributed ordinary income and capital gains for the
preceding respective one-year period. The Fund intends to meet these
distribution requirements to avoid excise tax liability. The Fund also intends
to continue distributing to shareholders all of the excess of net long-term
capital gain over net short-term capital loss on sales of securities. If the net
asset value of shares of the Fund should, by reason of a distribution of
realized capital gains, be reduced below a shareholder's cost, such distribution
would to that extent be a return of capital to that shareholder even though
taxable to the shareholder, and a sale of shares by a shareholder at net asset
value at that time would establish a capital loss for federal tax purposes.
In determining the extent to which the Fund's dividends may be eligible for
the 70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisors regarding other requirements applicable to the dividends received
deduction.
Special rules apply to the treatment of certain forward foreign currency
exchange contracts (Section 1256 contracts). At the end of each year, such
investments held by the Fund must be "marked to market" for federal income tax
purposes; that is, treated as having been sold at market value. Except to the
extent that such gains or losses are treated as "Section 988" gains or losses,
as described below, sixty percent of any gain or loss recognized on these
"deemed sales" and on actual dispositions may be treated as long-term capital
gain or loss, and the remainder will be treated as short-term capital gain or
loss.
Under the Internal Revenue Code, gains or losses attributable to
fluctuations in exchange rates which occur between the time the Fund accrues
interest or other receivables or accrues expenses or other liabilities
denominated in a foreign currency and the time the Fund actually collects such
receivables or pays such liabilities are treated as ordinary income or loss.
Similarly, gains or losses on forward foreign currency exchange contracts or
dispositions of debt securities denominated in a foreign currency attributable
to fluctuations in the value of the foreign currency between the date of
acquisition of the security and the date of disposition are also treated as
ordinary gain or loss. These gains, referred to as "Section 988" gains or
losses, increase or decrease the amount of the Fund's investment company taxable
income available to be distributed to its shareholders as ordinary income,
rather than increasing or decreasing the Fund's net capital gain. If Section 988
losses exceed other investment company taxable income during a taxable year, the
Fund would not be able to make any ordinary dividend distributions, and any
ordinary dividend distributions made before the losses were realized would be
recharacterized as a return of capital to shareholders, rather than as an
ordinary dividend, reducing the basis of each shareholder's shares.
Any loss realized on a sale, redemption or exchange of shares of the Fund
by a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by the Fund constitute a
replacement of shares.
The per share dividends on Class B and Class C shares will be lower than
the per share dividends on Class I and Class A shares as a result of the account
maintenance, distribution and higher transfer agency fees applicable with
respect to the Class B and Class C shares; similarly, the per share dividends on
Class A shares will be lower than the per share dividends on Class I shares as a
result of the account maintenance fees applicable with respect to the Class A
shares. See "Pricing of Shares -- Determination of Net Asset Value."
35
<PAGE> 405
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined separately for Class I, Class A, Class
B and Class C shares in accordance with a formula specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class I and Class A
shares and the CDSC that would be applicable to a complete redemption of the
investment at the end of the specified period as in the case of Class B and
Class C shares and the maximum sales charge in the case of Class I and Class A
shares. Dividends paid by the Fund with respect to all shares, to the extent any
dividends are paid, will be calculated in the same manner at the same time on
the same day and will be in the same amount, except that account maintenance and
the distribution charges and any incremental transfer agency costs relating to
each class of shares will be borne exclusively by that class.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time. The Fund's total return may be
expressed either as a percentage or as a dollar amount in order to illustrate
such total return on a hypothetical $1,000 investment in the Fund at the
beginning of each specified period.
Average annual total returns for the periods ended June 30, 2000 are as
follows:
<TABLE>
<CAPTION>
ONE FIVE SINCE
YEAR YEARS INCEPTION
----- ----- ---------
<S> <C> <C> <C> <C>
Class I............................... 15.10% 13.38% 13.31% (Since 10/1/90)
Class A............................... 15.36% N/A 16.26% (Since 6/2/99)
</TABLE>
In order to reflect the reduced sales charges in the case of Class I or
Class A shares or the waiver of the CDSC in the case of Class B or Class C
shares applicable to certain investors, as described under "Purchase of Shares"
and "Redemption of Shares," respectively, the total return data quoted by the
Fund in advertisements directed to such investors may take into account the
reduced, and not the maximum, sales charge or may take into account the CDSC and
therefore may reflect greater total return since, due to the reduced sales
charges or the waiver of sales charges, a lower amount of expenses is deducted.
In advertising and sales literature, the Fund may compare its performance
to that of various broad market indexes, including without limitation the Morgan
Stanley Capital International Europe, Australia, Far East (EAFE) Index, Standard
& Poor's 500 Composite Stock Price Index and other published indexes. When
comparing its performance to a market index, the Fund may refer to various
statistical measures derived from the historic performance of the Fund and the
index, such as standard deviation and beta. In addition, the Fund may refer in
advertising or sales literature to (i) mutual fund performance ratings, rankings
and comparisons (including risk-adjusted ratings, rankings and comparisons),
(ii) other comparisons of mutual fund data including assets, expenses, fees and
other data, and (iii) other discussions reported in or assigned by Barron's,
36
<PAGE> 406
Business Week, CDA Investment Technology, Inc., Financial World, Forbes
Magazine, Fortune Magazine, Lipper Inc., Money Magazine, U.S. News & World
Report, The Wall Street Journal and other industry publications. The Fund may
also make reference to awards that may be given to the Investment Adviser. As
with other performance data, performance comparisons should not be considered
indicative of the Fund's relative performance for any future period.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest and to divide or combine
the shares into a greater or lesser number of shares without thereby changing
the proportionate beneficial interest in each Fund. Each share represents an
interest in a Fund proportionately equal to the interest of each other share,
except that the Class A, B and C shares are subject to distribution fees payable
under the Plan of Distribution. Upon the Trust's liquidation, all shareholders
would share pro rata in the net assets of the Fund in question available for
distribution to shareholders. If they deem it advisable and in the best interest
of shareholders, the Board of Trustees may create additional classes of shares.
The Board of Trustees has created ten series of shares, and may create
additional series in the future, which have separate assets and liabilities.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a
Fund's shares may advise the Trustees in writing that they wish to communicate
with other shareholders for the purpose of requesting a meeting to remove a
Trustee. The Trustees will then, if requested by the applicants, mail at the
applicants' expense the applicants' communication to all other shareholders.
The Trust or any Fund may be terminated if approved by the vote of a
majority of the Trustees or by the approval of the holders of a majority of the
Trust's outstanding shares, as defined in the 1940 Act. If not so terminated,
the Trust will continue indefinitely.
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Trust or its Trustees. The Declaration of Trust provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for its obligations. While Massachusetts
law permits a shareholder of a trust such as this to be held personally liable
as a partner under certain circumstances, the risk of a shareholder incurring
financial loss on account of shareholder liability is highly unlikely and is
limited to the relatively remote circumstances in which the Trust would be
unable to meet its obligations.
37
<PAGE> 407
Common expenses incurred by the Trust are allocated among the portfolios
based upon: (1) relative net assets; (2) as incurred on a specific
identification basis; or (3) evenly among the portfolios, depending on the
nature of the expenditure.
Except for (1) changes which do not adversely affect the rights of Trust
shareholders; (2) a change in the name of the Trust, or a series or class
thereof; (3) authorization of a new series or class; (4) changes to supply any
omission or correct any ambiguous or defective provision; or (5) changes
required by any federal, state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust without the affirmative vote of the holders of at least 67%
of the Trust's outstanding shares at a meeting at which more than 50% of its
outstanding shares are present in person or represented by proxy. The holders of
shares have no preemptive or conversion rights. Shares when issued are fully
paid and non-assessable, except as set forth above.
ISSUANCE OF FUND SHARES FOR SECURITIES
Investors may purchase Fund shares for consideration consisting of
securities rather than cash when, in the judgment of the Investment Adviser, the
securities: (a) meet the investment objective and policies of the Fund, (b) are
liquid and not subject to restrictions on resale, and (c) have a value that is
readily ascertainable via listing on or trading in a recognized United States or
international exchange or market.
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment wholly
in cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of the Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund during
any 90 day period for any one shareholder. Should redemptions by any shareholder
exceed such limitation the Fund will have the option of redeeming the excess in
cash or in kind. If shares are redeemed in kind, the redeeming shareholder would
incur brokerage costs in converting the assets into cash.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202, has been selected as the independent auditors of the Fund. The
independent auditors are responsible for auditing the annual financial
statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109-3661, acts as custodian of the Portfolio's assets and the Fund's assets
(the "Custodian"). Under its contract with the Trust and the Fund, the Custodian
is authorized to establish separate accounts in foreign currencies and to cause
foreign securities owned by the Trust and the Fund to be held in its offices
outside the United States and with certain foreign banks and securities
depositories. The Custodian is responsible for safeguarding and controlling the
Trust's and the Fund's cash and securities, handling the receipt and delivery of
securities and collecting interest and dividends on the Trust's and the Fund's
investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly-owned subsidiary of ML & Co., acts as the
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement. The Transfer Agent is responsible
for the issuance, transfer and redemption of shares and the opening, maintenance
and servicing of shareholder accounts.
38
<PAGE> 408
LEGAL COUNSEL
Gardner, Carton & Douglas, 321 North Clark Street, Chicago, Illinois 60610,
is counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio and
other information. An annual report containing financial statements audited by
independent auditors is sent to shareholders each year. After the end of each
year, shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
PRINCIPAL HOLDERS
[TO COME]
39
<PAGE> 409
STATEMENT OF ADDITIONAL INFORMATION
MERCURY HW GLOBAL VALUE FUND
OF MERCURY HW FUNDS
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017 - Phone No.
(800) 236-4479
------------------------
Mercury HW Global Value Fund (the "Fund") is a fund of the Mercury HW Funds
(the "Trust"). The Trust is a diversified, open-end, management investment
company which is organized as a Massachusetts business trust. The investment
objective of the Fund is to seek to provide current income and long-term growth
of income, accompanied by growth of capital. The Fund seeks to achieve its
investment objective by investing primarily in U.S. and international stocks. No
assurance can be given that the investment objective of the Fund will be
realized. For more information on the Fund's investment objective and policies,
see "Investment Objective and Policies."
The Fund offers a single class (Class I) of shares. Only certain investors
are eligible to purchase Class I shares. See "Purchase of Shares."
------------------------
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the prospectus of the Fund, dated October , 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Fund at
1-800-236-4479 or your financial consultant or other financial intermediary, or
by writing to the Fund at Financial Data Services, Inc., P.O. Box 41621,
Jacksonville, Florida 32232-1621. The Prospectus is incorporated by reference
into this Statement of Additional Information, and this Statement of Additional
Information is incorporated by reference into the Prospectus. The Fund's
financial statements are incorporated by reference to its annual report for the
fiscal year ended June 30, 2000. You may request copies of the annual report at
no charge by calling 1-800-236-4479 between 8:00 a.m. and 8:00 p.m. on any
business day.
------------------------
MERCURY ADVISORS -- INVESTMENT ADVISER
FAM DISTRIBUTORS, INC. -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is October , 2000
<PAGE> 410
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Trust History............................................... 3
Investment Objective and Policies........................... 3
Investment Restrictions................................... 3
Repurchase Agreements..................................... 4
Bonds..................................................... 4
U.S. Government Securities................................ 4
Corporate Debt Securities................................. 5
Convertible Securities.................................... 5
Derivative Instruments.................................... 5
Foreign Securities........................................ 6
Foreign Currency Options and Related Risks................ 7
Forward Foreign Currency Exchange Contracts............... 7
Foreign Investment Risks.................................. 9
Swap Agreements........................................... 10
Illiquid Securities....................................... 11
Borrowing................................................. 12
When-Issued Securities.................................... 12
Real Estate Investment Trusts............................. 12
Shares of Other Investment Companies...................... 13
Limited Partnerships...................................... 13
Short Sales Against-the-Box............................... 13
Corporate Loans........................................... 13
Temporary Defensive Position.............................. 13
Management of the Fund...................................... 13
Advisory Arrangements..................................... 15
Accounting and Administrative Services.................... 16
Code of Ethics............................................ 17
Purchase of Shares.......................................... 17
Class I Shares............................................ 18
Reduced Initial Sales Charges............................. 19
Redemption of Shares........................................ 20
Redemption................................................ 21
Repurchase................................................ 21
Reinstatement Privilege -- Class I Shares................. 22
Pricing of Shares........................................... 22
Determination of Net Asset Value.......................... 22
Computation of Offering Price Per Share................... 23
Portfolio Transactions and Brokerage........................ 24
Transactions in Portfolio Securities...................... 24
Shareholder Services........................................ 25
Investment Account........................................ 25
Exchange Privilege........................................ 26
Fee-Based Programs........................................ 27
Retirement Plans.......................................... 27
Automatic Investment Plans................................ 27
Automatic Dividend Reinvestment Plan...................... 27
Systematic Withdrawal Plans............................... 28
Dividends and Tax Status.................................... 28
Performance Data............................................ 29
General Information......................................... 30
Description of Shares..................................... 30
Issuance of Fund Shares for Securities.................... 31
Redemption in Kind........................................ 32
Independent Auditors...................................... 32
Custodian................................................. 32
Transfer Agent............................................ 32
Legal Counsel............................................. 32
Reports to Shareholders................................... 32
Shareholder Inquiries..................................... 32
Additional Information.................................... 32
Principal Holders......................................... 33
</TABLE>
2
<PAGE> 411
TRUST HISTORY
The Trust was organized on August 22, 1984 as a Massachusetts business
trust. Before October 7, 1994, the Trust was called "Olympic Trust," and before
October , 2000, the Trust was called "Hotchkis and Wiley Funds." The Trust is
a diversified, open-end, management investment company currently consisting of
ten separate funds. Prior to October , 2000, the Fund was called the Global
Equity Fund.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide current income and
long-term growth of income, accompanied by growth of capital. Reference is made
to the discussion under "How the Fund Invests" and "Investment Risks" in the
Prospectus for information with respect to the Fund's investment objective and
policies.
Mercury Advisors (the "Investment Adviser"), the Fund's investment adviser,
is responsible for the management of the Fund's portfolio.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of that Fund's outstanding
voting securities, as defined in the Investment Company Act of 1940, as amended
(the "1940 Act"). Under the 1940 Act, the vote of the holders of a "majority" of
the Fund's outstanding voting securities means the vote of the holders of the
lesser of (1) 67% of the shares of the Fund represented at a meeting at which
the holders of more than 50% of its outstanding shares are represented or (2)
more than 50% of the outstanding shares.
Except as noted, the Fund may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Fund's total assets (determined at the time of investment) would
then be invested in securities of a single issuer; or (ii) more than
25% of the Fund's total assets (determined at the time of investment)
would be invested in one or more issuers having their principal
business activities in a single industry.
2. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions),
provided that the deposit or payment by the Fund of initial or
maintenance margin in connection with futures or options is not
considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short (short sale
against-the-box), and unless not more than 25% of the Fund's net assets
(taken at current value) is held as collateral for such sales at any
one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Fund may borrow from a bank for temporary or emergency purposes in
amounts not exceeding 10% (taken at the lower of cost or current value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings; the Fund will not purchase any
additional portfolio securities while such borrowings are outstanding.
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would
then hold more than 10% of the outstanding voting securities of an
issuer.
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6. Buy or sell commodities or commodity contracts or real estate or
interests in real estate, although it may purchase and sell securities
which are secured by real estate and securities of companies which
invest or deal in real estate. (For the purposes of this restriction,
forward foreign currency exchange contracts are not deemed to be
commodities or commodity contracts.)
7. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws.
8. Make investments for the purpose of exercising control or management.
9. Participate on a joint or joint and several basis in any trading
account in securities.
10. Make loans, except through repurchase agreements.
Any percentage limitation on the Fund's investments is determined when the
investment is made, unless otherwise noted.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement where the seller agrees to
repurchase a security from the Fund at a mutually agreed-upon time and price.
The period of maturity is usually quite short, possibly overnight or a few days,
although it may extend over a number of months. The resale price is more than
the purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Fund's money is invested in the repurchase agreement. The
Fund's repurchase agreements will at all times be fully collateralized in an
amount at least equal to the resale price. The instruments held as collateral
are valued daily, and if the value of instruments declines, the Fund will
require additional collateral. In the event of a default, insolvency or
bankruptcy by a seller, the Fund will promptly seek to liquidate the collateral.
In such circumstances, the Fund could experience a delay or be prevented from
disposing of the collateral. To the extent that the proceeds from any sale of
such collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
BONDS
The term "bond" or "bonds" as used in the Prospectus is intended to include
all manner of fixed-income securities, debt securities and other debt
obligations unless specifically defined otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the U.S. itself in the event the
agency or instrumentality does not meet its commitment. The Fund will invest in
securities of such instrumentality only when the Investment Adviser is satisfied
that the credit risk with respect to any instrumentality is acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely, either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (1) Treasury obligations from which the interest coupons
have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member bank representing ownership of Treasury obligation
components; or (4) receipts evidencing the component
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parts (corpus or coupons) of Treasury obligations that have not actually been
stripped. Such receipts evidence ownership of component parts of Treasury
obligations (corpus or coupons) purchased by a third party (typically an
investment banking firm) and held on behalf of the third party in physical or
book-entry form by a major commercial bank or trust company pursuant to a
custody agreement with the third party. These custodial receipts are known by
various names, including "Treasury Receipts," "Treasury Investment Growth
Receipts" ("TIGRs") and "Certificates of Accrual on Treasury Securities"
("CATS"), and are not issued by the U.S. Treasury; therefore they are not U.S.
Government securities, although the underlying bonds represented by these
receipts are debt obligations of the U.S. Treasury.
CORPORATE DEBT SECURITIES
The Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, are in the Investment Adviser's opinion comparable
in quality to corporate debt securities in which the Fund may invest. The rate
of return or return of principal on some debt obligations may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying common stock.
The price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
DERIVATIVE INSTRUMENTS
As indicated in the prospectus, to the extent consistent with its
investment objective and policies and the investment restrictions listed in this
Statement of Additional Information, the Fund may purchase and write call and
put options on securities, securities indexes and foreign currencies and enter
into forward contracts. The Fund also may enter into swap agreements with
respect to foreign currencies, interest rates and securities indexes. The Fund
may use these techniques to hedge against changes in interest rates, foreign
currency exchange rates, or securities prices or as part of its overall
investment strategies. The Fund may also purchase and sell options relating to
foreign currencies for the purpose of increasing exposure to a foreign currency
or to shift exposure to foreign currency fluctuations from one country to
another. The Fund will mark as segregated cash, U.S. government securities,
equity securities or other liquid, unencumbered assets, marked-to-market daily
(or, as permitted by applicable regulation, enter into certain offsetting
positions), to cover its obligations under forward contracts, swap agreements
and options to avoid leveraging of the Fund.
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Options on Securities and on Securities Indexes. The Fund may purchase put
options on securities to protect holdings in an underlying or related security
against a substantial decline in market value. The Fund may purchase call
options on securities to protect against substantial increases in prices of
securities the Fund intends to purchase pending its ability to invest in such
securities in an orderly manner. The Fund may sell put or call options it has
previously purchased, which could result in a net gain or loss depending on
whether the amount realized on the sale is more or less than the premium and
other transaction costs paid on the put or call option which is sold. The Fund
may write a call or put option only if the option is "covered" by the Fund
holding a position in the underlying securities or by other means which would
permit immediate satisfaction of the Fund's obligation as writer of the option.
Prior to exercise or expiration, an option may be closed out by an offsetting
purchase or sale of an option of the same series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
FOREIGN SECURITIES
The Fund may invest in American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") or other securities convertible into securities of
issuers based in foreign countries. These securities may not necessarily be
denominated in the same currency as the securities into which they may be
converted. ADRs are receipts, usually issued by a U.S. bank or trust company,
evidencing ownership of the underlying securities; EDRs are European receipts
evidencing a similar arrangement. Generally, ADRs are issued in
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registered form, denominated in U.S. dollars, and are designed for use in the
U.S. securities markets; EDRs are issued in bearer form, denominated in other
currencies, and are designed for use in European securities markets.
FOREIGN CURRENCY OPTIONS AND RELATED RISKS
The Fund may take positions in options on foreign currencies to hedge
against the risk that foreign exchange rate fluctuations will affect the value
of foreign securities the Fund holds in its portfolio or intends to purchase.
For example, if the Fund were to enter into a contract to purchase securities
denominated in a foreign currency, it could effectively fix the maximum U.S.
dollar cost of the securities by purchasing call options on that foreign
currency. Similarly, if the Fund held securities denominated in a foreign
currency and anticipated a decline in the value of that currency against the
U.S. dollar, it could hedge against such a decline by purchasing a put option on
the currency involved. The markets in foreign currency options are relatively
new, and the Fund's ability to establish and close out positions in such options
is subject to the maintenance of a liquid secondary market. There can be no
assurance that a liquid secondary market will exist for a particular option at
any specific time. In addition, options on foreign currencies are affected by
all of those factors that influence foreign exchange rates and investments
generally.
The quantities of currencies underlying option contracts represent odd lots
in a market dominated by transactions between banks, and as a result extra
transaction costs may be incurred upon exercise of an option.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations be firm or revised on a
timely basis. Quotation information is generally representative of very large
transactions in the interbank market and may not reflect smaller transactions
where rates may be less favorable. Option markets may be closed while
round-the-clock interbank currency markets are open, and this can create price
and rate discrepancies.
Risks of Options Trading. The Fund may effectively terminate its rights or
obligations under options by entering into closing transactions. Closing
transactions permit the Fund to realize profits or limit losses on its options
positions prior to the exercise or expiration of the option. The value of a
foreign currency option depends on the value of the underlying currency relative
to the U.S. dollar. Other factors affecting the value of an option are the time
remaining until expiration, the relationship of the exercise price to market
price, the historical price volatility of the underlying currency and general
market conditions. As a result, changes in the value of an option position may
have no relationship to the investment merit of a foreign security. Whether a
profit or loss is realized on a closing transaction depends on the price
movement of the underlying currency and the market value of the option.
Options normally have expiration dates of up to nine months. The exercise
price may be below, equal to or above the current market value of the underlying
currency. Options that expire unexercised have no value, and the Fund will
realize a loss of any premium paid and any transaction costs. Closing
transactions may be effected only by negotiating directly with the other party
to the option contract, unless a secondary market for the options develops.
Although the Fund intends to enter into foreign currency options only with
dealers which agree to enter into, and which are expected to be capable of
entering into, closing transactions with the Fund, there can be no assurance
that the Fund will be able to liquidate an option at a favorable price at any
time prior to expiration. In the event of insolvency of the counter-party, the
Fund may be unable to liquidate a foreign currency option. Accordingly, it may
not be possible to effect closing transactions with respect to certain options,
with the result that the Fund would have to exercise those options that it had
purchased in order to realize any profit.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may use forward contracts to protect against uncertainty in the
level of future exchange rates. The Fund will not speculate with forward
contracts or foreign currency exchange rates.
The Fund may enter into forward contracts with respect to specific
transactions. For example, when the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, or when
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the Fund anticipates the receipt in a foreign currency of dividend or interest
payments on a security that it holds, the Fund may desire to "lock in" the U.S.
dollar price of the security or the U.S. dollar equivalent of the payment, by
entering into a forward contract for the purchase or sale, for a fixed amount of
U.S. dollars or foreign currency, of the amount of foreign currency involved in
the underlying transaction. The Fund will thereby be able to protect itself
against a possible loss resulting from an adverse change in the relationship
between the currency exchange rates during the period between the date on which
the security is purchased or sold, or on which the payment is declared, and the
date on which such payments are made or received.
The Fund also may use forward contracts in connection with portfolio
positions to lock in the U.S. dollar value of those positions, to increase the
Fund's exposure to foreign currencies that the Investment Adviser believes may
rise in value relative to the U.S. dollar or to shift the Fund's exposure to
foreign currency fluctuations from one country to another. For example, when the
Investment Adviser believes that the currency of a particular foreign country
may suffer a substantial decline relative to the U.S. dollar or another
currency, it may enter into a forward contract to sell the amount of the former
foreign currency approximating the value of some or all of the Fund's portfolio
securities denominated in such foreign currency. This investment practice
generally is referred to as "cross-hedging" when another foreign currency is
used.
The precise matching of the forward contract amounts and the value of the
securities involved will not generally be possible because the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Accordingly, it may be necessary for
the Fund to purchase additional foreign currency on the spot (that is, cash)
market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Fund is obligated to
deliver and if a decision is made to sell the security and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio security if
its market value exceeds the amount of foreign currency the Fund is obligated to
deliver. The projection of short-term currency market movements is extremely
difficult, and the successful execution of a short-term hedging strategy is
highly uncertain. Forward contracts involve the risk that anticipated currency
movements will not be accurately predicted, causing the Fund to sustain losses
on these contracts and transaction costs. The Fund may enter into forward
contracts or maintain a net exposure to such contracts only if (1) the
consummation of the contracts would not obligate the Fund to deliver an amount
of foreign currency in excess of the value of the Fund's portfolio securities or
other assets denominated in that currency, or (2) the Fund maintains in a
segregated account cash, U.S. Government securities, equity securities or other
liquid, unencumbered assets, marked-to-market daily, in an amount not less than
the value of the Fund's total assets committed to the consummation of the
contracts. Under normal circumstances, consideration of the prospect for
currency parities will be incorporated into the longer term investment decisions
made with regard to overall diversification strategies. However, the Investment
Adviser believes it is important to have the flexibility to enter into such
forward contracts when it determines that the best interests of the Fund will be
served.
At or before the maturity date of a forward contract that requires the Fund
to sell a currency, the Fund may either sell a portfolio security and use the
sale proceeds to 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 that it is obligated to deliver. Similarly, the Fund
may close out a forward contract requiring it to purchase a specified currency
by entering into a second contract entitling it to sell the same amount of the
same currency on the maturity date of the first contract. The Fund would realize
a gain or loss as a result of entering into such an offsetting forward contract
under either circumstance to the extent the exchange rate between the currencies
involved moved between the execution dates of the first and second contracts.
The cost to the Fund of engaging in forward contracts varies with factors
such as the currencies involved, the length of the contract period and the
market conditions then prevailing. Because forward contracts are usually entered
into on a principal basis, no fees or commissions are involved. The use of
forward contracts does not eliminate fluctuations in the prices of the
underlying securities the Fund owns or intends to acquire, but it does fix a
rate of exchange in advance. In addition, although forward contracts limit the
risk of loss due
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to a decline in the value of the hedged currencies, at the same time they limit
any potential gain that might result should the value of the currencies
increase.
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend to convert holdings of foreign currencies into U.S. dollars on a
daily basis. The Fund may convert foreign currency from time to time, and
investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit
based on the difference between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to the
Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
FOREIGN INVESTMENT RISKS
Foreign Market Risk. Because the Fund may invest in foreign securities, the
Fund offers you more diversification than an investment only in the United
States since prices of securities traded on foreign markets have often, though
not always, moved counter to prices in the United States. Foreign security
investment, however, involves special risks not present in U.S. investments that
can increase the chances that the Fund will lose money. In particular, the Fund
is subject to the risk that because there are generally fewer investors on
foreign exchanges and a smaller number of shares traded each day, it may be
difficult for the Fund to buy and sell securities on those exchanges. In
addition, prices of foreign securities may fluctuate more than prices of
securities traded in the United States.
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of capital, resources, and
balance of payments position. Certain such economies may rely heavily on
particular industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a particular country
or countries, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. Investments in foreign markets may
also be adversely affected by governmental actions such as the imposition of
capital controls, nationalization of companies or industries, expropriation of
assets, or the imposition of punitive taxes. In addition, the governments of
certain countries may prohibit or impose substantial restrictions on foreign
investing in their capital markets or in certain industries. Any of these
actions could severely affect security prices, impair the Fund's ability to
purchase or sell foreign securities or transfer the Fund's assets or income back
into the United States, or otherwise adversely affect the Fund's operations.
Other foreign market risks include foreign exchange controls, difficulties in
pricing securities, defaults on foreign government securities, difficulties in
enforcing favorable legal judgments in foreign courts, and political and social
instability. Legal remedies available to investors in certain foreign countries
may be less extensive than those available to investors in the United States or
other foreign countries.
Currency Risk and Exchange Risk. Securities in which the Fund invests may
be denominated or quoted in currencies other than the U.S. dollar. Changes in
foreign currency exchange rates will affect the value of the securities of the
Fund. Generally, when the U.S. dollar rises in value against a foreign currency,
your investment in a security denominated in that currency loses value because
the currency is worth fewer U.S. dollars. Similarly when the U.S. dollar
decreases in value against a foreign currency, your investment in a security
denominated in that currency gains value because the currency is worth more U.S.
dollars. This risk is generally known as "currency risk" which is the
possibility that a stronger U.S. dollar will reduce returns for U.S. investors
investing overseas and a weak U.S. dollar will increase returns for U.S.
investors investing overseas.
For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU established a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU
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participants by July 1, 2002. Upon implementation of EMU, certain securities
issued in participating EU countries (beginning with government and corporate
bonds) were redenominated in the euro, and are now listed, traded, declaring
dividends and making other payments only in euros.
No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on the Fund's investments
in Europe generally or in specific countries participating in EMU.
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some countries may not have laws
to protect investors the way that the United States securities laws do.
Accounting standards in other countries are not necessarily the same as in the
United States. If the accounting standards in another country do not require as
much disclosure or detail as U.S. accounting standards, it may be harder for the
Fund's portfolio managers to completely and accurately determine a company's
financial condition.
Certain Risks of Holding Fund Assets Outside the United States. The Fund
generally holds the foreign securities in which it invests outside the United
States in foreign banks and securities depositories. These foreign banks and
securities depositories may be recently organized or new to the foreign custody
business. They may also have operations subject to limited or no regulatory
oversight. Also, the laws of certain countries may put limits on the Fund's
ability to recover its assets if a foreign bank or depository or issuer of a
security or any of their agents goes bankrupt. In addition, it can be expected
that it will be more expensive for the Fund to buy, sell and hold securities in
certain foreign markets than it is in the U.S. market due to higher brokerage,
transaction, custody and/or other costs. The increased expense of investing in
foreign markets reduces the amount the Fund can earn on its investments.
Settlement and clearance procedures in certain foreign markets differ
significantly from those in the United States. Foreign settlement and clearance
procedures and trade regulations also may involve certain risks (such as delays
in payment for or delivery of securities) not typically involved with the
settlement of U.S. investments. Communications between the United States and
emerging market countries may be unreliable, increasing the risk of delayed
settlements or losses of security certificates. Settlements in certain foreign
countries at times have not kept pace with the number of securities
transactions. These problems may make it difficult for a Fund to carry out
transactions. If the Fund cannot settle or is delayed in settling a purchase of
securities, it may miss attractive investment opportunities and certain of its
assets may be uninvested with no return earned thereon for some period. If the
Fund cannot settle or is delayed in settling a sale of securities, it may lose
money if the value of the security then declines or, if it has contracted to
sell the security to another party, the Fund could be liable to that party for
any losses incurred.
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
SWAP AGREEMENTS
The Fund may enter into interest rate, index and currency exchange rate
swap agreements for purposes of attempting to obtain a particular desired return
at a lower cost to the Fund than if the Fund had invested
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<PAGE> 419
directly in an instrument that yielded the desired return. Swap agreements are
two party contracts entered into primarily by institutional investors for
periods ranging from a few weeks to more than one year. In a standard "swap"
transaction, two parties agree to exchange the returns (or differentials in
rates of return) earned or realized on particular predetermined investments or
instruments. The gross returns to be exchanged or "swapped" between the parties
are calculated with respect to a "notional amount," i.e., the return on or
increase in value of a particular dollar amount invested at a particular
interest rate, in a particular foreign currency, or in a "basket" of securities
representing a particular index. The "notional amount" of the swap agreement is
only a fictive basis on which to calculate the obligations which the parties to
a swap agreement have agreed to exchange. The Fund's obligations (or rights)
under a swap agreement will generally be equal only to the net amount to be paid
or received under the agreement based on the relative values of the positions
held by each party to the agreement (the "net amount"). The Fund's obligations
under a swap agreement will be accrued daily (offset against any amounts owing
to the Fund) and any accrued but unpaid net amounts owed to a swap counter-party
will be covered by marking as segregated cash, U.S. government securities,
equity securities or other liquid, unencumbered assets, marked-to-market daily,
to avoid any potential leveraging of the Fund's portfolio. The Fund will not
enter into a swap agreement with any single party if the net amount owed or to
be received under existing contracts with that party would exceed 5% of the
Fund's assets.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Investment Adviser's
ability to correctly predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, the Fund bears the risk
of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counter-party.
Restrictions imposed by the Internal Revenue Code may limit the Fund's ability
to use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps market,
including potential government regulation, could adversely affect the Fund's
ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions of
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended ("Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
that have a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Limitations on resale may have an adverse effect on the
marketability of portfolio securities and a mutual fund might be unable to
dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemption within
seven days. The absence of a trading market can make it difficult to ascertain a
market value for illiquid investments. Also market quotations are less readily
available. The judgment of the Investment Adviser may at times play a greater
role in valuing these securities than in the case of unrestricted securities. A
mutual fund might also have to register such restricted securities in order to
dispose of them resulting in additional expense and delay. Adverse market
conditions could impede such a public offering of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to
11
<PAGE> 420
honor a demand for repayment. The fact that there are contractual or legal
restrictions on resale to the general public or to certain institutions may not
be indicative of the liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Investment Adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least two nationally recognized statistical
rating organizations ("NRSRO") or, if unrated, be of comparable quality in the
view of the Investment Adviser; and (2) it must not be in default as to
principal or interest. Investing in Rule 144A securities could have the effect
of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
BORROWING
The Fund may borrow for temporary or emergency purposes in amounts not
exceeding 10% of the Fund's total assets. This borrowing may be unsecured. The
1940 Act requires the Fund to maintain continuous asset coverage (that is, total
assets including borrowings, less liabilities exclusive of borrowings) of 300%
of the amount borrowed. Borrowing subjects the Fund to interest costs which may
or may not be recovered by appreciation of the securities purchased, and can
exaggerate the effect on net asset value of any increase or decrease in the
market value of the Fund's portfolio. This is the speculative factor known as
leverage.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value of the security each day in determining the Fund's net asset
value. The Fund will also mark as segregated with its custodian cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, equal in value to its obligations for when-issued
securities.
REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain Internal Revenue Code requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties, as well as
greater income
12
<PAGE> 421
potential than an investment in common stocks. Like any investment in real
estate, though, a REIT's performance depends on several factors, such as its
ability to find tenants for its properties, to renew leases and to finance
property purchases and renovations.
SHARES OF OTHER INVESTMENT COMPANIES
The Fund can invest in securities of other investment companies except to
the extent prohibited by law. Like all equity investments, these investments may
go up or down in value. They also may not perform in correlation with the Fund's
principal strategies. The Fund will pay additional fees through its investments
in other investment companies.
LIMITED PARTNERSHIPS
The Fund can invest in limited partnership interests.
SHORT SALES AGAINST-THE-BOX
The Fund can borrow and sell "short" securities when it also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund's
total assets can be held as collateral for short sales at any one time.
CORPORATE LOANS
The Fund can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Fund may not
recover its investment, or there might be a delay in the Fund's recovery. By
investing in a corporate loan, the Fund becomes a member of the syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, the Fund may invest
all or part of its assets in short-term investment grade debt obligations of the
U.S. government, its agencies and instrumentalities, bank certificates of
deposit, bankers' acceptances, high quality commercial paper, demand notes and
repurchase agreements.
MANAGEMENT OF THE FUND
The Trustees oversee the actions of the Fund's Investment Adviser and other
service providers and decide upon matters of general policy. The Trustees also
review the actions of the Trust's officers, who conduct and supervise the daily
business operations of the Trust. The Trustees (* denotes "interested" Trustee
as defined in the 1940 Act, due to the relationship with the Investment Adviser)
and officers of the Trust are:
MICHAEL BAXTER* (37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since 1999);
Managing Director of the Investment Adviser (since 1996); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
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<PAGE> 422
ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since 1994); Chairman, Gamma Services Corp.
(venture capital) (since 1968); Principal, Gavin, Dailey & Partners (consulting)
(since 1993); U.S. Ambassador to Mexico (1981 - 1986); Director, Apex Mortgage
Capital, Inc., Atlantic Richfield Co., International Wire Corp. and Krause's
Furniture.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (since 1986); Member of CIEBA's Executive Committee (since
1988) and its Chairman (from 1991 - 1992); Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds (1986 - 1993); Member of the Investment Advisory Committees of
the State of New York Common Retirement Fund and the Howard Hughes Medical
Institute (since 1997); Director, Duke Management Company (since 1992) and Vice
Chairman (since 1998); Director, Kimco Realty Corporation (since 1997);
Director, LaSalle Street Fund (since 1995); Member of the Investment Advisory
Committee of the Virginia Retirement System (since 1998); Director, Montpelier
Foundation (since 1998); Trustee or Director of 31 registered investment
companies (consisting of 47 portfolios) for which the Investment Adviser or an
advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since
1999); Managing Director of the Investment Adviser (since 1998); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (49) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 66 registered investment companies
(consisting of 71 portfolios) for which the Investment Adviser or an advisory
affiliate is the adviser.
NANCY D. CELICK (49) -- President -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Chief Administrative Officer of the Investment
Adviser (since 1998); Chief Financial Officer of the Investment Adviser
(1993 - 1998); Chief Financial Officer of Kennedy-Wilson, Inc. (auction
marketing services) (1992 - 1993); Chief Financial Officer of First National
Corporation (bank holding company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-9011. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services,
Inc. (since 1999); Vice President of FAM Distributors, Inc. (since 1999); First
Vice President of the Investment and Adviser (1990 - 1997).
ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
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<PAGE> 423
GRACIE FERMELIA (38) -- Vice President and Assistant Secretary -- 725 South
Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Director of the
Investment Adviser (since 2000); Vice President of the Investment Adviser
(1994 - 2000); Senior Manager, Price Waterhouse (1985 - 1994).
The Trust does not pay salaries to any of its officers or fees to any of
its Trustees affiliated with the Investment Adviser. The following table sets
forth the aggregate compensation paid to the Trustees during the Trust's fiscal
year ended June 30, 2000 and the aggregate compensation paid to the Trustees for
service on the Trust's Board and that of any other fund for which the Investment
Adviser serves as investment adviser or which has an investment adviser that is
an affiliated person of the Investment Adviser ("Fund Complex") for the year
ended December 31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $ $ 34,000
John A. G. Gavin................................... $ $ 25,000
Joe Grills......................................... $ $232,333
Nigel Hurst-Brown.................................. $ -0- $ -0-
Robert B. Hutchinson**............................. $ $ 34,000
Madeleine A. Kleiner............................... $ $ 18,000
Merle T. Welshans**................................ $ $ 34,000
Richard R. West.................................... $ $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of Mercury HW Variable Trust, Fund
Asset Management Master Trust and Merrill Lynch Investment Managers Funds,
Inc. Messrs. Grills and West also serve on the boards of other investment
companies advised by Merrill Lynch Investment Managers, L.P. and its advisory
affiliates.
** Messrs. Hutchinson and Welshans retired on November 12, 1999.
The Trustees may be eligible for reduced sales charges on purchases of
Class I shares. See "Reduced Initial Sales Charges -- Purchase Privileges of
Certain Persons."
For information as to ownership of shares, see "General
Information -- Principal Holders."
ADVISORY ARRANGEMENTS
Investment Advisory Services and Fee. The Trust on behalf of the Fund has
entered into an investment advisory agreement (the "Advisory Agreement") with
the Investment Adviser as investment adviser. Subject to the supervision of the
Trustees, the Investment Adviser is responsible for the actual management of the
Fund and constantly reviews the Fund's holdings in light of its own research
analysis and that from other relevant sources. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser. The Investment Adviser performs certain of the other administrative
services and provides all office space, facilities, equipment and necessary
personnel for management of the Fund. The Investment Adviser receives for its
services to the Fund a monthly fee at an annual rate of 0.75% of the Fund's
average daily net assets. For purposes of this calculation, average daily net
assets is determined at the end of each month on the basis of the average net
assets of the Fund for each day during the month.
Prior to October , 2000, the Fund was party to an investment advisory
agreement under which it paid Merrill Lynch Investment Managers, L.P., an
affiliate of the Investment Adviser, a fee at the annual rate of 0.75% of its
average daily net assets. For the fiscal years ended June 30, 2000, 1999 and
1998, as a result of its agreement to limit Fund expenses, Merrill Lynch
Investment Managers, L.P. waived a portion of its fee in the amounts of
$ , $68,393 and $111,644 respectively.
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<PAGE> 424
Subadvisers. The Investment Adviser has entered into subadvisory agreements
with Merrill Lynch Investment Managers International Limited and Merrill Lynch
Asset Management U.K. Limited, affiliated investment advisers that are indirect
subsidiaries of Merrill Lynch & Co., Inc. The subadvisory arrangements are for
investment research, recommendations and other investment-related services to be
provided to the Fund at rates of compensation as may be agreed by the parties.
There is no increase in the aggregate fees paid by the Fund for such services.
For the fiscal years ended June 30, 2000, 1999 and 1998, the Fund paid no
advisory fees and Merrill Lynch Investment Managers, L.P. reimbursed the Fund in
the amounts of $ , $16,239 and $67,175 respectively.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients of the Investment Adviser or an affiliate when one or more clients of
the Investment Adviser or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Payment of Fund Expenses. The Advisory Agreement obligates the Investment
Adviser to provide investment advisory services and to pay, or cause an
affiliate to pay, for maintaining its staff and personnel and to provide office
space, facilities and necessary personnel for the Fund. The Investment Adviser
is also obligated to pay, or cause an affiliate to pay, the fees of all officers
and Trustees who are affiliated persons of the Investment Adviser. The Fund
pays, or causes to be paid, all other expenses incurred in the operation of the
Fund (except to the extent paid by FAM Distributors, Inc. (the "Distributor")),
including, among other things, taxes, expenses for legal and auditing services,
costs of printing proxies, shareholder reports, copies of the Registration
Statement, charges of the custodian, any sub-custodian and the transfer agent,
expenses of portfolio transactions, expenses of redemption of shares, commission
fees, expenses of registering the shares under Federal, state or non-U.S. laws,
fees and actual out-of-pocket expenses of non-interested Trustees, accounting
and pricing costs (including the daily calculation of net asset value),
insurance, interest, brokerage costs, litigation and other extraordinary or
non-recurring expenses, and other expenses properly payable by the Fund.
Organization of the Investment Adviser. The Investment Adviser is a limited
partnership, the partners of which are Merrill Lynch & Co., Inc. ("ML & Co."), a
financial services holding company and the parent of Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"), and Princeton Services, Inc. ML &
Co. and Princeton Services, Inc. are "controlling persons" of the Investment
Adviser as defined under the 1940 Act because of their ownership of its voting
securities and their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Advisory Agreement will remain in effect from year to year if approved annually
(a) by the Board of Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees of the Trust who are
not parties to the Advisory Agreement or interested persons (as defined in the
1940 Act) of any such party. The Advisory Agreement is not assignable and will
automatically terminate in the event of its assignment. In addition, such
contract may be terminated by the vote of a majority of the outstanding voting
securities of the Fund or by the Investment Adviser without penalty on 60 days'
written notice to the other party.
ACCOUNTING AND ADMINISTRATIVE SERVICES
The Trust has entered into a Fund Accounting and Administration Servicing
Agreement (the "Fund Accounting Agreement") with the Investment Adviser acting
as service provider. The Fund Accounting Agreement obligates the Investment
Adviser to provide certain accounting and administrative services to the Trust.
The Trust reimburses the Investment Adviser for its costs in connection with
such services.
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<PAGE> 425
Transfer Agency Services. The Transfer Agent, a subsidiary of ML & Co.,
acts as the Fund's Transfer Agent pursuant to a Transfer Agency, Dividend
Disbursing Agency and Shareholder Servicing Agency Agreement (the "Transfer
Agency Agreement"). Pursuant to the Transfer Agency Agreement, the Transfer
Agent is responsible for the issuance, transfer and redemption of shares and the
opening and maintenance of shareholder accounts. Pursuant to the Transfer Agency
Agreement, the Transfer Agent receives a fee ranging from $16.00 to $20.00 per
account (depending on the level of services required) and certain other fees
relating to special processing of sub-transfer agency relationships. The
Transfer Agent is entitled to reimbursement for certain transaction charges and
out-of-pocket expenses incurred by the Transfer Agent under the Transfer Agency
Agreement. For purposes of the Transfer Agency Agreement, the term "account"
includes a shareholder account maintained directly by the Transfer Agent and any
other account representing the beneficial interest of a person in the relevant
share class on a recordkeeping system.
Distribution Expenses. The Fund has entered into a distribution agreement
with the Distributor in connection with the continuous offering of shares of the
Fund (the "Distribution Agreement"). The Distribution Agreement obligates the
Distributor to pay certain expenses in connection with the offering of the
shares of the Fund. After the prospectuses, statements of additional information
and periodic reports have been prepared, set in type and mailed to shareholders,
the Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to dealers and investors. The Distributor also pays
for other supplementary sales literature and advertising costs. The Distribution
Agreement is subject to the same renewal requirements and termination provisions
as the Advisory Agreement described above.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act that covers the Trust, the Investment Adviser and the
Distributor (the "Code of Ethics"). The Code of Ethics significantly restricts
the personal investing activities of all employees of the Investment Adviser and
the Distributor and, as described below, imposes additional more onerous
restrictions on fund investment personnel.
The Code of Ethics requires that all employees of the Investment Adviser
and the Distributor pre-clear any personal securities investments (with limited
exceptions, such as mutual funds, high-quality short-term securities and direct
obligations of the U.S. government). The pre-clearance requirement and
associated procedures are designed to identify any substantive prohibition or
limitation applicable to the proposed investment. The substantive restrictions
applicable to all employees of the Investment Adviser and the Distributor
include a ban on acquiring any securities in a "hot" initial public offering. In
addition, investment personnel are prohibited from profiting on short-term
trading in securities. No employee may purchase or sell any security that at the
time is being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Investment Adviser. Furthermore, the Code of Ethics provides for trading
"blackout periods" which prohibit trading by investment personnel of the Fund
within seven calendar days, before or after, of trading by the Fund in the same
or equivalent security.
PURCHASE OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus for certain information as to the purchase of
Fund shares.
The Fund issues a single class (Class I) of shares. Each share of the Fund
represents an identical interest in the investment portfolio of the Fund, and
has the same rights.
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share plus any sales charge applicable to the
shares. The applicable offering price for purchase orders is based upon the net
asset value of the Fund next determined after receipt of the purchase order by
the Distributor. As to purchase orders received by selected securities dealers
or other financial intermediaries prior to the close of regular trading on the
New York Stock Exchange (the "NYSE") (generally 4:00 p.m., Eastern time) which
17
<PAGE> 426
includes orders received after the determination of net asset value on the
previous day, the applicable offering price will be based on the net asset value
on the day the order is placed with the Distributor, provided that the orders
are received by the Distributor prior to 30 minutes after the close of regular
trading on the NYSE on that day. If the purchase orders are not received prior
to 30 minutes after the close of regular trading on the NYSE on that day, such
orders shall be deemed received on the next business day. Selected securities
dealers or other financial intermediaries have the responsibility of submitting
purchase orders to the Fund not later than 30 minutes after the close of regular
trading on the NYSE in order to purchase shares at that day's offering price.
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares at any time in response to conditions in the securities markets or
otherwise and may thereafter resume such offering from time to time. Any order
may be rejected by the Fund or the Distributor. Neither the Distributor nor the
selected securities dealers or other financial intermediaries are permitted to
withhold placing orders to benefit themselves by a price change. Certain
selected securities dealers or other financial intermediaries may charge a
processing fee to confirm a sale of shares. For example, the fee currently
charged by Merrill Lynch is $5.35. Purchases made directly through the Transfer
Agent are not subject to the processing fee.
CLASS I SHARES
Class I shares will be subject to an initial sales charge, unless you
qualify for a reduction or waiver of the sales charge. See "Reduced Initial
Sales Charges."
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class I shares of the
Fund, refers to a single purchase by an individual or to concurrent purchases,
which in the aggregate are at least equal to the prescribed amounts, by an
individual, his or her spouse and their children under the age of 21 years
purchasing shares for his, her or their own account and to single purchases by a
trustee or other fiduciary purchasing shares for a single trust estate or single
fiduciary account although more than one beneficiary is involved. The term
"purchase" also includes purchases by any "company," as that term is defined in
the 1940 Act, but does not include purchases by any such company that has not
been in existence for at least six months or which has no purpose other than the
purchase of shares of the Fund or shares of other registered investment
companies at a discount; provided, however, that it shall not include purchases
by any group of individuals whose sole organizational nexus is that the
participants therein are credit cardholders of a company, policyholders of an
insurance company, customers of either a bank or broker-dealer or clients of an
investment adviser.
Class I shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class I shares. Investors
who owned Investor Class shares or who currently own Class I shares of the Fund
in a shareholder account are entitled to purchase additional Class I shares of
the Fund in that account. Certain employer-sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class I shares at net asset
value provided such plans meet the required minimum number of eligible employees
or required amount of assets advised by the Investment Adviser or any of its
affiliates. Also eligible to purchase Class I shares at net asset value are
participants in certain investment programs including certain managed accounts
for which a trust institution, thrift or bank trust department provides
discretionary trustee services, certain collective investment trusts for which a
trust institution, thrift, or bank trust department serves as trustee, certain
purchases made in connection with certain fee-based programs and certain
purchases made through certain financial advisers that meet and adhere to
standards established by the Investment Adviser. Class I shares are available at
net asset value to corporate warranty insurance reserve fund programs and U.S.
branches of foreign banking institutions, provided that the participant has $3
million or more initially invested in Affiliate-Advised investment companies. In
addition, Class I shares are offered at net asset value to ML & Co. and its
subsidiaries and their directors and employees, to members of the Boards of
investment companies advised by the Investment Adviser or its affiliates,
including the Fund, and to employees of certain selected securities dealers or
other financial intermediaries. Class I shares may also be offered at net asset
value to certain accounts over which the Investment Adviser or an affiliate
exercises investment discretion. Although some investors who previously
purchased Class I shares may no longer be eligible to purchase Class I shares of
other affiliate-advised funds, those previously purchased Class I shares,
18
<PAGE> 427
together with Class A, Class B and Class C share holdings of other Mercury
mutual funds, will count toward a right of accumulation which may qualify the
investor for a reduced initial sales charge on new initial sales charge
purchases.
The Distributor may reallow discounts to selected securities dealers or
other financial intermediaries and retain the balance over such discounts. At
times the Distributor may reallow the entire sales charge to such selected
securities dealers or other financial intermediaries. Since selected securities
dealers or other financial intermediaries selling Class I shares of the Fund
will receive a concession equal to most of the sales charge, they may be deemed
to be underwriters under the Securities Act.
REDUCED INITIAL SALES CHARGES
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
to obtain such investments.
Reinvested Dividends. No initial sales charges are imposed upon Class I
shares issued as a result of the automatic reinvestment of dividends.
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other Mercury mutual funds. For any such right of accumulation to be
made available, the Distributor must be provided at the time of purchase, by the
purchaser or the purchaser's selected securities dealer or other financial
intermediary, with sufficient information to permit confirmation of
qualification. Acceptance of the purchase order is subject to such confirmation.
The right of accumulation may be amended or terminated at any time. Shares held
in the name of a nominee or custodian under pension, profit-sharing, or other
employee benefit plans may not be combined with other shares to qualify for the
right of accumulation.
Letter of Intent. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class I shares of the Fund or any other Mercury
mutual funds made within a 13-month period starting with the first purchase
pursuant to the Letter of Intent. The Letter of Intent is available only to
investors whose accounts are established and maintained at the Fund's Transfer
Agent. The Letter of Intent is not available to employee benefit plans for which
affiliates of the Investment Adviser provide plan participant record-keeping
services. The Letter of Intent is not a binding obligation to purchase any
amount of Class I shares; however, its execution will result in the purchaser
paying a lower sales charge at the appropriate quantity purchase level. A
purchase not originally made pursuant to a Letter of Intent may be included
under a subsequent Letter of Intent executed within 90 days of such purchase if
the Distributor is informed in writing of this intent within such 90-day period.
The value of Class I shares of the Fund and of other Mercury mutual funds
presently held, at cost or maximum offering price (whichever is higher), on the
date of the first purchase under the Letter of Intent, may be included as a
credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied only to new
purchases. If the total amount of shares does not equal the amount stated in the
Letter of Intent (minimum of $25,000), the investor will be notified and must
pay, within 20 days of the execution of such Letter, the difference between the
sales charge on the Class I shares purchased at the reduced rate and the sales
charge applicable to the shares actually purchased through the Letter. Class I
shares equal to 5.0% of the intended amount will be held in escrow during the
13-month period (while remaining registered in the name of the purchaser) for
this purpose. The first purchase under the Letter of Intent must be at least
5.0% of the dollar amount of such Letter. If a purchase during the term of such
Letter would otherwise be subject to a further reduced sales charge based on the
right of accumulation, the purchaser will be entitled on that purchase and
subsequent purchases to that further reduced percentage sales charge but there
will be no retroactive reduction of the sales charges on any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intent will be deducted from
the total purchases made under such Letter. An
19
<PAGE> 428
exchange from the Summit Cash Reserves Fund ("Summit") into the Fund that
creates a sales charge will count toward completing a new or existing Letter of
Intent from the Fund.
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and certain
other arrangements may purchase Class I shares at net asset value, based on the
number of employees or number of employees eligible to participate in the plan
and/or the aggregate amount invested by the plan in specified investments.
Minimum purchase requirements may be waived or varied for such plans. For
additional information regarding purchases by employer-sponsored retirement or
savings plans and certain other arrangements, call your plan administrator or
your selected securities dealer or other financial intermediary.
Managed Trusts. Class I shares are offered at net asset value to certain
trusts to which trust institutions, thrifts, and bank trust departments provide
discretionary trustee services.
Purchase Privileges of Certain Persons. Trustees of the Trust and of other
investment companies advised by the Investment Adviser or its affiliates,
directors and employees of ML & Co. and its subsidiaries (the term
"subsidiaries," when used herein with respect to ML & Co., includes the
Investment Adviser, Merrill Lynch Investment Managers, L.P., Merrill Lynch
Investment Managers International Limited and certain other entities directly or
indirectly wholly owned and controlled by ML & Co.), employees of certain
selected securities dealers, and any trust, pension, profit-sharing or other
benefit plan for such persons, may purchase Class I shares of the Fund at net
asset value. The Fund realizes economies of scale and reduction of sales-
related expenses by virtue of the familiarity of these persons with the Fund.
Employees and Trustees wishing to purchase shares of the Fund must satisfy the
Fund's suitability standards.
Class I shares are also offered at net asset value to certain accounts over
which the Investment Adviser or an affiliate exercises investment discretion.
Purchases Through Certain Financial Intermediaries. Reduced sales charges
may be applicable for purchases of Class I shares of the Fund through certain
financial advisers, selected securities dealers and other financial
intermediaries that meet and adhere to standards established by the Investment
Adviser from time to time.
A waived sales charge on a purchase of Class I shares will apply to current
beneficial shareholders who were also beneficial shareholders of the Fund as of
the opening of business of the Fund on October , 2000.
REDEMPTION OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Except for any deferred sales charge that may be applicable, there
will be no charge for redemption if the redemption request is sent directly to
the Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists, as defined by the
Commission, as a result of which disposal of portfolio securities or
determination of the net asset value of the Fund is not reasonably practicable,
and for such other periods as the Commission may by order permit for the
protection of shareholders of the Fund.
The value of shares of the Fund at the time of redemption may be more or
less than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
The Trust has entered into a joint committed line of credit with other
investment companies advised by the Investment Adviser and its affiliates and a
syndicate of banks that is intended to provide the Fund with a
20
<PAGE> 429
temporary source of cash to be used to meet redemption requests from Fund
shareholders in extraordinary or emergency circumstances.
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so by tendering the shares directly to the Fund's Transfer Agent, Financial Data
Services, Inc., P.O. Box 41621, Jacksonville, Florida 32232-1621. Redemption
requests delivered other than by mail should be delivered to Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting redemption. Redemption
requests should not be sent to the Fund. The redemption request in either event
requires the signature(s) of all persons in whose name(s) the shares are
registered, signed exactly as such name(s) appear(s) on the Transfer Agent's
register. The signature(s) on the redemption request may require a guarantee by
an "eligible guarantor institution" as defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications. In the
event a signature guarantee is required, notarized signatures are not
sufficient. In general, signature guarantees are waived on redemptions of less
than $50,000 as long as the following requirements are met: (i) all requests
require the signature(s) of all persons in whose name(s) shares are recorded on
the Transfer Agent's register; (ii) all checks must be mailed to the stencil
address of record on the Transfer Agent's register and (iii) the stencil address
must not have changed within 30 days. Certain rules may apply regarding certain
account types such as but not limited to UGMA/UTMA accounts, Joint Tenancies
with Rights of Survivorship, contra broker transactions and institutional
accounts. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority.
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the Transfer
Agent at 1-800-236-4479. The request must be made by the shareholder of record
and be for an amount less than $50,000. Before telephone requests will be
honored, signature approval from all shareholders of record on the account must
be obtained. The shares being redeemed must have been held for at least 15 days.
Telephone redemption requests will not be honored in the following situations:
the accountholder is deceased, the proceeds are to be sent to someone other than
the shareholder of record, funds are to be wired to the client's bank account, a
systematic withdrawal plan is in effect, the request is by an individual other
than the accountholder of record, the account is held by joint tenants who are
divorced, the address has changed within the last 30 days or share certificates
have been issued on the account.
Since this account feature involves a risk of loss from unauthorized or
fraudulent transactions, the Transfer Agent will take certain precautions to
protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address registered
on the account and the social security number registered on the account. The
Fund or the Transfer Agent may temporarily suspend telephone transactions at any
time.
For shareholders redeeming directly with the Transfer Agent, payments will
be mailed within seven days of receipt of a proper notice of redemption. At
various times the Fund may be requested to redeem shares for which it has not
yet received good payment (e.g., cash, Federal funds or certified check drawn on
a U.S. bank). The Fund may delay or cause to be delayed the mailing of a
redemption check until such time as good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank) has been collected for the purchase of
such Fund shares, which usually will not exceed 10 days. In the event that a
shareholder account held directly with the Transfer Agent contains a fractional
share balance, such fractional share balance will be automatically redeemed by
the Fund.
REPURCHASE
The Fund also will repurchase its shares through a shareholder's listed
selected securities dealer or other financial intermediary. The Fund normally
will accept orders to repurchase shares by wire or telephone from
21
<PAGE> 430
dealers for their customers at the net asset value next computed after the order
is placed. Shares will be priced at the net asset value calculated on the day
the request is received, provided that the request for repurchase is submitted
to the selected securities dealer or other financial intermediary prior to the
close of regular trading on the NYSE (generally, regular trading on the NYSE
closes at 4:00 p.m., Eastern time) and such request is received by the Fund from
such selected securities dealer or other financial intermediary not later than
30 minutes after the close of regular trading on the NYSE on the same day.
Selected securities dealers and other financial intermediaries have the
responsibility of submitting such repurchase requests to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to obtain
that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any applicable
deferred sales charge). Securities firms that do not have agreements with the
Distributor, however, may impose a transaction charge on the shareholder for
transmitting the notice of repurchase to the Fund. Certain selected securities
dealers and other financial intermediaries may charge a processing fee to
confirm a repurchase of shares. For example, the fee currently charged by
Merrill Lynch is $5.35. Fees charged by other selected securities dealers may be
higher or lower. Repurchases made through the Transfer Agent, on accounts held
at the Transfer Agent, are not subject to the processing fee. The Fund reserves
the right to reject any order for repurchase, which right of rejection might
adversely affect shareholders seeking redemption through the repurchase
procedure. A shareholder whose order for repurchase is rejected by the Fund,
however, may redeem Fund shares as set forth above.
REINSTATEMENT PRIVILEGE -- CLASS I SHARES
Shareholders of the Fund who have redeemed their Class I shares have a
privilege to reinstate their accounts by purchasing Class I shares of the Fund
at the net asset value without a sales charge up to the dollar amount redeemed.
The reinstatement privilege may be exercised by sending a notice of exercise
along with a check for the amount to be reinstated to the Transfer Agent within
30 days after the date the request for redemption was accepted by the Transfer
Agent or the Distributor. Alternatively, the reinstatement privilege may be
exercised through the investor's financial consultant within 30 days after the
date the request for redemption was accepted by the Transfer Agent or the
Distributor. The reinstatement will be made at the net asset value per share
next determined after the notice of reinstatement is received and cannot exceed
the amount of the redemption proceeds.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "Account Choices -- How Shares are Priced" in the
Prospectus.
The net asset value of the shares of the Fund is determined once daily
Monday through Friday as of the close of regular trading on the NYSE on each day
the NYSE is open for trading based on prices at the time of closing. Regular
trading on the NYSE generally closes at 4:00 p.m., Eastern time. Any assets or
liabilities initially expressed in terms of non-U.S. dollar currencies are
translated into U.S. dollars at the prevailing market rates as quoted by one or
more banks or dealers on the day of valuation. The NYSE is not open for trading
on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Net asset value of the Fund is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Investment Adviser, are accrued daily.
Portfolio securities, including ADRs, EDRs or GDRs, that are traded on
stock exchanges are valued at the last sale price (regular way) on the exchange
on which such securities are traded, as of the close of regular trading on the
day the securities are being valued or, lacking any sales, at the last available
bid price for long
22
<PAGE> 431
positions, and at the last available ask price for short positions. In cases
where securities are traded on more than one exchange, the securities are valued
on the exchange designated by or under the authority of the Board of Trustees as
the primary market. Long positions in securities traded in the OTC market are
valued at the last available bid price in the OTC market prior to the time of
valuation. Short positions in securities traded in the OTC market are valued at
the last available ask price in the OTC market prior to the time of valuation.
Portfolio securities that are traded both in the OTC market and on a stock
exchange are valued according to the broadest and most representative market.
When the Fund writes an option, the amount of the premium received is recorded
on the books of the Fund as an asset and an equivalent liability. The amount of
the liability is subsequently valued to reflect the current market value of the
option written, based upon the last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last ask price.
Options purchased by the Fund are valued at their last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last bid price. Other investments, including financial futures contracts and
related options, are stated at market value. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Trustees.
Such valuations and procedures will be reviewed periodically by the Board of
Trustees.
Generally, trading in non-U.S. securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of regular trading on the NYSE. The values of
such securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of regular trading on the NYSE. Occasionally,
events affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of regular trading
on the NYSE that may not be reflected in the computation of the Fund's net asset
value.
Each investor in the Fund may add to or reduce its investment in the Fund
on each day the NYSE is open for trading. The value of each investor's interest
in the Fund will be determined as of the close of regular trading on the NYSE by
multiplying the net asset value of the Fund by the percentage, effective for
that day, that represents that investor's share of the aggregate interests in
the Fund. The close of regular trading on the NYSE is generally 4:00 p.m.,
Eastern time. Any additions or withdrawals to be effected on that day will then
be effected. The investor's percentage of the aggregate beneficial interests in
the Fund will then be recomputed as the percentage equal to the fraction (i) the
numerator of which is the value of such investor's investment in the Fund as of
the time of determination on such day plus or minus, as the case may be, the
amount of any additions to or withdrawals from the investor's investment in the
Fund effected on such day, and (ii) the denominator of which is the aggregate
net asset value of the Fund as of such time on such day plus or minus, as the
case may be, the amount of the net additions to or withdrawals from the
aggregate investments in the Fund by all investors in the Fund. The percentage
so determined will then be applied to determine the value of the investor's
interest in the Fund after the close of regular trading on the NYSE on the next
determination of net asset value of the Fund.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for shares of the
Fund based on the net asset value of the Fund's shares on June 30, 2000 is as
follows:
<TABLE>
<CAPTION>
CLASS I
-------
<S> <C>
Net Assets.................................................. $
-------
Number of Shares Outstanding................................
-------
Net Asset Value Per Share (net assets divided by number of
shares outstanding)....................................... $
-------
Sales Charge (for Class I Shares; 5.25% of Offering Price;
( % of net amount invested))*.........................
-------
Offering Price.............................................. $
-------
</TABLE>
---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable. No sales charges were imposed as of June 30, 2000.
23
<PAGE> 432
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Subject to policies established by the Board of Trustees, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Fund, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and operational facilities of the firm and the
firm's risk in positioning a block of securities. While the Investment Adviser
generally seeks reasonably competitive commission rates, the Fund does not
necessarily pay the lowest spread or commission available. In addition,
consistent with the Conduct Rules of the NASD and policies established by the
Board of Trustees, the Investment Adviser may consider sales of Fund shares as a
factor in the selection of brokers or dealers to execute portfolio transactions
for the Fund; however, whether or not a particular broker or dealer sells shares
of the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Fund.
Subject to obtaining the best net results, brokers who provide supplemental
investment research to the Investment Adviser may receive orders for
transactions by the Fund. Such supplemental research services ordinarily consist
of assessments and analyses of the business or prospects of a company, industry
or economic sector. Information so received will be in addition to and not in
lieu of the services required to be performed by the Investment Adviser under
the Investment Advisory Agreement and the expenses of the Investment Adviser
will not necessarily be reduced as a result of the receipt of such supplemental
information. If in the judgment of the Investment Adviser the Fund will benefit
from supplemental research services, the Investment Adviser is authorized to pay
brokerage commissions to a broker furnishing such services that are in excess of
commissions that another broker may have charged for effecting the same
transactions. Certain supplemental research services may primarily benefit one
or more other investment companies or other accounts for which the Investment
Adviser exercises investment discretion. Conversely, the Fund may be the primary
beneficiary of the supplemental research services received as a result of
portfolio transactions effected for such other accounts or investment companies.
The Fund anticipates that its brokerage transactions involving securities
of issuers domiciled in countries other than the United States generally will be
conducted primarily on the principal stock exchanges of such countries.
Brokerage commissions and other transaction costs on foreign stock exchange
transactions generally are higher than in the United States, although the Fund
will endeavor to achieve the best net results in effecting its portfolio
transactions. There generally is less governmental supervision and regulation of
foreign stock exchanges and brokers than in the United States.
Foreign equity securities may be held by the Fund in the form of ADRs,
EDRs, GDRs or other securities convertible into foreign equity securities. ADRs,
EDRs and GDRs may be listed on stock exchanges, or traded in over-the-counter
markets in the United States or Europe, as the case may be. ADRs, like other
securities traded in the United States, will be subject to negotiated commission
rates. The Fund's ability and decisions to purchase or sell portfolio securities
of foreign issuers may be affected by laws or regulations relating to the
convertibility and repatriation of assets. Because the shares of the Fund are
redeemable on a daily basis in U.S. dollars, the Fund intends to manage the
portfolio so as to give reasonable assurance that it will be able to obtain U.S.
dollars to the extent necessary to meet anticipated redemptions. Under present
conditions, it is not believed that these considerations will have significant
effect on the Fund's portfolio strategies.
The Fund may invest in certain securities traded in the OTC market and
intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Fund and
persons who are affiliated with such affiliated persons are prohibited from
dealing with the Fund as principal in the purchase and sale of securities unless
a permissive order allowing such transactions is obtained from the Commission.
Since transactions in the OTC market usually involve transactions with the
dealers acting as principal for their
24
<PAGE> 433
own accounts, the Fund will not deal with affiliated persons, including Merrill
Lynch and its affiliates, in connection with such transactions. However, an
affiliated person of the Fund may serve as its broker in OTC transactions
conducted on an agency basis provided that, among other things, the fee or
commission received by such affiliated broker is reasonable and fair compared to
the fee or commission received by non-affiliated brokers in connection with
comparable transactions. In addition, the Fund may not purchase securities
during the existence of any underwriting syndicate for such securities of which
Merrill Lynch or an affiliate is a member or in a private placement in which
Merrill Lynch or an affiliate serves as placement agent except pursuant to
procedures approved by the Board of Trustees that either comply with rules
adopted by the Commission or with interpretations of the Commission staff. See
"Investment Objective and Policies -- Investment Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch or its affiliates acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund. Securities may be held by, or be appropriate
investments for, the Fund as well as other funds or investment advisory clients
of the Investment Adviser or its affiliates.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or its affiliates
when one or more clients of the Investment Adviser or its affiliates are selling
the same security. If purchases or sales of securities arise for consideration
at or about the same time that would involve the Fund or other clients or funds
for which the Investment Adviser or an affiliate acts as investment adviser,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Investment Adviser or
its affiliates during the same period may increase the demand for securities
being purchased or the supply of securities being sold, there may be an adverse
effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below that are
designed to facilitate investment in its shares. Full details as to each such
service and copies of the various plans or how to change options with respect
thereto, can be obtained from the Fund by calling the telephone number on the
cover page hereof, or from the Distributor or your selected securities dealer or
other financial intermediary. Certain of these services are available only to
U.S. investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of dividends. The statements
also will show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
dividends. A shareholder with an account held at the Transfer Agent may make
additions to his or her Investment Account at any time by mailing a check
directly to the Transfer Agent. The Fund does not issue share certificates.
Shareholders considering transferring their Class I shares from a selected
securities dealer or other financial intermediary to another brokerage firm or
financial institution should be aware that, if the firm to which the Class I
shares are to be transferred will not take delivery of shares of the Fund, a
shareholder either
25
<PAGE> 434
must redeem the shares so that the cash proceeds can be transferred to the
account at the new firm or such shareholder must continue to maintain an
Investment Account at the Transfer Agent for those shares.
Certain shareholder services may not be available for the transferred
shares. After the transfer, the shareholder may purchase additional shares of
funds owned before the transfer, and all future trading of these assets must be
coordinated by the new firm.
Shareholders considering transferring a tax-deferred retirement account,
such as an individual retirement account, from a selected securities dealer or
other financial intermediary to another brokerage firm or financial institution
should be aware that, if the firm to which the retirement account is to be
transferred will not take delivery of shares of the Fund, a shareholder must
either redeem the shares so that the cash proceeds can be transferred to the
account at the new firm, or such shareholder must continue to maintain a
retirement account at a selected securities dealer or other financial
intermediary for those shares.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other Mercury mutual funds and Summit, a series of Financial
Institutions Series Trust, which is a Merrill Lynch-sponsored money market fund
specifically designated as available for exchange by holders of Class I shares.
Shares with a net asset value of at least $100 are required to qualify for the
exchange privilege and any shares used in an exchange must have been held by the
shareholder for at least 15 days. Before effecting an exchange, shareholders
should obtain a currently effective prospectus of the fund into which the
exchange is to be made. Exercise of the exchange privilege is treated as a sale
of the exchanged shares and a purchase of the acquired shares for Federal income
tax purposes.
Exchanges of Class I Shares. Under the Fund's pricing system, Class I
shareholders may exchange Class I shares of the Fund for Class I shares of a
second Mercury mutual fund. If the Class I shareholder wants to exchange Class I
shares for shares of a second Mercury mutual fund, but does not hold Class I
shares of the second fund in his or her account at the time of exchange and is
not otherwise eligible to acquire Class I shares of the second fund, the
shareholder will receive Class A shares of the second fund as a result of the
exchange.
Exchanges of Class I shares outstanding ("outstanding Class I shares") for
Class I or Class A shares of another Mercury mutual fund, or for Class A shares
of Summit ("new Class I or Class A shares") are transacted on the basis of
relative net asset value per Class I or Class A share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously paid
on the outstanding Class I shares and the sales charge payable at the time of
the exchange on the new Class I or Class A shares. With respect to outstanding
Class I shares as to which previous exchanges have taken place, the "sales
charge previously paid" shall include the aggregate of the sales charges paid
with respect to such Class I shares in the initial purchase and any subsequent
exchange. Class I shares issued pursuant to dividend reinvestment are sold on a
no-load basis. For purposes of the exchange privilege, Class I shares acquired
through dividend reinvestment shall be deemed to have been sold with a sales
charge equal to the sales charge previously paid on the Class I shares on which
the dividend was paid. Based on this formula, Class I shares of the Fund
generally may be exchanged into the Class I and Class A shares, respectively, of
the other funds with a reduced or without a sales charge.
Exchanges for Shares of a Money Market Fund. Class I shares are
exchangeable for Class A shares of Summit. Class A shares of Summit have an
exchange privilege back into Class I or Class A shares of Affiliate-Advised
Funds. This exchange privilege does not apply with respect to certain fee-based
programs for which alternative exchange arrangements may exist. Please see your
financial consultant for further information.
Prior to October 12, 1998, exchanges from other affiliate-advised Funds
into a money market fund were directed to certain affiliate-advised money market
funds other than Summit. Shareholders who exchanged affiliate-advised Fund
shares for such other money market funds and subsequently wish to exchange those
money market fund shares for shares of the Fund will be subject to the CDSC
schedule applicable to such Fund shares, if any. The holding period for those
money market fund shares will not count toward satisfaction
26
<PAGE> 435
of the holding period requirement for reduction of the CDSC imposed on such
shares, if any, and, with respect to Class B shares, toward satisfaction of the
Conversion Period. However, the holding period for Class B or Class C shares of
the Fund received in exchange for such money market fund shares will be
aggregated with the holding period for the fund shares originally exchanged for
such money market fund shares for purposes of reducing the CDSC or satisfying
the Conversion Period.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her financial consultant, who will advise the
relevant Fund of the exchange. Shareholders of the Fund and shareholders of the
other funds described above with shares for which certificates have not been
issued may exercise the exchange privilege by wire through their selected
securities dealers or other financial intermediaries. The Fund reserves the
right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated in accordance with the rules of the
Commission. The Fund reserves the right to limit the number of times an investor
may exercise the exchange privilege. Certain funds may suspend the continuous
offering of their shares to the general public at any time and may thereafter
resume such offering from time to time. The exchange privilege is available only
to U.S. shareholders in states where the exchange legally may be made. It is
contemplated that the exchange privilege may be applicable to other new mutual
funds whose shares may be distributed by the Distributor.
FEE-BASED PROGRAMS
Certain fee-based programs, including pricing alternatives for securities
transactions (each referred to in this paragraph as a "Program"), may permit the
purchase of Class I shares at net asset value. Under specified circumstances,
participants in certain Programs may deposit other classes of shares, which will
be exchanged for Class I shares. Initial or deferred sales charges otherwise due
in connection with such exchanges may be waived or modified. Termination of
participation in certain Programs may result in the redemption of shares held
therein. [In addition, upon termination of participation in a Program, shares
that have been held for less than specified periods within such Program may be
subject to a fee based on the current value of such shares.] These Programs also
generally prohibit such shares from being transferred to another account, to
another broker-dealer or to the Transfer Agent. Additional information regarding
certain specific Programs offered through particular selected securities dealers
or other financial intermediaries (including charges and limitations on
transferability applicable to shares that may be held in such Programs) is
available in each such Program's client agreement and from the Transfer Agent at
1-800-236-4479.
RETIREMENT PLANS
The minimum initial purchase to establish a retirement plan is $100.
Dividends received in retirement plans are exempt from Federal taxation until
distributed from the plans. Different tax rules apply to Roth IRA plans and
educational savings plans. Investors considering participation in any retirement
or education savings plan should review specific tax laws relating thereto and
should consult their attorneys or tax advisers with respect to the establishment
and maintenance of any such plan.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class I shares at the applicable public offering price. These
purchases may be made either through the shareholder's securities dealer or by
mail directly to the Transfer Agent, acting as agent for such securities dealer.
You may also add to your account by automatically investing a specific amount in
the Fund on a periodic basis through your selected securities dealer or other
financial intermediary. The current minimum for such automatic additional
investments is $100. This minimum may be waived or revised under certain
circumstances.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Shareholders may, at any time, by written notification to their selected
securities dealer or other financial intermediary if their account is maintained
with a selected securities dealer or other financial intermediary, or by written
notification or by telephone (1-800-236-4479) to the Transfer Agent, if their
account is maintained with the Transfer Agent, elect to have subsequent
dividends of ordinary income and/or capital gains paid with
27
<PAGE> 436
respect to shares of the Fund in cash, rather than reinvested in shares of the
Fund (provided that, in the event that a payment on an account maintained at the
Transfer Agent would amount to $10.00 or less, a shareholder will not receive
such payment in cash and such payment will automatically be reinvested in
additional shares). Commencing ten days after the receipt by the Transfer Agent
of such notice, those instructions will be effected. The Fund is not responsible
for any failure of delivery to the shareholder's address of record and no
interest will accrue on amounts represented by uncashed dividend checks. Cash
payments can also be directly deposited to the shareholder's bank account.
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals are available for shareholders with
shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed from
those on deposit in the shareholder's account to provide the withdrawal payment
specified by the shareholder. The shareholder may specify the dollar amount to
be redeemed. Redemptions will be made at net asset value as of the close of
regular trading on the NYSE (generally, the NYSE closes at 4:00 p.m., Eastern
time) on the 24th day of each month or the 24th day of the last month of each
quarter, whichever is applicable. If the NYSE is not open for business on such
date, the shares will be redeemed at the net asset value determined after the
close of regular trading on the NYSE on the following business day. The check
for the withdrawal payment will be mailed, or the direct deposit for withdrawal
payment will be made, on the next business day following redemption. When a
shareholder is making systematic withdrawals, dividends on all shares in the
Investment Account are reinvested automatically in Fund shares. A shareholder's
systematic withdrawal plan may be terminated at any time, without a charge or
penalty, by the shareholder, the Fund, the Transfer Agent or the Distributor.
If an investor wishes to change the amount being withdrawn in a systematic
withdrawal plan the investor should contact his or her financial consultant.
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax liabilities.
The Fund will not knowingly accept purchase orders for shares of the Fund from
investors who maintain a systematic withdrawal plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
DIVIDENDS AND TAX STATUS
The Fund has qualified as a regulated investment company. Qualification as
a regulated investment company requires, among other things, that (1) at least
90% of the Fund's annual gross income, without offset for losses from the sale
or other disposition of securities, be derived from payments with respect to
securities loans, interest, dividends and gains from the sale or other
disposition of stock, securities, or foreign currencies or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities, or currencies; and (2) the Fund diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of the Fund's assets is represented by cash, U.S. government securities,
securities of other regulated investment companies, and other securities limited
in respect of any one issuer to an amount not greater than 5% of the Fund's
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. government securities or the securities of other
regulated investment companies). In addition, in order not to be subject to
federal taxation,
28
<PAGE> 437
the Fund must distribute to its shareholders at least 90% of its investment
company taxable income earned in each year.
The Fund is required to pay an excise tax to the extent it does not
distribute to its shareholders during any calendar year at least 98% of its
ordinary income for that calendar year, 98% of the excess of its capital gains
over its capital losses for the one-year period ending October 31 in such
calendar year, and all undistributed ordinary income and capital gains for the
preceding respective one-year period. The Fund intends to meet these
distribution requirements to avoid excise tax liability. The Fund also intends
to continue distributing to shareholders all of the excess of net long-term
capital gain over net short-term capital loss on sales of securities. If the net
asset value of shares of the Fund should, by reason of a distribution of
realized capital gains, be reduced below a shareholder's cost, such distribution
would to that extent be a return of capital to that shareholder even though
taxable to the shareholder, and a sale of shares by a shareholder at net asset
value at that time would establish a capital loss for federal tax purposes.
In determining the extent to which the Fund's dividends may be eligible for
the 70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisors regarding other requirements applicable to the dividends received
deduction.
Special rules apply to the treatment of certain forward foreign currency
exchange contracts (Section 1256 contracts). At the end of each year, such
investments held by the Fund must be "marked to market" for federal income tax
purposes; that is, treated as having been sold at market value. Except to the
extent that such gains or losses are treated as "Section 988" gains or losses,
as described below, sixty percent of any gain or loss recognized on these
"deemed sales" and on actual dispositions may be treated as long-term capital
gain or loss, and the remainder will be treated as short-term capital gain or
loss.
Under the Internal Revenue Code, gains or losses attributable to
fluctuations in exchange rates which occur between the time the Fund accrues
interest or other receivables or accrues expenses or other liabilities
denominated in a foreign currency and the time the Fund actually collects such
receivables or pays such liabilities are treated as ordinary income or loss.
Similarly, gains or losses on forward foreign currency exchange contracts or
dispositions of debt securities denominated in a foreign currency attributable
to fluctuations in the value of the foreign currency between the date of
acquisition of the security and the date of disposition are also treated as
ordinary gain or loss. These gains, referred to as "Section 988" gains or
losses, increase or decrease the amount of the Fund's investment company taxable
income available to be distributed to its shareholders as ordinary income,
rather than increasing or decreasing the Fund's net capital gain. If Section 988
losses exceed other investment company taxable income during a taxable year, the
Fund would not be able to make any ordinary dividend distributions, and any
ordinary dividend distributions made before the losses were realized would be
recharacterized as a return of capital to shareholders, rather than as an
ordinary dividend, reducing the basis of each shareholder's shares.
Any loss realized on a sale, redemption or exchange of shares of the Fund
by a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by the Fund constitute a
replacement of shares.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined in accordance with a formula specified
by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the
29
<PAGE> 438
redeemable value of such investment at the end of each period. Average annual
total return is computed assuming all dividends and distributions are reinvested
and taking into account all applicable recurring and nonrecurring expenses,
including the maximum sales charge.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time. The Fund's total return may be
expressed either as a percentage or as a dollar amount in order to illustrate
such total return on a hypothetical $1,000 investment in the Fund at the
beginning of each specified period.
Average annual total returns for the periods ended June 30, 2000 are as
follows:
<TABLE>
<CAPTION>
ONE SINCE
YEAR INCEPTION
----- ---------
<S> <C> <C> <C>
Class I........................................ -1.37% 6.75% (Since 1/2/97)
</TABLE>
In order to reflect the reduced sales charges applicable to certain
investors, as described under "Purchase of Shares" and "Redemption of Shares,"
respectively, the total return data quoted by the Fund in advertisements
directed to such investors may take into account the reduced, and not the
maximum, sales charge and therefore may reflect greater total return since, due
to the reduced sales charges or the waiver of sales charges, a lower amount of
expenses is deducted.
In advertising and sales literature, the Fund may compare its performance
to that of various broad market indexes, including without limitation the Morgan
Stanley Capital International World Index, Standard & Poor's 500 Composite Stock
Price Index and other published indexes. When comparing its performance to a
market index, the Fund may refer to various statistical measures derived from
the historic performance of the Fund and the index, such as standard deviation
and beta. In addition, the Fund may refer in advertising or sales literature to
(i) mutual fund performance ratings, rankings and comparisons (including
risk-adjusted ratings, rankings and comparisons), (ii) other comparisons of
mutual fund data including assets, expenses, fees and other data, and (iii)
other discussions reported in or assigned by Barron's, Business Week, CDA
Investment Technology, Inc., Financial World, Forbes Magazine, Fortune Magazine,
Lipper Inc., Money Magazine, U.S. News & World Report, The Wall Street Journal
and other industry publications. The Fund may also make reference to awards that
may be given to the Investment Adviser. As with other performance data,
performance comparisons should not be considered indicative of the Fund's
relative performance for any future period.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest and to divide or combine
the shares into a greater or lesser number of shares without thereby changing
the proportionate beneficial interest in the Fund. Each share represents an
interest in a Fund proportionately equal to the interest of each other share.
Upon the Trust's liquidation, all shareholders would share pro rata in the net
assets of the Fund in question available for distribution to shareholders. If
they deem it advisable and in the best interest of shareholders, the Board of
Trustees may create additional classes of shares. The Board of Trustees has
created ten series of shares, and may create additional series in the future,
which have separate assets and liabilities.
30
<PAGE> 439
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a
Fund's shares may advise the Trustees in writing that they wish to communicate
with other shareholders for the purpose of requesting a meeting to remove a
Trustee. The Trustees will then, if requested by the applicants, mail at the
applicants' expense the applicants' communication to all other shareholders.
The Trust or the Fund may be terminated if approved by the vote of a
majority of the Trustees or by the approval of the holders of a majority of the
Trust's outstanding shares, as defined in the 1940 Act. If not so terminated,
the Trust will continue indefinitely.
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Trust or its Trustees. The Declaration of Trust provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for its obligations. While Massachusetts
law permits a shareholder of a trust such as this to be held personally liable
as a partner under certain circumstances, the risk of a shareholder incurring
financial loss on account of shareholder liability is highly unlikely and is
limited to the relatively remote circumstances in which the Trust would be
unable to meet its obligations.
Common expenses incurred by the Trust are allocated among the portfolios
based upon: (1) relative net assets; (2) as incurred on a specific
identification basis; or (3) evenly among the portfolios, depending on the
nature of the expenditure.
Except for (1) changes which do not adversely affect the rights of Trust
shareholders; (2) a change in the name of the Trust, or a series or class
thereof; (3) authorization of a new series or class; (4) changes to supply any
omission or correct any ambiguous or defective provision; or (5) changes
required by any federal, state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust without the affirmative vote of the holders of at least 67%
of the Trust's outstanding shares at a meeting at which more than 50% of its
outstanding shares are present in person or represented by proxy. The holders of
shares have no preemptive or conversion rights. Shares when issued are fully
paid and non-assessable, except as set forth above.
ISSUANCE OF FUND SHARES FOR SECURITIES
Investors may purchase Fund shares for consideration consisting of
securities rather than cash when, in the judgment of the Investment Adviser, the
securities: (a) meet the investment objective and policies of the Fund, (b) are
liquid and not subject to restrictions on resale, and (c) have a value that is
readily ascertainable via listing on or trading in a recognized United States or
international exchange or market.
31
<PAGE> 440
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment wholly
in cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of the Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund during
any 90 day period for any one shareholder. Should redemptions by any shareholder
exceed such limitation the Fund will have the option of redeeming the excess in
cash or in kind. If shares are redeemed in kind, the redeeming shareholder would
incur brokerage costs in converting the assets into cash.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202, has been selected as the independent auditors of the Fund. The
independent auditors are responsible for auditing the annual financial
statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109-3661, acts as custodian of the Fund's assets (the "Custodian"). Under its
contract with the Trust, the Custodian is authorized to establish separate
accounts in foreign currencies and to cause foreign securities owned by the
Trust to be held in its offices outside the United States and with certain
foreign banks and securities depositories. The Custodian is responsible for
safeguarding and controlling the Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and dividends on the
Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly-owned subsidiary of ML & Co., acts as the
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement. The Transfer Agent is responsible
for the issuance, transfer and redemption of shares and the opening, maintenance
and servicing of shareholder accounts.
LEGAL COUNSEL
Gardner, Carton & Douglas, 321 North Clark Street, Chicago, Illinois 60610,
is counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio and
other information. An annual report containing financial statements audited by
independent auditors is sent to shareholders each year. After the end of each
year, shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
32
<PAGE> 441
PRINCIPAL HOLDERS
[to come]
33
<PAGE> 442
STATEMENT OF ADDITIONAL INFORMATION
MERCURY HW BALANCED FUND
OF MERCURY HW FUNDS
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017 - Phone No.
(800) 236-4479
------------------------
Mercury HW Balanced Fund (the "Fund") is a fund of Mercury HW Funds (the
"Trust"). The Trust is a diversified open-end management investment company
which is organized as a Massachusetts business trust. The investment objective
of the Fund is to seek to preserve capital while producing a high total return.
The Fund seeks to achieve its investment objective by investing primarily in
stocks of U.S. companies and investment grade bonds. No assurance can be given
that the investment objective of the Fund will be realized. For more information
on the Fund's investment objective and policies, see "Investment Objective and
Policies."
The Fund offers two classes of shares, each with a different combination of
sales charges, ongoing fees and other features. Only certain investors are
eligible to buy Class I shares. See "Purchase of Shares."
------------------------
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the prospectus of the Fund, dated October , 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Fund at
1-800-236-4479 or your financial consultant or other financial intermediary or
by writing to the Fund at Financial Data Services, Inc., P.O. Box 41621,
Jacksonville, Florida 32232-1621. The Prospectus is incorporated by reference
into this Statement of Additional Information, and this Statement of Additional
Information is incorporated by reference into the Prospectus. The Fund's
financial statements are incorporated by reference to its annual report for the
fiscal year ended June 30, 2000. You may request copies of the annual report at
no charge by calling 1-800-236-4479 between 8:00 a.m. and 8:00 p.m. on any
business day.
------------------------
MERCURY ADVISORS -- INVESTMENT ADVISER
FAM DISTRIBUTORS, INC. -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is October , 2000
<PAGE> 443
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Trust History............................................... 3
Investment Objective and Policies........................... 3
Investment Restrictions................................... 3
Repurchase Agreements..................................... 4
Bonds..................................................... 4
U.S. Government Securities................................ 4
Municipal Obligations..................................... 5
Corporate Debt Securities................................. 6
Convertible Securities.................................... 6
Mortgage-Related Securities............................... 7
Asset-Backed Securities................................... 10
Risk Factors Relating to Investing in Mortgage-Related and
Asset-Backed Securities................................. 10
Duration.................................................. 11
Derivative Instruments.................................... 11
Foreign Securities........................................ 12
Foreign Investment Risks.................................. 13
Swap Agreements........................................... 14
Risk Factors Relating to Investing in High Yield
Securities.............................................. 14
Illiquid Securities....................................... 15
Reverse Repurchase Agreements............................. 16
Dollar Rolls.............................................. 16
Borrowing................................................. 16
When-Issued Securities.................................... 16
Real Estate Investment Trusts............................. 16
Shares of Other Investment Companies...................... 17
Limited Partnerships...................................... 17
Short Sales Against-the-Box............................... 17
Corporate Loans........................................... 17
Temporary Defensive Position.............................. 17
Management of the Fund...................................... 17
Advisory Arrangements..................................... 19
Accounting and Administrative Sources..................... 20
Code of Ethics............................................ 21
Purchase of Shares.......................................... 21
Class I and Class A Shares................................ 22
Reduced Initial Sales Charges............................. 23
Distribution Plan......................................... 24
Redemption of Shares........................................ 25
Redemption................................................ 25
Repurchase................................................ 26
Reinstatement Privilege -- Class I and Class A Shares..... 27
Pricing of Shares........................................... 27
Determination of Net Asset Value.......................... 27
Computation of Offering Price Per Share................... 28
Portfolio Transactions and Brokerage........................ 29
Transactions in Portfolio Securities...................... 29
Shareholder Services........................................ 30
Investment Account........................................ 30
Exchange Privilege........................................ 31
Fee-Based Programs........................................ 32
Retirement Plans.......................................... 32
Automatic Investment Plans................................ 32
Automatic Dividend Reinvestment Plan...................... 33
Systematic Withdrawal Plans............................... 33
Dividends and Tax Status.................................... 33
Performance Data............................................ 34
General Information......................................... 35
Description of Shares..................................... 35
Issuance of Fund Shares for Securities.................... 36
Redemption in Kind........................................ 37
Independent Auditors...................................... 37
Custodian................................................. 37
Transfer Agent............................................ 37
Legal Counsel............................................. 37
Reports to Shareholders................................... 37
Shareholder Inquiries..................................... 37
Additional Information.................................... 38
Principal Holders......................................... 38
Appendix--Description of Ratings............................ A-1
</TABLE>
2
<PAGE> 444
TRUST HISTORY
The Trust was organized on August 22, 1984 as a Massachusetts business
trust. Before October 7, 1994, the Trust was called "Olympic Trust," and before
October , 2000, the Trust was called "Hotchkis and Wiley Funds." The Trust is
a diversified, open-end, management investment company currently consisting of
ten separate funds. Prior to October , 2000, the Fund was called the Balanced
Fund.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to preserve capital while producing
a high total return. Reference is made to the discussion under "How the Fund
Invests" and "Investment Risks" in the Prospectus for information with respect
to the Fund's investment objective and policies.
Mercury Advisors (the "Investment Adviser"), the Fund's investment adviser,
is responsible for the management of the Fund's portfolio.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of the Fund's outstanding
voting securities, as defined in the Investment Company Act of 1940, as amended
(the "1940 Act"). Under the 1940 Act, the vote of the holders of a "majority" of
the Fund's outstanding voting securities means the vote of the holders of the
lesser of (1) 67% of the shares of the Fund represented at a meeting at which
the holders of more than 50% of its outstanding shares are represented or (2)
more than 50% of the outstanding shares.
Except as noted, the Fund may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Fund's total assets (determined at the time of investment) would
then be invested in securities of a single issuer; or (ii) more than
25% of the Fund's total assets (determined at the time of investment)
would be invested in one or more issuers having their principal
business activities in a single industry.
2. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions),
provided that the deposit or payment by the Fund of initial or
maintenance margin in connection with futures or options is not
considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short (short sale
against-the-box), and unless not more than 25% of the Fund's net assets
(taken at current value) is held as collateral for such sales at any
one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Fund may borrow from a bank for temporary or emergency purposes in
amounts not exceeding 10% (taken at the lower of cost or current value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings; the Fund will not purchase any
additional portfolio securities while such borrowings are outstanding.
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would
then hold more than 10% of the outstanding voting securities of an
issuer.
6. Buy or sell commodities or commodity contracts or real estate or
interests in real estate, although it may purchase and sell securities
which are secured by real estate and securities of companies which
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invest or deal in real estate. (For the purposes of this restriction,
forward foreign currency exchange contracts are not deemed to be
commodities or commodity contracts.)
7. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws.
8. Make investments for the purpose of exercising control or management.
9. Participate on a joint or joint and several basis in any trading
account in securities.
10. Make loans, except through repurchase agreements.
11. Purchase or sell foreign currencies.
Any percentage limitation on the Fund's investments is determined when the
investment is made, unless otherwise noted.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement where the seller agrees to
repurchase a security from the Fund at a mutually agreed-upon time and price.
The period of maturity is usually quite short, possibly overnight or a few days,
although it may extend over a number of months. The resale price is more than
the purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Fund's money is invested in the repurchase agreement. The
Fund's repurchase agreements will at all times be fully collateralized in an
amount at least equal to the resale price. The instruments held as collateral
are valued daily, and if the value of instruments declines, the Fund will
require additional collateral. In the event of a default, insolvency or
bankruptcy by a seller, the Fund will promptly seek to liquidate the collateral.
In such circumstances, the Fund could experience a delay or be prevented from
disposing of the collateral. To the extent that the proceeds from any sale of
such collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
BONDS
The term "bond" or "bonds" as used in the Prospectus is intended to include
all manner of fixed-income securities, debt securities, asset-backed and
mortgage-backed securities and other debt obligations unless specifically
defined or the context requires otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. The Fund will
invest in securities of such instrumentality only when the Investment Adviser is
satisfied that the credit risk with respect to any instrumentality is
acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely, either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (1) Treasury obligations from which the interest coupons
have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member
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bank representing ownership of Treasury obligation components; or (4) receipts
evidencing the component parts (corpus or coupons) of Treasury obligations that
have not actually been stripped. Such receipts evidence ownership of component
parts of Treasury obligations (corpus or coupons) purchased by a third party
(typically an investment banking firm) and held on behalf of the third party in
physical or book-entry form by a major commercial bank or trust company pursuant
to a custody agreement with the third party. These custodial receipts are known
by various names, including "Treasury Receipts," "Treasury Investment Growth
Receipts" ("TIGRs") and "Certificates of Accrual on Treasury Securities"
("CATS"), and are not issued by the U.S. Treasury; therefore they are not U.S.
Government securities, although the underlying bonds represented by these
receipts are debt obligations of the U.S. Treasury.
MUNICIPAL OBLIGATIONS
The Fund may invest in municipal obligations. The two principal
classifications of municipal bonds, notes and commercial paper are "general
obligation" and "revenue" bonds, notes or commercial paper. General obligation
bonds, notes or commercial paper are secured by the issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest.
Issuers of general obligation bonds, notes or commercial paper include states,
counties, cities, towns and other governmental units. Revenue bonds, notes and
commercial paper are payable from the revenues derived from a particular
facility or class of facilities or, in some cases, from specific revenue
sources. Revenue bonds, notes or commercial paper are issued for a wide variety
of purposes, including the financing of electric, gas, water and sewer systems
and other public utilities; industrial development and pollution control
facilities; single and multifamily housing units; public buildings and
facilities; air and marine ports; transportation facilities such as toll roads,
bridges and tunnels; and health and educational facilities such as hospitals and
dormitories. They rely primarily on user fees to pay debt service, although the
principal revenue source is often supplemented by additional security features
which are intended to enhance the creditworthiness of the issuer's obligations.
In some cases, particularly revenue bonds issued to finance housing and public
buildings, a direct or implied "moral obligation" of a governmental unit may be
pledged to the payment of debt service. In other cases, a special tax or other
charge may augment user fees.
Included within the revenue bonds category are participations in municipal
lease obligations or installment purchase contracts of municipalities
(collectively, "lease obligations"). State and local governments issue lease
obligations to acquire equipment leases and facilities. Lease obligations may
have risks not normally associated with general obligation or other revenue
bonds. Leases and installment purchase or conditional sale contracts (which may
provide for title to the leased asset to pass eventually to the issuer) have
developed as a means for governmental issuers to acquire property and equipment
without the necessity of complying with the constitutional and statutory
requirements generally applicable for the issuance of debt. Certain lease
obligations contain "non-appropriation" clauses that provide that the
governmental issuer has no obligation to make future payments under the lease or
contract unless money is appropriated for such purpose by the appropriate
legislative body on an annual or other periodic basis. Consequently, continued
lease payments on those lease obligations containing "non-appropriation" clauses
are dependent on future legislative actions. If such legislative actions do not
occur, the holders of the lease obligations may experience difficulty in
exercising their rights, including disposition of the property.
Private activity obligations are issued to finance, among other things,
privately operated housing facilities, pollution control facilities, convention
or trade show facilities, mass transit, airport, port or parking facilities and
certain facilities for water supply, gas, electricity, sewage or solid waste
disposal. Private activity obligations are also issued to privately held or
publicly owned corporations in the financing of commercial or industrial
facilities. The principal and interest on these obligations may be payable from
the general revenues of the users of such facilities. Shareholders, depending on
their individual tax status, may be subject to the federal alternative minimum
tax on the portion of a distribution attributable to these obligations. Interest
on private activity obligations will be considered exempt from federal income
taxes; however, shareholders should consult their own tax advisors to determine
whether they may be subject to the federal alternative minimum tax.
Resource recovery obligations are a type of municipal revenue obligation
issued to build facilities such as solid waste incinerators or waste-to-energy
plants. Usually, a private corporation will be involved and the
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revenue cash flow will be supported by fees or units paid by municipalities for
the use of the facilities. The viability of a resource recovery project,
environmental protections regulations and project operator tax incentives may
affect the value and credit quality of these obligations.
Tax, revenue or bond anticipation notes are issued by municipalities in
expectation of future tax or other revenues which are payable from these
specific taxes or revenues. Bond anticipation notes usually provide interim
financing in advance of an issue of bonds or notes, the proceeds of which are
used to repay the anticipation notes. Tax-exempt commercial paper is issued by
municipalities to help finance short-term capital or operating needs in
anticipation of future tax or other revenue.
A variable rate obligation is one whose terms provide for the adjustment of
its interest rate on set dates and which, upon such adjustment, can reasonably
be expected to have a market value that approximates its par value. A floating
rate obligation has terms which provide for the adjustment of its interest rate
whenever a specified interest rate changes and which, at any time, can
reasonably be expected to have a market value that approximates its par value.
Variable or floating rate obligations may be secured by bank letters of credit.
Variable rate auction and residual interest obligations are created when an
issuer or dealer separates the principal portion of a long-term, fixed-rate
municipal bond into two long-term, variable-rate instruments. The interest rate
on one portion reflects short-term interest rates, while the interest rate on
the other portion is typically higher than the rate available on the original
fixed-rate bond.
Yields on municipal securities are dependent on a variety of factors,
including the general conditions of the municipal bond and municipal note
markets, the size of a particular offering, the maturity of the obligation and
the rating of the issue. The achievement of the Fund's investment objective is
dependent in part on the continuing ability of the issuers of municipal
securities in which the Fund invests to meet their obligations for the payment
of principal and interest when due. Obligations of issuers of municipal
securities are subject to the provisions of bankruptcy, insolvency and other
laws affecting the rights and remedies of creditors, such as the Bankruptcy
Reform Act of 1978, as amended. Therefore, the possibility exists that, as a
result of litigation or other conditions, the ability of any issuer to pay, when
due, the principal of and interest on its municipal securities may be materially
affected.
CORPORATE DEBT SECURITIES
The Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, are in the Investment Adviser's opinion comparable
in quality to corporate debt securities in which the Fund may invest. The rate
of return or return of principal on some debt obligations may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a
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convertible security is also influenced by the market value of the security's
underlying common stock. The price of a convertible security tends to increase
as the market value of the underlying stock rises, whereas it tends to decrease
as the market value of the underlying stock declines. While no securities
investment is without some risk, investments in convertible securities generally
entail less risk than investments in the common stock of the same issuer.
MORTGAGE-RELATED SECURITIES
The Fund may invest in residential or commercial mortgage-related
securities, including mortgage pass-through securities, collateralized mortgage
obligations ("CMOs"), adjustable rate mortgage securities, CMO residuals,
stripped mortgage-related securities, floating and inverse floating rate
securities and tiered index bonds.
Mortgage Pass-Through Securities. Mortgage pass-through securities
represent interests in pools of mortgages in which payments of both principal
and interest on the securities are generally made monthly, in effect "passing
through" monthly payments made by borrowers on the residential or commercial
mortgage loans which underlie the securities (net of any fees paid to the issuer
or guarantor of the securities). Mortgage pass-through securities differ from
other forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Early repayment of principal on mortgage pass-through securities (arising
from prepayments of principal due to the sale of underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose the Fund to a lower rate of return upon reinvestment of principal. Also,
if a security subject to repayment has been purchased at a premium, in the event
of prepayment, the value of the premium would be lost.
There are currently three types of mortgage pass-through securities: (1)
those issued by the U.S. Government or one of its agencies or instrumentalities,
such as the Government National Mortgage Association ("Ginnie Mae"), the Federal
National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage
Corporation ("Freddie Mac"); (2) those issued by private issuers that represent
an interest in or are collateralized by pass-through securities issued or
guaranteed by the U.S. Government or one of its agencies or instrumentalities;
and (3) those issued by private issuers that represent an interest in or are
collateralized by whole mortgage loans or pass-through securities without a
government guarantee but usually having some form of private credit enhancement.
Ginnie Mae is a wholly-owned United States Government corporation within
the Department of Housing and Urban Development. Ginnie Mae is authorized to
guarantee, with the full faith and credit of the United States Government, the
timely payment of principal and interest on securities issued by the
institutions approved by Ginnie Mae (such as savings and loan institutions,
commercial banks and mortgage banks), and backed by pools of FHA-insured or
VA-guaranteed mortgages.
Obligations of Fannie Mae and Freddie Mac are not backed by the full faith
and credit of the United States government. In the case of obligations not
backed by the full faith and credit of the United States government, the Fund
must look principally to the agency issuing or guaranteeing the obligation for
ultimate repayment. Fannie Mae and Freddie Mac may borrow from the U.S. Treasury
to meet their obligations, but the U.S. Treasury is under no obligation to lend
to Fannie Mae or Freddie Mac.
Private mortgage pass-through securities are structured similarly to Ginnie
Mae, Fannie Mae, and Freddie Mac mortgage pass-through securities and are issued
by originators of and investors in mortgage loans, including depository
institutions, mortgage banks, investment banks and special purpose subsidiaries
of the foregoing.
Pools created by private mortgage pass-through issuers generally offer a
higher rate of interest than government and government-related pools because
there are no direct or indirect government or agency guarantees of payments in
the private pools. However, timely payment of interest and principal of these
pools may be supported by various forms of insurance or guarantees, including
individual loan, title, pool and hazard insurance and letters of credit. The
insurance and guarantees are issued by governmental entities, private insurers
and the mortgage poolers. The insurance and guarantees and the creditworthiness
of the issuers
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thereof will be considered in determining whether a mortgage-related security
meets the Fund's investment quality standards. There can be no assurance that
the private insurers or guarantors can meet their obligations under the
insurance policies or guarantee arrangements. Private mortgage pass-through
securities may be bought without insurance or guarantees if, through an
examination of the loan experience and practices of the originator/servicers and
poolers, the Investment Adviser determines that the securities meet the Fund's
quality standards.
Collateralized Mortgage Obligations. CMOs are debt obligations
collateralized by residential or commercial mortgage loans or residential or
commercial mortgage pass-through securities. Interest and prepaid principal are
generally paid monthly. CMOs may be collateralized by whole mortgage loans or
private mortgage pass-through securities but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by Ginnie Mae,
Freddie Mac, or Fannie Mae. The issuer of a series of CMOs may elect to be
treated as a Real Estate Mortgage Investment Conduit ("REMIC"). All future
references to CMOs also include REMICs.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral which is ordinarily unrelated to the stated
maturity date. CMOs often provide for a modified form of call protection through
a de facto breakdown of the underlying pool of mortgages according to how
quickly the loans are repaid. Monthly payment of principal received from the
pool of underlying mortgages, including prepayments, is first returned to
investors holding the shortest maturity class. Investors holding the longer
maturity classes usually receive principal only after the first class has been
retired. An investor may be partially protected against a sooner than desired
return of principal because of the sequential payments.
Certain issuers of CMOs are not considered investment companies pursuant to
a rule adopted by the Commission, and the Fund may invest in the securities of
such issuers without the limitations imposed by the 1940 Act on investments by
the Fund in other investment companies. In addition, in reliance on an earlier
Commission interpretation, the Fund's investments in certain other qualifying
CMOs, which cannot or do not rely on the rule, are also not subject to the
limitation of the 1940 Act on acquiring interests in other investment companies.
In order to be able to rely on the Commission's interpretation, these CMOs must
be unmanaged, fixed asset issuers, that: (1) invest primarily in mortgage-backed
securities; (2) do not issue redeemable securities; (3) operate under general
exemptive orders exempting them from all provisions of the 1940 Act; and (4) are
not registered or regulated under the 1940 Act as investment companies. To the
extent that the Fund selects CMOs that cannot rely on the rule or do not meet
the above requirements, the Fund may not invest more than 10% of its assets in
all such entities and may not acquire more than 3% of the voting securities of
any single such entity.
The Fund may also invest in, among other things, parallel pay CMOs, Planned
Amortization Class CMOs ("PAC bonds"), sequential pay CMOs, and floating rate
CMOs. Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. PAC bonds generally require payments of a
specified amount of principal on each payment date. Sequential pay CMOs
generally pay principal to only one class while paying interest to several
classes. Floating rate CMOs are securities whose coupon rate fluctuates
according to some formula related to an existing market index or rate. Typical
indexes would include the eleventh district cost-of-funds index ("COFI"), the
London Interbank Offered Rate ("LIBOR"), one-year Treasury yields, and ten-year
Treasury yields.
Adjustable Rate Mortgage Securities. Adjustable rate mortgage securities
("ARMs") are pass-through securities collateralized by mortgages with adjustable
rather than fixed rates. ARMs eligible for inclusion in a mortgage pool
generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, thirty-six, or sixty scheduled monthly
payments. Thereafter, the interest rates are subject to periodic adjustment
based on changes to a designated benchmark index.
The ARMs contain maximum and minimum rates beyond which the mortgage
interest rate may not vary over the lifetime of the security. In addition,
certain ARMs provide for additional limitations on the maximum amount by which
the mortgage interest rate may adjust for any single adjustment period. In the
event that market rates of interest rise more rapidly to levels above that of
the ARM's maximum rate, the ARM's
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coupon may represent a below market rate of interest. In these circumstances,
the market value of the ARM security will likely have fallen.
Certain ARMs contain limitations on changes in the required monthly
payment. In the event that a monthly payment is not sufficient to pay the
interest accruing on an ARM, any such excess interest is added to the principal
balance of the mortgage loan, which is repaid through future monthly payments.
If the monthly payment for such an instrument exceeds the sum of the interest
accrued at the applicable mortgage interest rate and the principal payment
required at such point to amortize the outstanding principal balance over the
remaining term of the loan, the excess is then utilized to reduce the
outstanding principal balance of the ARM.
CMO Residuals. CMO residuals are derivative mortgage securities issued by
agencies or instrumentalities of the U.S. Government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks, and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
part, the yield to maturity on the CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-related securities. See
"Stripped Mortgage-Related Securities" below. In addition, if a series of a CMO
includes a class that bears interest at an adjustable rate, the yield to
maturity on the related CMO residual will also be extremely sensitive to changes
in the level of the index upon which interest rate adjustments are based. As
described below with respect to stripped mortgage-related securities, in certain
circumstances the Fund may fail to recoup fully its initial investment in a CMO
residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has recently developed and CMO residuals currently may not have
the liquidity of other more established securities trading in other markets.
Transactions in CMO residuals are generally completed only after careful review
of the characteristics of the securities in question. In addition, CMO residuals
may or, pursuant to an exemption therefrom, may not have been registered under
the Securities Act of 1933, as amended ("Securities Act"). CMO residuals,
whether or not registered under such Act, may be subject to certain restrictions
on transferability, and may be deemed "illiquid" and subject to the Fund's
limitations on investment in illiquid securities.
Stripped Mortgage-Related Securities. Stripped mortgage-related securities
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. Government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks, and special purpose entities
of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the IO class), while
the other class will receive all of the principal (the PO class). The yield to
maturity on an IO class is extremely sensitive to the rate of principal payments
(including prepayments) on the related underlying mortgage assets, and a rapid
rate of principal payments may have a material adverse effect on the Fund's
yield to maturity from these securities. If the underlying mortgage assets
experience greater than anticipated prepayments of principal, the Fund may fail
to fully recoup its initial investment in these securities even if the security
is in one of the highest rating categories.
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Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently introduced. As a result, established trading markets have not
yet been fully developed and accordingly, these securities may be deemed
"illiquid" and subject to the Fund's limitations on investment in illiquid
securities.
Inverse Floaters. An inverse floater is a debt instrument with a floating
or variable interest rate that moves in the opposite direction to the interest
rate on another security or index level. Changes in the interest rate on the
other security or index inversely affect the residual interest rate paid on the
inverse floater, with the result that the inverse floater's price will be
considerably more volatile than that of a fixed rate bond. Inverse floaters may
experience gains when interest rates fall and may suffer losses in periods of
rising interest rates. The market for inverse floaters is relatively new.
Tiered Index Bonds. Tiered index bonds are relatively new forms of
mortgage-related securities. The interest rate on a tiered index bond is tied to
a specified index or market rate. So long as this index or market rate is below
a predetermined "strike" rate, the interest rate on the tiered index bond
remains fixed. If, however, the specified index or market rate rises above the
"strike" rate, the interest rate of the tiered index bond will decrease. Thus,
under these circumstances, the interest rate on a tiered index bond, like an
inverse floater, will move in the opposite direction of prevailing interest
rates, with the result that the price of the tiered index bond may be
considerably more volatile than that of a fixed-rate bond.
ASSET-BACKED SECURITIES
The Fund may invest in various types of asset-backed securities. Through
the use of trusts and special purpose corporations, various types of assets,
primarily automobile and credit card receivables and home equity loans, are
being securitized in pass-through structures similar to the mortgage
pass-through or in a pay-through structure similar to the CMO structure.
Investments in these and other types of asset-backed securities must be
consistent with the investment objective and policies of the Fund.
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-RELATED AND ASSET-BACKED
SECURITIES
The yield characteristics of mortgage-related and asset-backed securities
differ from traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
or other assets generally may be prepaid at any time. As a result, if the Fund
purchases such a security at a premium, a prepayment rate that is faster than
expected will reduce yield to maturity, while a prepayment rate that is slower
than expected will have the opposite effect of increasing yield to maturity.
Alternatively, if the Fund purchases these securities at a discount, faster than
expected prepayments will increase, while slower than expected prepayments will
reduce, yield to maturity. The Fund may invest a portion of its assets in
derivative mortgage-related securities which are highly sensitive to changes in
prepayment and interest rates. The Investment Adviser will seek to manage these
risks (and potential benefits) by diversifying its investments in such
securities and through hedging techniques.
During periods of declining interest rates, prepayment of mortgages
underlying mortgage-related securities can be expected to accelerate.
Accordingly, the Fund's ability to maintain positions in high-yielding
mortgage-related securities will be affected by reductions in the principal
amount of such securities resulting from such prepayments, and its ability to
reinvest the returns of principal at comparable yields is subject to generally
prevailing interest rates at that time. Conversely, slower than expected
prepayments may effectively change a security that was considered short or
intermediate-term at the time of purchase into a long-term security. Long-term
securities tend to fluctuate more in response to interest rate changes, leading
to increased net asset value volatility. Prepayments may also result in the
realization of capital losses with respect to higher yielding securities that
had been bought at a premium or the loss of opportunity to realize capital gains
in the future from possible future appreciation.
Asset-backed securities involve certain risks that are not posed by
mortgage-related securities, resulting mainly from the fact that asset-backed
securities do not usually contain the complete benefit of a security interest in
the related collateral. For example, credit card receivables generally are
unsecured and the debtors
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are entitled to the protection of a number of state and federal consumer credit
laws, some of which may reduce the ability to obtain full payment. In the case
of automobile receivables, due to various legal and economic factors, proceeds
from repossessed collateral may not always be sufficient to support payments on
these securities.
DURATION
In selecting securities for the Fund, the Investment Adviser makes use of
the concept of duration for fixed-income securities. Duration is a measure of
the expected life of a fixed-income security. Duration incorporates a bond's
yield, coupon interest payments, final maturity and call features into one
measure. Most debt obligations provide interest ("coupon") payments in addition
to a final ("par") payment at maturity. Some obligations also have call
provisions. Depending on the relative magnitude of these payments, the market
values of debt obligations may respond differently to changes in the level and
structure of interest rates.
Duration is a measure of the expected life of a fixed-income security on a
present value basis. Duration takes the length of the time intervals between the
present time and the time that the interest and principal payments are scheduled
or, in the case of a callable bond, expected to be received, and weights them by
the present values of the cash to be received at each future point in time. For
any fixed-income security with interest payments occurring prior to the payment
of principal, duration is always less than maturity. In general, all other
things being the same, the lower the stated or coupon rate of interest of a
fixed-income security, the longer the duration of the security; conversely, the
higher the stated or coupon rate of interest of a fixed-income security, the
shorter the duration of the security.
Futures, options and options on futures have durations which, in general,
are closely related to the duration of the securities which underlie them.
Holding long futures or call option positions (backed by a segregated account of
cash and cash equivalents) will lengthen the Fund's duration by approximately
the same amount that holding an equivalent amount of the underlying securities
would.
Short futures or put options positions have durations roughly equal to the
negative duration of the securities that underlie those positions, and have the
effect of reducing portfolio duration by approximately the same amount that
selling an equivalent amount of the underlying securities would.
There are some situations where even the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by duration is the case of mortgage pass-through securities. The stated
final maturity of such securities is generally 30 years, but current prepayment
rates are more critical in determining the securities' interest rate exposure.
In these and other similar situations, the Investment Adviser will use more
sophisticated analytical techniques that incorporate the economic life of a
security into the determination of its interest rate exposure.
DERIVATIVE INSTRUMENTS
As indicated in the prospectus, to the extent consistent with its
investment objective and policies and the investment restrictions listed in this
Statement of Additional Information, the Fund may purchase and write call and
put options on securities and securities indexes and enter into forward
contracts. The Fund also may enter into swap agreements with respect to interest
rates and securities indexes. The Fund may use these techniques to hedge against
changes in interest rates, or securities prices or as part of its overall
investment strategies. The Fund will mark as segregated cash, U.S. government
securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily (or, as permitted by applicable regulation, enter into
certain offsetting positions), to cover its obligations under forward contracts,
swap agreements and options to avoid leveraging of the Fund.
Options on Securities and on Securities Indexes. The Fund may purchase put
options on securities to protect holdings in an underlying or related security
against a substantial decline in market value. The Fund may purchase call
options on securities to protect against substantial increases in prices of
securities the Fund intends to purchase pending its ability to invest in such
securities in an orderly manner. The Fund may sell put
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<PAGE> 453
or call options it has previously purchased, which could result in a net gain or
loss depending on whether the amount realized on the sale is more or less than
the premium and other transaction costs paid on the put or call option which is
sold. The Fund may write a call or put option only if the option is "covered" by
the Fund holding a position in the underlying securities or by other means which
would permit immediate satisfaction of the Fund's obligation as writer of the
option. Prior to exercise or expiration, an option may be closed out by an
offsetting purchase or sale of an option of the same series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
FOREIGN SECURITIES
The Fund may invest in American Depositary Receipts ("ADRs"), other
securities convertible into securities of issuers based in foreign countries and
other foreign securities that can be purchased and sold in U.S. dollars. ADRs
are receipts, usually issued by a U.S. bank or trust company, evidencing
ownership of the underlying securities. Generally, ADRs are issued in registered
form, denominated in U.S. dollars, and are designed for use in the U.S.
securities markets.
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FOREIGN INVESTMENT RISKS
Foreign Market Risk. The Fund may invest a portion of its assets in foreign
securities. Foreign security investment involves special risks not present in
U.S. investments that can increase the chances that the Fund will lose money.
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of capital, resources, and
balance of payments position. Certain such economies may rely heavily on
particular industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a particular country
or countries, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. Investments in foreign markets may
also be adversely affected by governmental actions such as the imposition of
capital controls, nationalization of companies or industries, expropriation of
assets, or the imposition of punitive taxes. In addition, the governments of
certain countries may prohibit or impose substantial restrictions on foreign
investing in their capital markets or in certain industries. Any of these
actions could severely affect security prices, impair the Fund's ability to
purchase or sell foreign securities or otherwise adversely affect the Fund's
operations. Other foreign market risks include difficulties in pricing
securities, defaults on foreign government securities, difficulties in enforcing
favorable legal judgments in foreign courts, and political and social
instability. Legal remedies available to investors in certain foreign countries
may be less extensive than those available to investors in the United States or
other foreign countries.
EMU. For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU established a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU participants by July 1, 2002. Upon implementation of EMU,
certain securities issued in participating EU countries (beginning with
government and corporate bonds) were redenominated in the euro, and are now
listed, traded, declaring dividends and making other payments only in euros.
No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on the Fund's investments
in Europe generally or in specific countries participating in EMU.
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some countries may not have laws
to protect investors the way that the United States securities laws do.
Accounting standards in other countries are not necessarily the same as in the
United States. If the accounting standards in another country do not require as
much disclosure or detail as U.S. accounting standards, it may be harder for the
Fund's portfolio managers to completely and accurately determine a company's
financial condition.
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<PAGE> 455
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
SWAP AGREEMENTS
The Fund may enter into interest rate, index and currency exchange rate
swap agreements for purposes of attempting to obtain a particular desired return
at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded the desired return. Swap agreements are two party
contracts entered into primarily by institutional investors for periods ranging
from a few weeks to more than one year. In a standard "swap" transaction, two
parties agree to exchange the returns (or differentials in rates of return)
earned or realized on particular predetermined investments or instruments. The
gross returns to be exchanged or "swapped" between the parties are calculated
with respect to a "notional amount," i.e., the return on or increase in value of
a particular dollar amount invested at a particular interest rate or in a
"basket" of securities representing a particular index. The "notional amount" of
the swap agreement is only a fictive basis on which to calculate the obligations
which the parties to a swap agreement have agreed to exchange. The Fund's
obligations (or rights) under a swap agreement will generally be equal only to
the net amount to be paid or received under the agreement based on the relative
values of the positions held by each party to the agreement (the "net amount").
The Fund's obligations under a swap agreement will be accrued daily (offset
against any amounts owing to the Fund) and any accrued but unpaid net amounts
owed to a swap counter-party will be covered by marking as segregated cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, to avoid any potential leveraging of the Fund's
portfolio. The Fund will not enter into a swap agreement with any single party
if the net amount owed or to be received under existing contracts with that
party would exceed 5% of the Fund's assets.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Investment Adviser's
ability to correctly predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, the Fund bears the risk
of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counter-party.
Restrictions imposed by the Internal Revenue Code may limit the Fund's ability
to use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps market,
including potential government regulation, could adversely affect the Fund's
ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
RISK FACTORS RELATING TO INVESTING IN HIGH YIELD SECURITIES
A description of security ratings is attached as an Appendix. Lower-rated
or unrated (that is, high yield) securities are more likely to react to
developments affecting market risk (such as interest rate sensitivity, market
perception of the creditworthiness of the issuer and general market liquidity)
and credit risk (such as the issuer's inability to meet its obligations) than
are more highly rated securities, which react primarily to movements in the
general level of interest rates. The Investment Adviser considers both credit
risk and market risk in making investment decisions for the Fund.
The amount of high yield securities outstanding proliferated in the 1980's
in conjunction with the increase in merger and acquisition and leveraged buyout
activity. Under adverse economic conditions, there is a risk that highly
leveraged issuers may be unable to service their debt obligations upon maturity.
In addition, the secondary market for high yield securities, which is
concentrated in relatively few market makers, may not be as liquid as the
secondary market for more highly rated securities. Under adverse market or
economic conditions, the secondary market for high yield securities could
contract further, independent of any specific adverse changes in the condition
of a particular issuer. As a result, the Investment Adviser could find it more
difficult to sell these securities or may be able to sell the securities only at
prices lower than if such securities were widely traded. Prices realized upon
the sale of such lower-rated or unrated securities, under these circumstances,
may be less than the prices used in calculating the Fund's net asset value prior
to the sale.
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<PAGE> 456
Lower-rated or unrated debt obligations also present risks based on payment
expectations. If an issuer calls the obligation for redemption, the Fund may
have to replace the security with a lower yielding security, resulting in a
decreased return for investors. If the Fund experiences unexpected net
redemptions, it may be forced to sell its higher-rated securities, resulting in
a decline in the overall credit quality of the Fund's portfolio and increasing
the exposure of the Fund to the risks of high yield securities.
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions of
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act securities which are otherwise not readily
marketable and repurchase agreements that have a maturity of longer than seven
days. Securities which have not been registered under the Securities Act are
referred to as private placements or restricted securities and are purchased
directly from the issuer or in the secondary market. Limitations on resale may
have an adverse effect on the marketability of portfolio securities and a mutual
fund might be unable to dispose of restricted or other illiquid securities
promptly or at reasonable prices and might thereby experience difficulty
satisfying redemption within seven days. The absence of a trading market can
make it difficult to ascertain a market value for illiquid investments. Also
market quotations are less readily available. The judgment of the Investment
Adviser may at times play a greater role in valuing these securities than in the
case of unrestricted securities. A mutual fund might also have to register such
restricted securities in order to dispose of them resulting in additional
expense and delay. Adverse market conditions could impede such a public offering
of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Investment Adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least one nationally recognized statistical
rating organizations ("NRSRO"), or, if unrated, be of comparable quality in the
view of the Investment Adviser; and (2) it must not be in default as to
principal or interest. Investing in Rule 144A securities could have the effect
of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
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REVERSE REPURCHASE AGREEMENTS
The Fund may enter into reverse repurchase agreements, whereby the Fund
sells securities concurrently with entering into an agreement to repurchase
those securities at a later date at a fixed price. During the reverse repurchase
agreement period, the Fund continues to receive principal and interest payments
on those securities. Reverse repurchase agreements are speculative techniques
involving leverage and are considered borrowings by the Fund for purposes of the
limit applicable to borrowings.
DOLLAR ROLLS
The Fund may use dollar rolls as part of its investment strategy. In a
dollar roll, the Fund sells securities for delivery in the current month and
simultaneously contracts to repurchase substantially similar securities (same
type and coupon) on a specified future date from the same party. During the roll
period, the Fund forgoes principal and interest paid on the securities. The Fund
is compensated by the difference between the current sales price and the forward
price for the future purchase (often referred to as the "drop") as well as by
the interest earned on the cash proceeds of the initial sale. A "covered roll"
is a specific type of dollar roll for which there is an offsetting cash position
or cash equivalent security position that matures on or before the forward
settlement date of the dollar roll transaction.
The Fund will mark as segregated cash, U.S. government securities, equity
securities or other liquid, unencumbered assets, marked-to-market daily, equal
in value to their obligations with respect to dollar rolls. Dollar rolls involve
the risk that the market value of the securities retained by the Fund may
decline below the price of the securities the Fund has sold but is obligated to
repurchase under the agreement. If the buyer of the securities under a dollar
roll files for bankruptcy or becomes insolvent, the Fund's use of the proceeds
of the agreement may be restricted pending a determination by the other party,
or its trustee or receiver, whether to enforce the Fund's obligation to
repurchase the securities. Dollar rolls are speculative techniques involving
leverage and are considered borrowings by the Fund for purposes of the limit
applicable to borrowings.
BORROWING
The Fund may borrow for temporary or emergency purposes in amounts not
exceeding 10% of the Fund's total assets. This borrowing may be unsecured. The
1940 Act requires the Fund to maintain continuous asset coverage (that is, total
assets including borrowings, less liabilities exclusive of borrowings) of 300%
of the amount borrowed. Borrowing subjects the Fund to interest costs which may
or may not be recovered by appreciation of the securities purchased, and can
exaggerate the effect on net asset value of any increase or decrease in the
market value of the Fund's portfolio. This is the speculative factor known as
leverage.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value of the security each day in determining the Fund's net asset
value. The Fund will also mark as segregated with its custodian cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, equal in value to its obligations for when-issued
securities.
REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain Internal Revenue Code requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties, as well as
greater income
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<PAGE> 458
potential than an investment in common stocks. Like any investment in real
estate, though, a REIT's performance depends on several factors, such as its
ability to find tenants for its properties, to renew leases and to finance
property purchases and renovations.
SHARES OF OTHER INVESTMENT COMPANIES
The Fund can invest in securities of other investment companies except to
the extent prohibited by law. Like all equity investments, these investments may
go up or down in value. They also may not perform in correlation with the Fund's
principal strategies. The Fund will pay additional fees through its investments
in other investment companies.
LIMITED PARTNERSHIPS
The Fund can invest in limited partnership interests.
SHORT SALES AGAINST-THE-BOX
The Fund can borrow and sell "short" securities when it also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund's
total assets can be held as collateral for short sales at any one time.
CORPORATE LOANS
The Fund can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Fund may not
recover its investment, or there might be a delay in the Fund's recovery. By
investing in a corporate loan, the Fund becomes a member of the syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, the Fund may invest
all or part of its assets in short-term investment grade debt obligations of the
U.S. government, its agencies and instrumentalities, bank certificates of
deposit, bankers' acceptances, high quality commercial paper, demand notes and
repurchase agreements.
MANAGEMENT OF THE FUND
The Trustees oversee the actions of the Fund's Investment Adviser and other
service providers and decide upon matters of general policy. The Trustees also
review the actions of the Trust's officers, who conduct and supervise the daily
business operations of the Trust. The Trustees (* denotes "interested" Trustee
as defined in the 1940 Act, due to the relationship with the Investment Adviser)
and officers of the Trust are:
MICHAEL BAXTER*(37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since 1999);
Managing Director of the Investment Adviser (since 1996); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
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ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since 1994); Chairman, Gamma Services Corp.
(venture capital) (since 1968); Principal, Gavin, Dailey & Partners (consulting)
(since 1993); U.S. Ambassador to Mexico (1981 - 1986); Director, Apex Mortgage
Capital, Inc., Atlantic Richfield Co., International Wire Corp. and Krause's
Furniture.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (since 1986); Member of CIEBA's Executive Committee (since
1988) and its Chairman (from 1991 - 1992); Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds (1986 - 1993); Member of the Investment Advisory Committees of
the State of New York Common Retirement Fund and the Howard Hughes Medical
Institute (since 1997); Director, Duke Management Company (since 1992) and Vice
Chairman (since 1998); Director, Kimco Realty Corporation (since 1997);
Director, LaSalle Street Fund (since 1995); Member of the Investment Advisory
Committee of the Virginia Retirement System (since 1998); Director, Montpelier
Foundation (since 1998); Trustee or Director of 31 registered investment
companies (consisting of 47 portfolios) for which the Investment Advisor or an
advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since
1999); Managing Director of the Investment Adviser (since 1998); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (49) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 66 registered investment companies
(consisting of 70 portfolios) for which the Investment Adviser or an affiliate
is the adviser.
NANCY D. CELICK (49) -- President -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Chief Administrative Officer of the Investment
Adviser (since 1998); Chief Financial Officer of the Investment Adviser
(1993 - 1998); Chief Financial Officer of Kennedy-Wilson, Inc. (auction
marketing services) (1992 - 1993); Chief Financial Officer of First National
Corporation (bank holding company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-9011. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services,
Inc. (since 1999); Vice President of FAM Distributors, Inc. (since 1999); First
Vice President of the Investment Adviser (1990 - 1997).
ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
18
<PAGE> 460
GRACIE FERMELIA (38) -- Vice President and Assistant Secretary -- 725 South
Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Director of the
Investment Adviser (since 2000); Vice President of the Investment Adviser
(1994-2000). Senior Manager, Price Waterhouse (1985 - 1994).
The Trust does not pay salaries to any of its officers or fees to any of
its Trustees affiliated with the Investment Adviser. The following table sets
forth the aggregate compensation paid to the Trustees during the Trust's fiscal
year ended June 30, 2000 and the aggregate compensation paid to the Trustees for
service on the Trust's Board and that of any other fund for which the Investment
Adviser serves as investment adviser or which has an investment adviser that is
an affiliated person of the Investment Adviser ("Fund Complex") for the year
ended December 31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $ $ 34,000
John A. G. Gavin................................... $ $ 25,000
Joe Grills......................................... $ $232,000
Nigel Hurst-Brown.................................. $ -0- $ -0-
Robert B. Hutchinson**............................. $ $ 34,000
Madeleine A. Kleiner............................... $ $ 18,000
Merle T. Welshans**................................ $ $ 34,000
Richard R. West.................................... $ $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of Mercury HW Variable Trust, Fund
Asset Management Master Trust and Merrill Lynch Investment Managers Funds,
Inc. Messrs. Grills and West also serve on the boards of other investment
companies advised by the Investment Adviser and its advisory affiliates.
** Messrs. Hutchinson and Welshans retired on November 12, 1999.
The Trustees may be eligible for reduced sales charges on purchases of
Class I shares. See "Reduced Initial Sales Charges -- Purchase Privileges of
Certain Persons."
For information as to ownership of shares, see "General
Information -- Principal Holders."
ADVISORY ARRANGEMENTS
Investment Advisory Services and Fee. The Trust on behalf of the Fund has
entered into an investment advisory agreement (the "Advisory Agreement") with
the Investment Adviser as investment adviser. Subject to the supervision of the
Trustees, the Investment Adviser is responsible for the actual management of the
Fund and constantly reviews the Fund's holdings in light of its own research
analysis and that from other relevant sources. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser. The Investment Adviser performs certain of the other administrative
services and provides all office space, facilities, equipment and necessary
personnel for management of the Fund. The Investment Adviser receives for its
services to the Fund a monthly fee at an annual rate of 0.75% of the Fund's
average daily net assets. For purposes of this calculation, average daily net
assets is determined at the end of each month on the basis of the average net
assets of the Fund for each day during the month.
Prior to October , 2000, the Fund was party to an investment advisory
agreement under which it paid Merrill Lynch Investment Managers, L.P., an
affiliate of the Investment Adviser, a fee at the annual rate of 0.75% of its
average daily net assets. For the fiscal years ended June 30, 2000, 1999 and
1998, the Fund paid Merrill Lynch Investment Managers, L.P. $ ,
$747,848 and $761,196, respectively. For the fiscal years ended June 30, 2000
and 1999, as a result of its agreement to limit Fund expenses, Merrill Lynch
19
<PAGE> 461
Investment Managers, L.P. waived a portion of its fee in the amounts of
$ and $26,952, respectively.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients of the Investment Adviser or an affiliate when one or more clients of
the Investment Adviser or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Payment of Fund Expenses. The Advisory Agreement obligates the Investment
Adviser to provide investment advisory services and to pay, or cause an
affiliate to pay, for maintaining its staff and personnel and to provide office
space, facilities and necessary personnel for the Fund. The Investment Adviser
is also obligated to pay, or cause an affiliate to pay, the fees of all officers
and Trustees who are affiliated persons of the Investment Adviser. The Fund
pays, or causes to be paid, all other expenses incurred in the operation of the
Fund (except to the extent paid by FAM Distributors, Inc. (the "Distributor")),
including, among other things, taxes, expenses for legal and auditing services,
costs of printing proxies, shareholder reports, copies of the Registration
Statement, charges of the custodian, any sub-custodian and the transfer agent,
expenses of portfolio transactions, expenses of redemption of shares, Commission
fees, expenses of registering the shares under Federal, state or non-U.S. laws,
fees and actual out-of-pocket expenses of non-interested Trustees, accounting
and pricing costs (including the daily calculation of net asset value),
insurance, interest, brokerage costs, litigation and other extraordinary or
non-recurring expenses, and other expenses properly payable by the Fund.
Organization of the Investment Adviser. The Investment Adviser is a limited
partnership, the partners of which are Merrill Lynch & Co., Inc. ("ML & Co."), a
financial services holding company and the parent of Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch") and Princeton Services, Inc. ML &
Co. and Princeton Services, Inc. are "controlling persons" of the Investment
Adviser as defined under the 1940 Act because of their ownership of its voting
securities and their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Advisory Agreement will remain in effect from year to year if approved annually
(a) by the Board of Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees of the Trust who are
not parties to the Advisory Agreement or interested persons (as defined in the
1940 Act) of any such party. The Advisory Agreement is not assignable and will
automatically terminate in the event of its assignment. In addition, such
contract may be terminated by the vote of a majority of the outstanding voting
securities of the Fund or by the Investment Adviser without penalty on 60 days'
written notice to the other party.
ACCOUNTING AND ADMINISTRATIVE SERVICES
The Trust has entered into a Fund Accounting and Administration Servicing
Agreement (the "Fund Accounting Agreement") with the Investment Adviser acting
as service provider. The Fund Accounting Agreement obligates the Investment
Adviser to provide certain accounting and administrative services to the Trust.
The Trust reimburses the Investment Adviser for its costs in connection with
such services.
Transfer Agency Services. The Transfer Agent, a subsidiary of ML & Co.,
acts as the Fund's Transfer Agent pursuant to a Transfer Agency, Dividend
Disbursing Agency and Shareholder Servicing Agency Agreement (the "Transfer
Agency Agreement"). Pursuant to the Transfer Agency Agreement, the Transfer
Agent is responsible for the issuance, transfer and redemption of shares and the
opening and maintenance of shareholder accounts. Pursuant to the Transfer Agency
Agreement, the Transfer Agent receives a fee ranging from $16.00 to $22.00 per
account (depending on the level of services required) and certain other fees
relating
20
<PAGE> 462
to special processing of sub-transfer agency relationships. The Transfer Agent
is entitled to reimbursement for certain transaction charges and out-of-pocket
expenses incurred by the Transfer Agent under the Transfer Agency Agreement. For
purposes of the Transfer Agency Agreement, the term "account" includes a
shareholder account maintained directly by the Transfer Agent and any other
account representing the beneficial interest of a person in the relevant share
class on a recordkeeping system.
Distribution Expenses. The Fund has entered into a distribution agreement
with the Distributor in connection with the continuous offering of shares of the
Fund (the "Distribution Agreement"). The Distribution Agreement obligates the
Distributor to pay certain expenses in connection with the offering of the
shares of the Fund. After the prospectuses, statements of additional information
and periodic reports have been prepared, set in type and mailed to shareholders,
the Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to dealers and investors. The Distributor also pays
for other supplementary sales literature and advertising costs. The Distribution
Agreement is subject to the same renewal requirements and termination provisions
as the Advisory Agreement described above.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act that covers the Trust, the Investment Adviser and the
Distributor (the "Code of Ethics"). The Code of Ethics significantly restricts
the personal investing activities of all employees of the Investment Adviser and
the Distributor and, as described below, imposes additional more onerous
restrictions on fund investment personnel.
The Code of Ethics requires that all employees of the Investment Adviser
and the Distributor pre-clear any personal securities investments (with limited
exceptions, such as mutual funds, high-quality short-term securities and direct
obligations of the U.S. government). The pre-clearance requirement and
associated procedures are designed to identify any substantive prohibition or
limitation applicable to the proposed investment. The substantive restrictions
applicable to all employees of the Investment Adviser and the Distributor
include a ban on acquiring any securities in a "hot" initial public offering. In
addition, investment personnel are prohibited from profiting on short-term
trading in securities. No employee may purchase or sell any security that at the
time is being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Investment Adviser. Furthermore, the Code of Ethics provides for trading
"blackout periods" which prohibit trading by investment personnel of the Fund
within seven calendar days, before or after, of trading by the Fund in the same
or equivalent security.
PURCHASE OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus for certain information as to the purchase of
Fund shares.
The Fund issues two classes of shares: Class I and Class A. Each Class I
and Class A share of the Fund represents an identical interest in the investment
portfolio of the Fund, and has the same rights, except that Class A shares bear
the expenses of the ongoing account maintenance fees (also known as service
fees). The account maintenance fees that are imposed on Class A shares are
imposed directly against the class and not against all assets of the Fund, and,
accordingly, such charges do not affect the net asset value of the other class.
Dividends paid by the Fund for each class of shares are calculated in the same
manner at the same time and differ only to the extent that account maintenance
fees are borne exclusively by that class. Class A shares have exclusive voting
rights with respect to the Rule 12b-1 distribution plan adopted with respect to
such class pursuant to which the account maintenance fees are paid. Each class
has different exchange privileges. See "Shareholder Services -- Exchange
Privilege."
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share plus any sales charge applicable to the
class of shares selected by the investor. The applicable offering price for
purchase orders is based upon the net asset value of the Fund next determined
after receipt of the purchase
21
<PAGE> 463
order by the Distributor. As to purchase orders received by selected securities
dealers or other financial intermediaries prior to the close of regular trading
on the New York Stock Exchange (the "NYSE") (generally 4:00 p.m., Eastern time)
which includes orders received after the determination of net asset value on the
previous day, the applicable offering price will be based on the net asset value
on the day the order is placed with the Distributor, provided that the orders
are received by the Distributor prior to 30 minutes after the close of regular
trading on the NYSE on that day. If the purchase orders are not received prior
to 30 minutes after the close of regular trading on the NYSE on that day, such
orders shall be deemed received on the next business day. Selected securities
dealers or other financial intermediaries have the responsibility of submitting
purchase orders to the Fund not later than 30 minutes after the close of regular
trading on the NYSE in order to purchase shares at that day's offering price.
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Any order may be rejected by the Fund or the Distributor. Neither
the Distributor nor the selected securities dealers or other financial
intermediaries are permitted to withhold placing orders to benefit themselves by
a price change. Certain selected securities dealers or other financial
intermediaries may charge a processing fee to confirm a sale of shares. For
example, the fee currently charged by Merrill Lynch is $5.35. Purchases made
directly through the Transfer Agent are not subject to the processing fee.
CLASS I AND CLASS A SHARES
Investors may elect to purchase Class A shares or, if an eligible investor,
Class I shares.
Investors who are eligible to purchase Class I shares should purchase Class
I shares rather than Class A shares, because there is an account maintenance fee
imposed on Class A shares.
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class I and Class A
shares of the Fund, refers to a single purchase by an individual or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his or her spouse and their children under
the age of 21 years purchasing shares for his, her or their own account and to
single purchases by a trustee or other fiduciary purchasing shares for a single
trust estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company," as that
term is defined in the 1940 Act, but does not include purchases by any such
company that has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
Class I shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class I shares. Investors
who owned Investor Class shares or who currently own Class I shares of the Fund
in a shareholder account are entitled to purchase additional Class I shares of
the Fund in that account. Certain employer-sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class I shares at net asset
value provided such plans meet the required minimum number of eligible employees
or required amount of assets advised by the Investment Adviser or any of its
affiliates. Also eligible to purchase Class I shares at net asset value are
participants in certain investment programs including certain managed accounts
for which a trust institution, thrift or bank trust department provides
discretionary trustee services, certain collective investment trusts for which a
trust institution, thrift, or bank trust department serves as trustee, certain
purchases made in connection with certain fee-based programs and certain
purchases made through certain financial advisers that meet and adhere to
standards established by the Investment Adviser. Class I shares are available at
net asset value to corporate warranty insurance reserve fund programs and U.S.
branches of foreign banking institutions, provided that the participant has $3
million or more initially invested in affiliate-advised investment companies. In
addition, Class I shares are offered at net asset value to ML & Co. and its
subsidiaries and their directors and employees, to members of the Boards of
investment companies advised by the Investment Adviser or its affiliates,
including the Fund, and to
22
<PAGE> 464
employees of certain selected securities dealers or other financial
intermediaries. Class I shares may also be offered at net asset value to certain
accounts over which the Investment Adviser or an affiliate exercises investment
discretion. Although some investors who previously purchased Class I shares may
no longer be eligible to purchase Class I shares of other affiliate-advised
funds, those previously purchased Class I shares, together with Class A share
holdings, will count toward a right of accumulation which may qualify the
investor for a reduced initial sales charge on new initial sales charge
purchases. The ongoing Class A account maintenance fees will cause Class A
shares to have a higher expense ratio, pay lower dividends and have a lower
total return than Class I shares.
The Distributor may reallow discounts to selected securities dealers or
other financial intermediaries and retain the balance over such discounts. At
times the Distributor may reallow the entire sales charge to such selected
securities dealers or other financial intermediaries. Since selected securities
dealers or other financial intermediaries selling Class I and Class A shares of
the Fund will receive a concession equal to most of the sales charge, they may
be deemed to be underwriters under the Securities Act.
REDUCED INITIAL SALES CHARGES
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
to obtain such investments.
Reinvested Dividends. No initial sales charges are imposed upon Class I and
Class A shares issued as a result of the automatic reinvestment of dividends.
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other Mercury mutual funds. For any such right of accumulation to be
made available, the Distributor must be provided at the time of purchase, by the
purchaser or the purchaser's selected securities dealer or other financial
intermediary, with sufficient information to permit confirmation of
qualification. Acceptance of the purchase order is subject to such confirmation.
The right of accumulation may be amended or terminated at any time. Shares held
in the name of a nominee or custodian under pension, profit-sharing, or other
employee benefit plans may not be combined with other shares to qualify for the
right of accumulation.
Letter of Intent. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class I or Class A shares of the Fund or any
other Mercury mutual funds made within a 13-month period starting with the first
purchase pursuant to the Letter of Intent. The Letter of Intent is available
only to investors whose accounts are established and maintained at the Fund's
Transfer Agent. The Letter of Intent is not available to employee benefit plans
for which affiliates of the Investment Adviser provide plan participant
record-keeping services. The Letter of Intent is not a binding obligation to
purchase any amount of Class I or Class A shares; however, its execution will
result in the purchaser paying a lower sales charge at the appropriate quantity
purchase level. A purchase not originally made pursuant to a Letter of Intent
may be included under a subsequent Letter of Intent executed within 90 days of
such purchase if the Distributor is informed in writing of this intent within
such 90-day period. The value of Class I and Class A shares of the Fund and of
other Mercury mutual funds presently held, at cost or maximum offering price
(whichever is higher), on the date of the first purchase under the Letter of
Intent, may be included as a credit toward the completion of such Letter, but
the reduced sales charge applicable to the amount covered by such Letter will be
applied only to new purchases. If the total amount of shares does not equal the
amount stated in the Letter of Intent (minimum of $25,000), the investor will be
notified and must pay, within 20 days of the execution of such Letter, the
difference between the sales charge on the Class I or Class A shares purchased
at the reduced rate and the sales charge applicable to the shares actually
purchased through the Letter. Class I or Class A shares equal to 5.0% of the
intended amount will be held in escrow during the 13-month period (while
remaining registered in the name of the purchaser) for this purpose. The first
purchase under the Letter of Intent must be at least 5.0% of the dollar amount
of such Letter. If a purchase during the term of such Letter
23
<PAGE> 465
would otherwise be subject to a further reduced sales charge based on the right
of accumulation, the purchaser will be entitled on that purchase and subsequent
purchases to that further reduced percentage sales charge but there will be no
retroactive reduction of the sales charges on any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intent will be deducted from
the total purchases made under such Letter. An exchange from the Summit Cash
Reserves Fund ("Summit") into the Fund that creates a sales charge will count
toward completing a new or existing Letter of Intent from the Fund.
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and certain
other arrangements may purchase Class I or Class A shares at net asset value,
based on the number of employees or number of employees eligible to participate
in the plan and/or the aggregate amount invested by the plan in specified
investments. Minimum purchase requirements may be waived or varied for such
plans. For additional information regarding purchases by employer-sponsored
retirement or savings plans and certain other arrangements, call your plan
administrator or your selected securities dealer or other financial
intermediary.
Managed Trusts. Class I shares are offered at net asset value to certain
trusts to which trust institutions, thrifts, and bank trust departments provide
discretionary trustee services.
Purchase Privileges of Certain Persons. Trustees of the Trust and of other
investment companies advised by the Investment Adviser or its affiliates,
directors and employees of ML & Co. and its subsidiaries (the term
"subsidiaries," when used herein with respect to ML & Co., includes the
Investment Adviser, Merrill Lynch Investment Managers, L.P., Merrill Lynch
Investment Managers, International Limited and certain other entities directly
or indirectly wholly-owned and controlled by ML & Co.), employees of certain
selected securities dealers, and any trust, pension, profit-sharing or other
benefit plan for such persons, may purchase Class I shares of the Fund at net
asset value. The Fund realizes economies of scale and reduction of sales-
related expenses by virtue of the familiarity of these persons with the Fund.
Employees and Trustees wishing to purchase shares of the Fund must satisfy the
Fund's suitability standards.
Class I and Class A shares are also offered at net asset value to certain
accounts over which the Investment Adviser or an affiliate exercises investment
discretion.
Acquisition of Certain Investment Companies. Class A shares may be offered
at net asset value in connection with the acquisition of the assets of or merger
or consolidation with a personal holding company or a public or private
investment company.
Purchases Through Certain Financial Intermediaries. Reduced sales charges
may be applicable for purchases of Class I or Class A shares of the Fund through
certain financial advisers, selected securities dealers and other financial
intermediaries that meet and adhere to standards established by the Investment
Adviser from time to time.
A waived sales charge on a purchase of Class I shares will apply to current
beneficial shareholders who were also beneficial shareholders of the Fund as of
the opening of business of the Fund on October , 2000.
DISTRIBUTION PLAN
Reference is made to "Account Choices -- Pricing of Shares" in the
Prospectus for certain information with respect to the distribution plan for
Class A shares pursuant to Rule 12b-1 under the 1940 Act (the "Distribution
Plan") with respect to the account maintenance fees paid by the Fund to the
Distributor with respect to such class.
The Distribution Plan of the Class A shares provides that the Fund pays the
Distributor an account maintenance fee relating to the Class A shares, accrued
daily and paid monthly, at the annual rate of 0.25% of the average daily net
assets of the Fund in order to compensate the Distributor and selected
securities dealers or other financial intermediaries (pursuant to
sub-agreements) in connection with account maintenance activities with respect
to Class A shares. Holders of Class A shares have exclusive voting rights with
respect to the Distribution Plan adopted with respect to such class pursuant to
which account maintenance fees are paid.
24
<PAGE> 466
The Fund's Distribution Plan is subject to the provisions of Rule 12b-1
under the 1940 Act. In their consideration of the Distribution Plan, the
Trustees must consider all factors they deem relevant, including information as
to the benefits of the Distribution Plan to the Fund and the related class of
shareholders. The Distribution Plan further provides that, so long as the
Distribution Plan remains in effect, the selection and nomination of
non-interested Trustees shall be committed to the discretion of the
non-interested Trustees then in office. In approving the Distribution Plan in
accordance with Rule 12b-1, the non-interested Trustees concluded that there is
a reasonable likelihood that such Distribution Plan will benefit the Fund and
its related class of shareholders. The Distribution Plan can be terminated at
any time, without penalty, by the vote of a majority of the non-interested
Trustees or by the vote of the holders of a majority of the outstanding Class A
shares of the Fund. The Distribution Plan cannot be amended to increase
materially the amount to be spent by the Fund without the approval of the Class
A shareholders, and all material amendments are required to be approved by the
vote of Trustees, including a majority of the non-interested Trustees who have
no direct or indirect financial interest in such Distribution Plan, cast in
person at a meeting called for that purpose. Rule 12b-1 further requires that
the Fund preserve copies of the Distribution Plan and any report made pursuant
to such plan for a period of not less than six years from the date of such
Distribution Plan or such report, the first two years in an easily accessible
place.
Among other things, the Distribution Plan provides that the Distributor
shall provide and the Trustees shall review quarterly reports of the
disbursement of the account maintenance fees paid to the Distributor. Payments
under the Distribution Plan are based on a percentage of average daily net
assets attributable to the shares regardless of the amount of expenses incurred.
For the fiscal year ended June 30, 2000, the Fund made payments of
$ to the Distributor under the Rule 12b-1 Plan for the Distributor
Class shares (which were redesignated as Class A shares).
REDEMPTION OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Except for any deferred sales charge that may be applicable, there
will be no charge for redemption if the redemption request is sent directly to
the Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists, as defined by the
Commission, as a result of which disposal of portfolio securities or
determination of the net asset value of the Fund is not reasonably practicable,
and for such other periods as the Commission may by order permit for the
protection of shareholders of the Fund.
The value of shares of the Fund at the time of redemption may be more or
less than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
The Trust has entered into a joint committed line of credit with other
investment companies advised by the Investment Adviser and its affiliates and a
syndicate of banks that is intended to provide the Fund with a temporary source
of cash to be used to meet redemption requests from Fund shareholders in
extraordinary or emergency circumstances.
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so by tendering the shares directly to the Fund's Transfer Agent, Financial Data
Services, Inc., P.O. Box 41621, Jacksonville, Florida 32232-1621. Redemption
requests delivered other than by mail should be delivered to Financial Data
25
<PAGE> 467
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting redemption. Redemption
requests should not be sent to the Fund. The redemption request in either event
requires the signature(s) of all persons in whose name(s) the shares are
registered, signed exactly as such name(s) appear(s) on the Transfer Agent's
register. The signature(s) on the redemption request may require a guarantee by
an "eligible guarantor institution" as defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications. In the
event a signature guarantee is required, notarized signatures are not
sufficient. In general, signature guarantees are waived on redemptions of less
than $50,000 as long as the following requirements are met: (i) all requests
require the signature(s) of all persons in whose name(s) shares are recorded on
the Transfer Agent's register; (ii) all checks must be mailed to the stencil
address of record on the Transfer Agent's register and (iii) the stencil address
must not have changed within 30 days. Certain rules may apply regarding certain
account types such as but not limited to UGMA/UTMA accounts, Joint Tenancies
with Rights of Survivorship, contra broker transactions and institutional
accounts. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority.
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the Transfer
Agent at 1-800-236-4479. The request must be made by the shareholder of record
and be for an amount less than $50,000. Before telephone requests will be
honored, signature approval from all shareholders of record on the account must
be obtained. The shares being redeemed must have been held for at least 15 days.
Telephone redemption requests will not be honored in the following situations:
the accountholder is deceased, the proceeds are to be sent to someone other than
the shareholder of record, funds are to be wired to the client's bank account, a
systematic withdrawal plan is in effect, the request is by an individual other
than the accountholder of record, the account is held by joint tenants who are
divorced, the address has changed within the last 30 days or share certificates
have been issued on the account.
Since this account feature involves a risk of loss from unauthorized or
fraudulent transactions, the Transfer Agent will take certain precautions to
protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address registered
on the account and the social security number registered on the account. The
Fund or the Transfer Agent may temporarily suspend telephone transactions at any
time.
For shareholders redeeming directly with the Transfer Agent, payments will
be mailed within seven days of receipt of a proper notice of redemption. At
various times the Fund may be requested to redeem shares for which it has not
yet received good payment (e.g., cash, Federal funds or certified check drawn on
a U.S. bank). The Fund may delay or cause to be delayed the mailing of a
redemption check until such time as good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank) has been collected for the purchase of
such Fund shares, which usually will not exceed 10 days. In the event that a
shareholder account held directly with the Transfer Agent contains a fractional
share balance, such fractional share balance will be automatically redeemed by
the Fund.
REPURCHASE
The Fund also will repurchase its shares through a shareholder's listed
selected securities dealer or other financial intermediary. The Fund normally
will accept orders to repurchase shares by wire or telephone from dealers for
their customers at the net asset value next computed after the order is placed.
Shares will be priced at the net asset value calculated on the day the request
is received, provided that the request for repurchase is submitted to the
selected securities dealer or other financial intermediary prior to the close of
regular trading on the NYSE (generally, regular trading on the NYSE closes at
4:00 p.m., Eastern time) and such request is received by the Fund from such
selected securities dealer or other financial intermediary not later than 30
minutes after the close of regular trading on the NYSE on the same day.
26
<PAGE> 468
Selected securities dealers and other financial intermediaries have the
responsibility of submitting such repurchase requests to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to obtain
that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any applicable
deferred sales charge). Securities firms that do not have agreements with the
Distributor, however, may impose a transaction charge on the shareholder for
transmitting the notice of repurchase to the Fund. Certain selected securities
dealers and other financial intermediaries may charge a processing fee to
confirm a repurchase of shares. For example, the fee currently charged by
Merrill Lynch is $5.35. Fees charged by other selected securities dealers may be
higher or lower. Repurchases made through the Transfer Agent, on accounts held
at the Transfer Agent, are not subject to the processing fee. The Fund reserves
the right to reject any order for repurchase, which right of rejection might
adversely affect shareholders seeking redemption through the repurchase
procedure. A shareholder whose order for repurchase is rejected by the Fund,
however, may redeem Fund shares as set forth above.
REINSTATEMENT PRIVILEGE -- CLASS I AND CLASS A SHARES
Shareholders of the Fund who have redeemed their Class I and Class A shares
have a privilege to reinstate their accounts by purchasing Class I or Class A
shares of the Fund, as the case may be, at the net asset value without a sales
charge up to the dollar amount redeemed. The reinstatement privilege may be
exercised by sending a notice of exercise along with a check for the amount to
be reinstated to the Transfer Agent within 30 days after the date the request
for redemption was accepted by the Transfer Agent or the Distributor.
Alternatively, the reinstatement privilege may be exercised through the
investor's financial consultant within 30 days after the date the request for
redemption was accepted by the Transfer Agent or the Distributor. The
reinstatement will be made at the net asset value per share next determined
after the notice of reinstatement is received and cannot exceed the amount of
the redemption proceeds.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "Account Choices -- How Shares are Priced" in the
Prospectus.
The net asset value of the shares of all classes of the Fund is determined
once daily Monday through Friday as of the close of regular trading on the NYSE
on each day the NYSE is open for trading based on prices at the time of closing.
Regular trading on the NYSE generally closes at 4:00 p.m., Eastern time. Any
assets or liabilities initially expressed in terms of non-U.S. dollar currencies
are translated into U.S. dollars at the prevailing market rates as quoted by one
or more banks or dealers on the day of valuation. The NYSE is not open for
trading on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
Net asset value of the Fund is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Investment Adviser, are accrued daily.
The per share net asset value of Class A shares generally will be lower
than the per share net asset value of Class I shares, reflecting the daily
expense accruals of the account maintenance fees applicable with respect to
Class A shares. It is expected, however, that the per share net asset value of
the two classes of the Fund will tend to converge (although not necessarily
meet) immediately after the payment of dividends which will differ by
approximately the amount of the expense accrual differentials between the
classes.
Portfolio securities, including ADRs, EDRs or GDRs, that are traded on
stock exchanges are valued at the last sale price (regular way) on the exchange
on which such securities are traded, as of the close of regular trading on the
day the securities are being valued or, lacking any sales, at the last available
bid price for long positions, and at the last available ask price for short
positions. In cases where securities are traded on more
27
<PAGE> 469
than one exchange, the securities are valued on the exchange designated by or
under the authority of the Board of Trustees as the primary market. Long
positions in securities traded in the OTC market are valued at the last
available bid price in the OTC market prior to the time of valuation. Short
positions in securities traded in the OTC market are valued at the last
available ask price in the OTC market prior to the time of valuation. Portfolio
securities that are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market. When the Fund
writes an option, the amount of the premium received is recorded on the books of
the Fund as an asset and an equivalent liability. The amount of the liability is
subsequently valued to reflect the current market value of the option written,
based upon the last sale price in the case of exchange-traded options or, in the
case of options traded in the OTC market, the last ask price. Options purchased
by the Fund are valued at their last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last bid price.
Other investments, including financial futures contracts and related options,
are stated at market value. Securities and assets for which market quotations
are not readily available are valued at fair value as determined in good faith
by or under the direction of the Board of Trustees. Such valuations and
procedures will be reviewed periodically by the Board of Trustees.
Generally, trading in non-U.S. securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of regular trading on the NYSE. The values of
such securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of regular trading on the NYSE. Occasionally,
events affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of regular trading
on the NYSE that may not be reflected in the computation of the Fund's net asset
value.
Each investor in the Fund may add to or reduce its investment in the Fund
on each day the NYSE is open for trading. The value of each investor's interest
in the Fund will be determined as of the close of regular trading on the NYSE by
multiplying the net asset value of the Fund by the percentage, effective for
that day, that represents that investor's share of the aggregate interests in
the Fund. The close of regular trading on the NYSE is generally 4:00 p.m.,
Eastern time. Any additions or withdrawals to be effected on that day will then
be effected. The investor's percentage of the aggregate beneficial interests in
the Fund will then be recomputed as the percentage equal to the fraction (i) the
numerator of which is the value of such investor's investment in the Fund as of
the time of determination on such day plus or minus, as the case may be, the
amount of any additions to or withdrawals from the investor's investment in the
Fund effected on such day, and (ii) the denominator of which is the aggregate
net asset value of the Fund as of such time on such day plus or minus, as the
case may be, the amount of the net additions to or withdrawals from the
aggregate investments in the Fund by all investors in the Fund. The percentage
so determined will then be applied to determine the value of the investor's
interest in the Fund after the close of regular trading on the NYSE on the next
determination of net asset value of the Fund.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class I and
Class A shares of the Fund based on the net asset value of the Fund's shares on
June 30, 2000 is as follows:
<TABLE>
<CAPTION>
CLASS I CLASS A
------- -------
<S> <C> <C>
Net Assets.................................................. $ $
------- -------
Number of Shares Outstanding................................
------- -------
Net Asset Value Per Share (net assets divided by number of
shares outstanding)....................................... $ $
------- -------
Sales Charge (for Class I and Class A Shares; 5.25% of
Offering Price; ( % of net amount invested))*.........
------- -------
Offering Price.............................................. $ $
------- -------
</TABLE>
---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
28
<PAGE> 470
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Subject to policies established by the Board of Trustees, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Fund, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and operational facilities of the firm and the
firm's risk in positioning a block of securities. While the Investment Adviser
generally seeks reasonably competitive commission rates, the Fund does not
necessarily pay the lowest spread or commission available. In addition,
consistent with the Conduct Rules of the NASD and policies established by the
Board of Trustees, the Investment Adviser may consider sales of Fund shares as a
factor in the selection of brokers or dealers to execute portfolio transactions
for the Fund; however, whether or not a particular broker or dealer sells shares
of the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Fund.
Subject to obtaining the best net results, brokers who provide supplemental
investment research to the Investment Adviser may receive orders for
transactions by the Fund. Such supplemental research services ordinarily consist
of assessments and analyses of the business or prospects of a company, industry
or economic sector. Information so received will be in addition to and not in
lieu of the services required to be performed by the Investment Adviser under
the Investment Advisory Agreement and the expenses of the Investment Adviser
will not necessarily be reduced as a result of the receipt of such supplemental
information. If in the judgment of the Investment Adviser the Fund will benefit
from supplemental research services, the Investment Adviser is authorized to pay
brokerage commissions to a broker furnishing such services that are in excess of
commissions that another broker may have charged for effecting the same
transactions. Certain supplemental research services may primarily benefit one
or more other investment companies or other accounts for which the Investment
Adviser exercises investment discretion. Conversely, the Fund may be the primary
beneficiary of the supplemental research services received as a result of
portfolio transactions effected for such other accounts or investment companies.
Foreign equity securities may be held by the Fund in the form of ADRs,
other securities convertible into foreign equity securities and other foreign
securities that can be purchased and sold in U.S. dollars. ADRs, may be listed
on stock exchanges, or traded in over-the-counter markets in the United States.
ADRs, like other securities traded in the United States, will be subject to
negotiated commission rates. The Fund's ability and decisions to purchase or
sell portfolio securities of foreign issuers may be affected by laws or
regulations relating to the convertibility and repatriation of assets. Because
the shares of the Fund are redeemable on a daily basis in U.S. dollars, the Fund
intends to manage the portfolio so as to give reasonable assurance that it will
be able to obtain U.S. dollars to the extent necessary to meet anticipated
redemptions. Under present conditions, it is not believed that these
considerations will have significant effect on the Fund's portfolio strategies.
The Fund may invest in certain securities traded in the OTC market and
intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Fund and
persons who are affiliated with such affiliated persons are prohibited from
dealing with the Fund as principal in the purchase and sale of securities unless
a permissive order allowing such transactions is obtained from the Commission.
Since transactions in the OTC market usually involve transactions with the
dealers acting as principal for their own accounts, the Fund will not deal with
affiliated persons, including Merrill Lynch and its affiliates, in connection
with such transactions. However, an affiliated person of the Fund may serve as
its broker in OTC transactions conducted on an agency basis provided that, among
other things, the fee or commission received by such affiliated broker is
reasonable and fair compared to the fee or commission received by non-affiliated
brokers in connection with comparable transactions. In addition, the Fund may
not purchase securities during the existence of any underwriting syndicate for
such securities of which Merrill Lynch or an affiliate is a
29
<PAGE> 471
member or in a private placement in which Merrill Lynch or an affiliate serves
as placement agent except pursuant to procedures approved by the Board of
Trustees that either comply with rules adopted by the Commission or with
interpretations of the Commission staff. See "Investment Objective and
Policies -- Investment Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch or its affiliates acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund. Securities may be held by, or be appropriate
investments for, the Fund as well as other funds or investment advisory clients
of the Investment Adviser or its affiliates.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or its affiliates
when one or more clients of the Investment Adviser or its affiliates are selling
the same security. If purchases or sales of securities arise for consideration
at or about the same time that would involve the Fund or other clients or funds
for which the Investment Adviser or an affiliate acts as investment adviser,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Investment Adviser or
its affiliates during the same period may increase the demand for securities
being purchased or the supply of securities being sold, there may be an adverse
effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below that are
designed to facilitate investment in its shares. Full details as to each such
service and copies of the various plans or how to change options with respect
thereto, can be obtained from the Fund by calling the telephone number on the
cover page hereof, or from the Distributor or your selected securities dealer or
other financial intermediary. Certain of these services are available only to
U.S. investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of dividends. The statements
also will show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
dividends. A shareholder with an account held at the Transfer Agent may make
additions to his or her Investment Account at any time by mailing a check
directly to the Transfer Agent. The Fund does not issue share certificates.
Shareholders considering transferring their Class I or Class A shares from
a selected securities dealer to another brokerage firm or financial institution
should be aware that, if the firm to which the Class I or Class A shares are to
be transferred will not take delivery of shares of the Fund, a shareholder
either must redeem the Class I or Class A shares so that the cash proceeds can
be transferred to the account at the new firm or such shareholder must continue
to maintain an Investment Account at the Transfer Agent for those Class I or
Class A shares.
30
<PAGE> 472
Certain shareholder services may not be available for the transferred
shares. After the transfer, the shareholder may purchase additional shares of
funds owned before the transfer, and all future trading of these assets must be
coordinated by the new firm.
Shareholders considering transferring a tax-deferred retirement account,
such as an individual retirement account, from a selected securities dealer or
other financial intermediary to another brokerage firm or financial institution
should be aware that, if the firm to which the retirement account is to be
transferred will not take delivery of shares of the Fund, a shareholder must
either redeem the shares so that the cash proceeds can be transferred to the
account at the new firm, or such shareholder must continue to maintain a
retirement account at a selected securities dealer or other financial
intermediary for those shares.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other Mercury mutual funds and Summit, a series of Financial
Institutions Series Trust, which is a Merrill Lynch-sponsored money market fund
specifically designated as available for exchange by holders of Class I and
Class A shares. Shares with a net asset value of at least $100 are required to
qualify for the exchange privilege and any shares used in an exchange must have
been held by the shareholder for at least 15 days. Before effecting an exchange,
shareholders should obtain a currently effective prospectus of the fund into
which the exchange is to be made. Exercise of the exchange privilege is treated
as a sale of the exchanged shares and a purchase of the acquired shares for
Federal income tax purposes.
Exchanges of Class I and Class A Shares. Under the Fund's pricing system,
Class I shareholders may exchange Class I shares of the Fund for Class I shares
of a second Mercury mutual fund. If the Class I shareholder wants to exchange
Class I shares for shares of a second Mercury mutual fund, but does not hold
Class I shares of the second fund in his or her account at the time of exchange
and is not otherwise eligible to acquire Class I shares of the second fund, the
shareholder will receive Class A shares of the second fund as a result of the
exchange. Class A shares also may be exchanged for Class I shares of a second
Mercury mutual fund at any time as long as, at the time of the exchange, the
shareholder is eligible to acquire Class I shares of any Mercury mutual fund.
Exchanges of Class I or Class A shares outstanding ("outstanding Class I or
Class A shares") for Class I or Class A shares of another Mercury mutual fund,
or for Class A shares of Summit ("new Class I or Class A shares") are transacted
on the basis of relative net asset value per Class I or Class A share,
respectively, plus an amount equal to the difference, if any, between the sales
charge previously paid on the outstanding Class I or Class A shares and the
sales charge payable at the time of the exchange on the new Class I or Class A
shares. With respect to outstanding Class I or Class A shares as to which
previous exchanges have taken place, the "sales charge previously paid" shall
include the aggregate of the sales charges paid with respect to such Class I or
Class A shares in the initial purchase and any subsequent exchange. Class I or
Class A shares issued pursuant to dividend reinvestment are sold on a no-load
basis. For purposes of the exchange privilege, Class I and Class A shares
acquired through dividend reinvestment shall be deemed to have been sold with a
sales charge equal to the sales charge previously paid on the Class I or Class A
shares on which the dividend was paid. Based on this formula, Class I and Class
A shares of the Fund generally may be exchanged into the Class I and Class A
shares, respectively, of the other funds with a reduced or without a sales
charge.
Exchanges for Shares of a Money Market Fund. Class I and Class A shares are
exchangeable for Class A shares of Summit. Class A shares of Summit have an
exchange privilege back into Class I or Class A shares of affiliate-advised
Funds. This exchange privilege does not apply with respect to certain fee-based
programs for which alternative exchange arrangements may exist. Please see your
financial consultant for further information.
Prior to October 12, 1998, exchanges from other affiliate-advised Funds
into a money market fund were directed to certain affiliate-advised money market
funds other than Summit. Shareholders who exchanged affiliate-advised Fund
shares for such other money market funds and subsequently wish to exchange those
money market fund shares for shares of the Fund will be subject to the CDSC
schedule applicable to such Fund shares, if any. The holding period for those
money market fund shares will not count toward satisfaction
31
<PAGE> 473
of the holding period requirement for reduction of the CDSC imposed on such
shares, if any, and, with respect to Class B shares, toward satisfaction of the
Conversion Period. However, the holding period for Class B or Class C shares of
the Fund received in exchange for such money market fund shares will be
aggregated with the holding period for the fund shares originally exchanged for
such money market fund shares for purposes of reducing the CDSC or satisfying
the Conversion Period.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her financial consultant, who will advise the
relevant Fund of the exchange. Shareholders of the Fund and shareholders of the
other funds described above with shares for which certificates have not been
issued may exercise the exchange privilege by wire through their selected
securities dealers or other financial intermediaries. The Fund reserves the
right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated in accordance with the rules of the
Commission. The Fund reserves the right to limit the number of times an investor
may exercise the exchange privilege. Certain funds may suspend the continuous
offering of their shares to the general public at any time and may thereafter
resume such offering from time to time. The exchange privilege is available only
to U.S. shareholders in states where the exchange legally may be made. It is
contemplated that the exchange privilege may be applicable to other new mutual
funds whose shares may be distributed by the Distributor.
FEE-BASED PROGRAMS
Certain fee-based programs, including pricing alternatives for securities
transactions (each referred to in this paragraph as a "Program"), may permit the
purchase of Class I shares at net asset value. Under specified circumstances,
participants in certain Programs may deposit other classes of shares, which will
be exchanged for Class I shares. Initial or deferred sales charges otherwise due
in connection with such exchanges may be waived or modified. Termination of
participation in certain Programs may result in the redemption of shares held
therein or the automatic exchange thereof to another class at net asset value.
In addition, upon termination of participation in a Program, shares that have
been held for less than specified periods within such Program may be subject to
a fee based on the current value of such shares. These Programs also generally
prohibit such shares from being transferred to another account, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and account maintenance fees) in order for the
investment not to be subject to Program fees. Additional information regarding
certain specific Programs offered through particular selected securities dealers
or other financial intermediaries (including charges and limitations on
transferability applicable to shares that may be held in such Programs) is
available in each such Program's client agreement and from the Transfer Agent at
1-800-236-4479.
RETIREMENT PLANS
The minimum initial purchase to establish a retirement plan is $100.
Dividends received in retirement plans are exempt from Federal taxation until
distributed from the plans. Different tax rules apply to Roth IRA plans and
educational savings plans. Investors considering participation in any retirement
or education savings plan should review specific tax laws relating thereto and
should consult their attorneys or tax advisers with respect to the establishment
and maintenance of any such plan.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class I shares (if he or she is an eligible Class I investor) or
Class A shares at the applicable public offering price. These purchases may be
made either through the shareholder's securities dealer or by mail directly to
the Transfer Agent, acting as agent for such securities dealer. You may also add
to your account by automatically investing a specific amount in the Fund on a
periodic basis through your selected securities dealer or other financial
intermediary. The current minimum for such automatic additional investments is
$100. This minimum may be waived or revised under certain circumstances.
32
<PAGE> 474
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Shareholders may, at any time, by written notification to their selected
securities dealer or other financial intermediary if their account is maintained
with a selected securities dealer or other financial intermediary, or by written
notification or by telephone (1-800-236-4479) to the Transfer Agent, if their
account is maintained with the Transfer Agent, elect to have subsequent
dividends of ordinary income and/or capital gains paid with respect to shares of
the Fund in cash, rather than reinvested in shares of the Fund (provided that,
in the event that a payment on an account maintained at the Transfer Agent would
amount to $10.00 or less, a shareholder will not receive such payment in cash
and such payment will automatically be reinvested in additional shares).
Commencing ten days after the receipt by the Transfer Agent of such notice,
those instructions will be effected. The Fund is not responsible for any failure
of delivery to the shareholder's address of record and no interest will accrue
on amounts represented by uncashed dividend checks. Cash payments can also be
directly deposited to the shareholder's bank account.
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals are available for shareholders with
shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed from
those on deposit in the shareholder's account to provide the withdrawal payment
specified by the shareholder. The shareholder may specify the dollar amount and
class of shares to be redeemed. Redemptions will be made at net asset value as
of the close of regular trading on the NYSE (generally, the NYSE closes at 4:00
p.m., Eastern time) on the 24th day of each month or the 24th day of the last
month of each quarter, whichever is applicable. If the NYSE is not open for
business on such date, the shares will be redeemed at the net asset value
determined after the close of regular trading on the NYSE on the following
business day. The check for the withdrawal payment will be mailed, or the direct
deposit for withdrawal payment will be made, on the next business day following
redemption. When a shareholder is making systematic withdrawals, dividends on
all shares in the Investment Account are reinvested automatically in Fund
shares. A shareholder's systematic withdrawal plan may be terminated at any
time, without a charge or penalty, by the shareholder, the Fund, the Transfer
Agent or the Distributor.
If an investor wishes to change the amount being withdrawn in a systematic
withdrawal plan the investor should contact his or her financial consultant.
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax liabilities.
The Fund will not knowingly accept purchase orders for shares of the Fund from
investors who maintain a systematic withdrawal plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
DIVIDENDS AND TAX STATUS
The Fund has qualified as a regulated investment company. Qualification as
a regulated investment company requires, among other things, that (1) at least
90% of the Fund's annual gross income, without offset for losses from the sale
or other disposition of securities, be derived from payments with respect to
securities loans, interest, dividends and gains from the sale or other
disposition of stock, securities, or foreign currencies or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities, or currencies; and (2) the Fund diversify its
33
<PAGE> 475
holdings so that, at the end of each quarter of the taxable year, (i) at least
50% of the market value of the Fund's assets is represented by cash, U.S.
government securities, securities of other regulated investment companies, and
other securities limited in respect of any one issuer to an amount not greater
than 5% of the Fund's assets and 10% of the outstanding voting securities of
such issuer, and (ii) not more than 25% of the value of its assets is invested
in the securities of any one issuer (other than U.S. government securities or
the securities of other regulated investment companies). In addition, in order
not to be subject to federal taxation, the Fund must distribute to its
shareholders at least 90% of its investment company taxable income earned in
each year.
The Fund is required to pay an excise tax to the extent it does not
distribute to its shareholders during any calendar year at least 98% of its
ordinary income for that calendar year, 98% of the excess of its capital gains
over its capital losses for the one-year period ending October 31 in such
calendar year, and all undistributed ordinary income and capital gains for the
preceding respective one-year period. The Fund intends to meet these
distribution requirements to avoid excise tax liability. The Fund also intends
to continue distributing to shareholders all of the excess of net long-term
capital gain over net short-term capital loss on sales of securities. If the net
asset value of shares of the Fund should, by reason of a distribution of
realized capital gains, be reduced below a shareholder's cost, such distribution
would to that extent be a return of capital to that shareholder even though
taxable to the shareholder, and a sale of shares by a shareholder at net asset
value at that time would establish a capital loss for federal tax purposes.
In determining the extent to which the Fund's dividends may be eligible for
the 70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisors regarding other requirements applicable to the dividends received
deduction.
Any loss realized on a sale, redemption or exchange of shares of the Fund
by a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by the Fund constitute a
replacement of shares.
The per share dividends on Class A shares will be lower than the per share
dividends on Class I shares as a result of the account maintenance fees
applicable with respect to the Class A shares. See "Pricing of
Shares -- Determination of Net Asset Value."
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined separately for Class I and Class A
shares in accordance with a formula specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class I and Class A
shares. Dividends paid by the Fund with respect to all shares, to the extent any
dividends are paid, will be calculated in the same manner at the same time on
the same day and will be in the same amount, except that account maintenance
charges will be borne exclusively by Class A.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that
34
<PAGE> 476
(1) as required by the periods of the quotations, actual annual, annualized or
aggregate data, rather than average annual data, may be quoted and (2) the
maximum applicable sales charges will not be included with respect to annual or
annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time. The Fund's total return may be
expressed either as a percentage or as a dollar amount in order to illustrate
such total return on a hypothetical $1,000 investment in the Fund at the
beginning of each specified period.
Average annual total returns for the periods ended June 30, 2000 are as
follows:
<TABLE>
<CAPTION>
ONE FIVE TEN SINCE
YEAR YEARS YEARS INCEPTION
----- ----- ----- ---------
<S> <C> <C> <C> <C> <C>
Investor Class............... (Since 8/13/85)
Distributor Class............ (Since /99)
</TABLE>
In order to reflect the reduced sales charges in the case of Class I or
Class A shares applicable to certain investors, as described under "Purchase of
Shares" and "Redemption of Shares," respectively, the total return data quoted
by the Fund in advertisements directed to such investors may take into account
the reduced, and not the maximum, sales charge and therefore may reflect greater
total return since, due to the reduced sales charges or the waiver of sales
charges, a lower amount of expenses is deducted.
In advertising and sales literature, the Fund may compare its performance
to that of various broad market indexes, including without limitation the Lehman
Brothers Government/Credit Intermediate Bond Index, Standard & Poor's 500
Composite Stock Price Index and other published indexes. When comparing its
performance to a market index, the Fund may refer to various statistical
measures derived from the historic performance of the Fund and the index, such
as standard deviation and beta. In addition, the Fund may refer in advertising
or sales literature to (i) mutual fund performance ratings, rankings and
comparisons (including risk-adjusted ratings, rankings and comparisons), (ii)
other comparisons of mutual fund data including assets, expenses, fees and other
data, and (iii) other discussions reported in or assigned by Barron's, Business
Week, CDA Investment Technology, Inc., Financial World, Forbes Magazine, Fortune
Magazine, Lipper Inc., Money Magazine, U.S. News & World Report, The Wall Street
Journal and other industry publications. The Fund may also make reference to
awards that may be given to the Investment Adviser. As with other performance
data, performance comparisons should not be considered indicative of the Fund's
relative performance for any future period.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest and to divide or combine
the shares into a greater or lesser number of shares without thereby changing
the proportionate beneficial interest in the Fund. Each share represents an
interest in the Fund proportionately equal to the interest of each other share,
except that the Class A shares are subject to account maintenance fees payable
under the Plan of Distribution. Upon the Trust's liquidation, all shareholders
would share pro rata in the net assets of the Fund available for distribution to
shareholders. If they deem it advisable and in the best interest of
shareholders, the Board of Trustees may create additional
35
<PAGE> 477
classes of shares. The Board of Trustees has created ten series of shares, and
may create additional series in the future, which have separate assets and
liabilities.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a
Fund's shares may advise the Trustees in writing that they wish to communicate
with other shareholders for the purpose of requesting a meeting to remove a
Trustee. The Trustees will then, if requested by the applicants, mail at the
applicants' expense the applicants' communication to all other shareholders.
The Trust or the Fund may be terminated if approved by the vote of a
majority of the Trustees or by the approval of the holders of a majority of the
Trust's outstanding shares, as defined in the 1940 Act. If not so terminated,
the Trust will continue indefinitely.
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Trust or its Trustees. The Declaration of Trust provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for its obligations. While Massachusetts
law permits a shareholder of a trust such as this to be held personally liable
as a partner under certain circumstances, the risk of a shareholder incurring
financial loss on account of shareholder liability is highly unlikely and is
limited to the relatively remote circumstances in which the Trust would be
unable to meet its obligations.
Common expenses incurred by the Trust are allocated among the portfolios
based upon: (1) relative net assets; (2) as incurred on a specific
identification basis; or (3) evenly among the portfolios, depending on the
nature of the expenditure.
Except for (1) changes which do not adversely affect the rights of Trust
shareholders; (2) a change in the name of the Trust, or a series or class
thereof; (3) authorization of a new series or class; (4) changes to supply any
omission or correct any ambiguous or defective provision; or (5) changes
required by any federal, state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust without the affirmative vote of the holders of at least 67%
of the Trust's outstanding shares at a meeting at which more than 50% of its
outstanding shares are present in person or represented by proxy. The holders of
shares have no preemptive or conversion rights. Shares when issued are fully
paid and non-assessable, except as set forth above.
ISSUANCE OF FUND SHARES FOR SECURITIES
Investors may purchase Fund shares for consideration consisting of
securities rather than cash when, in the judgment of the Investment Adviser, the
securities: (a) meet the investment objective and policies of the Fund, (b) are
liquid and not subject to restrictions on resale, and (c) have a value that is
readily ascertainable via listing on or trading in a recognized United States or
international exchange or market.
36
<PAGE> 478
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment wholly
in cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of the Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund during
any 90 day period for any one shareholder. Should redemptions by any shareholder
exceed such limitation the Fund will have the option of redeeming the excess in
cash or in kind. If shares are redeemed in kind, the redeeming shareholder would
incur brokerage costs in converting the assets into cash.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202, has been selected as the independent auditors of the Fund. The
independent auditors are responsible for auditing the annual financial
statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109-3661, acts as custodian of the Fund's assets (the "Custodian"). Under its
contract with the Trust, the Custodian is authorized to establish separate
accounts in foreign currencies and to cause foreign securities owned by the
Trust to be held in its offices outside the United States and with certain
foreign banks and securities depositories. The Custodian is responsible for
safeguarding and controlling the Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and dividends on the
Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly-owned subsidiary of ML & Co., acts as the
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement (the "Transfer Agency Agreement").
The Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts.
LEGAL COUNSEL
Gardner, Carton & Douglas, 321 North Clark Street, Chicago, Illinois 60610,
is counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio and
other information. An annual report containing financial statements audited by
independent auditors is sent to shareholders each year. After the end of each
year, shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
The Fund's financial statements are incorporated in this Statement of
Additional Information by reference to its annual report for the fiscal year
ended June 30, 2000. You may request copies of the annual report at no charge by
calling 1-800-236-4479 between 8:00 a.m. and 8:00 p.m. on any business day.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
37
<PAGE> 479
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
PRINCIPAL HOLDERS
[to come]
38
<PAGE> 480
APPENDIX -- DESCRIPTION OF RATINGS
MOODY'S INVESTORS SERVICE
BOND RATINGS:
"Aaa" -- Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
"Aa" -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
Moody's applies numerical modifiers "1," "2" and "3" in each generic rating
classification from Aa through B. The modifier "1" indicates that the obligation
ranks in the higher end of its generic rating category; the modifier "2"
indicates a mid-range ranking; and the modifier "3" indicates that the company
ranks in the lower end of that generic rating category.
"A" -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
"Baa" -- Bonds which are rated Baa are considered as medium-grade obligations
(that is, 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 which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
"B" -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
SHORT-TERM DEBT RATINGS:
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
"PRIME-1" -- Issuers rated "Prime-1" (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of these characteristics:
- Leading market positions in well-established industries.
- High rates of return on funds employed.
- Conservative capitalization structure with moderate reliance on debt and
ample asset protection.
- Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
- Well-established access to a range of financial markets and assured
sources of alternate liquidity.
"PRIME-2" -- Issuers rated "Prime-2" (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above,
A-1
<PAGE> 481
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. Adequate alternate
liquidity is maintained.
MUNICIPAL BOND RATINGS:
Moody's ratings for state and municipal short-term obligations are designated
Moody's Investment Grade or "MIG" with variable rate demand obligations being
designated as "VMIG." A VMIG rating may also be assigned to commercial paper
programs which are characterized as having variable short-term maturities, but
having neither a variable rate nor demand feature. Factors used in determining
ratings include liquidity of the borrower and short-term cyclical elements.
STANDARD & POOR'S RATING GROUP
BOND RATINGS:
"AAA" -- An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong.
"AA" -- An obligation rated AA differs from the highest rated obligations only
in small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
"A" -- An obligation rated A is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
"BBB" -- An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its commitment on the
obligation.
Obligations rated BB and B are regarded as having significant speculative
characteristics. While such obligations will likely have some quality and
protective characteristics, these may be outweighed by large uncertainties or
major exposures to adverse conditions.
COMMERCIAL PAPER RATINGS:
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market.
"A-1" -- This designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
"A-2" -- Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
MUNICIPAL BOND RATINGS:
S&P uses SP-1, SP-2 and SP-3 to rate short-term municipal obligations. A rating
of SP-1 denotes a strong capacity to pay principal and interest. An issue
determined to possess a very strong capacity to pay debt service is given a (+)
designation.
FITCH INVESTORS SERVICE, INC.
BOND RATINGS:
The following summarizes the ratings used by Fitch for corporate bonds:
"AAA" -- Highest credit quality. "AAA" ratings denote the lowest expectation of
credit risk. They 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.
A-2
<PAGE> 482
"AA" -- Very high credit quality. "AA" ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
"A" -- High credit quality. "A" ratings denote a low expectation of credit risk.
The capacity for timely payment of financial commitments is considered strong.
This capacity may, nevertheless, be more vulnerable to changes in circumstances
or in economic conditions than is the case for higher ratings.
"BBB" -- Good credit quality. "BBB" ratings indicate 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" -- Speculative. "BB" 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" -- Highly speculative. "B" 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.
PLUS (+) MINUS (--) -- Plus and minus signs may be appended to a rating to
denote relative status within major rating categories. Such suffixes are not
added to the "AAA" long-term rating category or to short-term ratings other than
"F1."
SHORT-TERM DEBT RATINGS:
"F1" -- Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
"F2" -- Good credit quality. 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.
"F3" -- Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
DUFF & PHELPS CREDIT RATING CO.
BOND RATINGS:
The following summarizes the ratings used by Duff & Phelps for long-term debt:
"AAA" -- Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
"AA+," "AA," "AA--" -- High credit quality. Protection factors are strong. Risk
is modest but may vary slightly from time to time because of economic
conditions.
"A+," "A," "A--" -- Protection factors are average but adequate. However, risk
factors are more variable and greater in periods of economic stress.
"BBB+," "BBB," "BBB--" -- Below-average protection factors but still considered
sufficient for prudent investment. Considerable variability in risk during
economic cycles.
"BB+," "BB," "BB--" -- Below investment grade but deemed likely to meet
obligations when due. Present or prospective financial protection factors
fluctuate according to industry conditions or company fortunes. Overall quality
may move up or down frequently within this category.
"B+," "B," "B--" -- Below investment grade and possessing risk that obligations
will not be met when due. Financial protection factors will fluctuate widely
according to economic cycles, industry conditions and/or
A-3
<PAGE> 483
company fortunes. Potential exists for frequent changes in the rating within
this category or into a higher or lower rating grade.
SHORT-TERM DEBT RATINGS:
"D-1+" -- Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of funds, is
outstanding and safety is just below risk-free U.S. Treasury short-term
obligations.
"D-1" -- Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are minor.
"D-1--" -- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
"D-2" -- Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small.
A-4
<PAGE> 484
STATEMENT OF ADDITIONAL INFORMATION
MERCURY TOTAL RETURN BOND FUND
OF MERCURY HW FUNDS
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017 - Phone No.
(800) 236-4479
------------------------
Mercury Total Return Bond Fund (the "Fund") is a fund of Mercury HW Funds
(the "Trust"). The Trust is a diversified, open-end management investment
company which is organized as a Massachusetts business trust. The investment
objective of Fund is to seek to maximize long-term total return. The Fund seeks
to achieve its investment objective by investing primarily in a diversified
portfolio of bonds of different maturities. No assurance can be given that the
investment objective of the Fund will be realized. For more information on the
Fund's investment objective and policies, see "Investment Objective and
Policies."
The Fund is a "feeder" fund that invests all of its assets in the Total
Return Bond Master Portfolio (the "Portfolio") of the Fund Asset Management
Master Trust (the "Master Trust"). The Portfolio has the same objective as the
Fund. All investments will be made at the Master Trust level. The Fund's
investment results will correspond directly to the investment results of the
Portfolio. There can be no assurance that the Fund will achieve its investment
objective.
The Fund offers four classes of shares, each with a different combination
of sales charges, ongoing fees and other features. These alternatives permit an
investor to choose the method of purchasing shares that the investor believes is
most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances. See
"Purchase of Shares."
------------------------
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the prospectus of the Fund, dated October , 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Fund at
1-800-236-4479 or your financial consultant or other financial intermediary, or
by writing to the Fund at Financial Data Services, Inc., P.O. Box 41621,
Jacksonville, Florida 32232-1621. The Prospectus is incorporated by reference
into this Statement of Additional Information, and this Statement of Additional
Information is incorporated by reference into the Prospectus.
------------------------
MERCURY ADVISORS -- INVESTMENT ADVISER
FAM DISTRIBUTORS, INC. -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is October , 2000
<PAGE> 485
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Trust History............................................... 3
Investment Objective and Policies........................... 3
Investment Restrictions................................... 3
Repurchase Agreements..................................... 4
U.S. Government Securities................................ 4
Municipal Obligations..................................... 5
Corporate Debt Securities................................. 6
Convertible Securities.................................... 6
Mortgage-Related Securities............................... 7
Asset-Backed Securities................................... 10
Risk Factors Relating to Investing in Mortgage-Related and
Asset-Backed Securities................................. 10
Duration.................................................. 11
Derivative Instruments.................................... 11
Foreign Securities........................................ 15
Foreign Currency Options and Related Risks................ 17
Forward Foreign Currency Exchange Contracts............... 17
Foreign Investment Risks.................................. 19
Risk Factors Relating to Investing in High Yield
Securities.............................................. 21
Illiquid Securities....................................... 21
Reverse Repurchase Agreements............................. 22
Dollar Rolls.............................................. 23
Borrowing................................................. 23
Loans of Portfolio Securities............................. 23
When-Issued Securities.................................... 23
Real Estate Investment Trusts............................. 23
Shares of Other Investment Companies...................... 24
Temporary Defensive Position.............................. 24
Short Sales Against-the-Box............................... 24
Corporate Loans........................................... 24
Management of the Fund...................................... 24
Management and Advisory Arrangements...................... 26
Administration Arrangements............................... 27
Code of Ethics............................................ 28
Purchase of Shares.......................................... 29
Initial Sales Charge Alternatives -- Class I and Class A
Shares.................................................. 30
Reduced Initial Sales Charges............................. 31
Deferred Sales Charge Alternatives -- Class B and Class C
Shares.................................................. 32
Distribution Plans........................................ 35
Limitations on the Payment of Deferred Sales Charges...... 36
Redemption of Shares........................................ 36
Redemption................................................ 37
Repurchase................................................ 37
Reinstatement Privilege -- Class I and Class A Shares..... 38
Pricing of Shares........................................... 38
Determination of Net Asset Value.......................... 38
Computation of Offering Price Per Share................... 40
Portfolio Transactions and Brokerage........................ 40
Transactions in Portfolio Securities...................... 40
Shareholder Services........................................ 42
Investment Account........................................ 42
Exchange Privilege........................................ 42
Fee-Based Programs........................................ 44
Retirement Plans.......................................... 44
Automatic Investment Plans................................ 44
Automatic Dividend Reinvestment Plan...................... 45
Systematic Withdrawal Plans............................... 45
Dividends and Tax Status.................................... 46
Performance Data............................................ 47
General Information......................................... 49
Description of Shares..................................... 49
Issuance of Fund Shares for Securities.................... 50
Redemption in Kind........................................ 50
Principal Holders......................................... 51
Independent Auditors...................................... 51
Custodian................................................. 51
Transfer Agent............................................ 51
Legal Counsel............................................. 51
Reports to Shareholders................................... 51
Shareholder Inquiries..................................... 51
Additional Information.................................... 51
Appendix--Description of Ratings............................ A-1
Financial Statements........................................ F-1
</TABLE>
2
<PAGE> 486
TRUST HISTORY
The Trust was organized on August 22, 1984 as a Massachusetts business
trust. Before October 7, 1994, the Trust was called "Olympic Trust," and before
October , 2000, the Trust was called "Hotchkis and Wiley Funds." The Trust is
a diversified, open-end management investment company currently consisting of
ten separate funds. Prior to October , 2000, the Fund was called the Total
Return Bond Fund.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to maximize long-term total return.
The Fund is a "feeder" fund that invests all of its assets in the
Portfolio, which has the same investment objective as the Fund. All investments
will be made at the Portfolio level. This structure is sometimes called a
"master/feeder" structure. The Fund's investment results will correspond
directly to the investment results of the Portfolio. For simplicity, however,
this Statement of Additional Information, like the Prospectus, uses the term
"Fund" to include the Portfolio. There can be no assurance that the investment
objective of the Fund or the investment objective of the Portfolio will be
realized. The investment objective of the Fund is a fundamental policy of the
Fund and may not be changed without the approval of a majority of the Fund's
outstanding voting securities as defined in the Investment Company Act of 1940,
as amended (the "1940 Act"). The investment objective of the Portfolio is a
fundamental policy of the Portfolio and may not be changed without the approval
of a majority of the Portfolio's outstanding voting securities as defined in the
1940 Act. Reference is made to the discussion under "How the Fund Invests" and
"Investment Risks" in the Prospectus for information with respect to the Fund's
and the Portfolio's investment objective and policies.
Mercury Advisors (the "Investment Adviser"), the Fund's investment adviser,
is responsible for the management of the Fund's portfolio.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of the Fund's outstanding
voting securities, as defined in the 1940 Act. Under the 1940 Act, the vote of
the holders of a "majority" of the Fund's outstanding voting securities means
the vote of the holders of the lesser of (1) 67% of the shares of the Fund
represented at a meeting at which the holders of more than 50% of its
outstanding shares are represented or (2) more than 50% of the outstanding
shares.
Except as noted, the Fund may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Fund's total assets (determined at the time of investment) would
then be invested in securities of a single issuer; or (ii) more than
25% of the Fund's total assets (determined at the time of investment)
would be invested in one or more issuers having their principal
business activities in a single industry; provided that the Fund may
invest all of its assets in an open-end management investment company,
or portfolio thereof, with substantially the same investment objective
and policies as the Fund, without regard to the limitations set forth
in this paragraph.
2. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions),
provided that the deposit or payment by the Fund of initial or
maintenance margin in connection with futures or options is not
considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in
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amount to, the securities sold short (short sale against-the-box), and
unless not more than 25% of the Fund's net assets (taken at current
value) is held as collateral for such sales at any one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Fund may borrow from a bank for temporary or emergency purposes in
amounts not exceeding 10% (taken at the lower of cost or current value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings. (The Fund may borrow from banks or
enter into reverse repurchase agreements and pledge assets in
connection therewith, but only if immediately after each borrowing
there is asset coverage of 300%.)
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would
then hold more than 10% of the outstanding voting securities of an
issuer; provided that the Fund may invest all of its assets in an
open-end management investment company, or portfolio thereof, with
substantially the same investment objective and policies as the Fund,
without regard to the limitations set forth in this paragraph.
6. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws; provided that the
purchase by the Fund of securities issued by an open-end management
investment company, or portfolio thereof, with substantially the same
investment objective and policies as the Fund shall not constitute an
underwriting for purposes of this paragraph.
7. Make investments for the purpose of exercising control or management;
provided that the Fund may invest all of its assets in an open-end
management investment company, or portfolio thereof, with substantially
the same investment objective and policies as the Fund, without regard
to the limitations set forth in this paragraph.
8. Participate on a joint or joint and several basis in any trading
account in securities.
Any percentage limitation on the Fund's investments is determined when the
investment is made, unless otherwise noted.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement where the seller agrees to
repurchase a security from the Fund at a mutually agreed-upon time and price.
The period of maturity is usually quite short, possibly overnight or a few days,
although it may extend over a number of months. The resale price is more than
the purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Fund's money is invested in the repurchase agreement. The
Fund's repurchase agreements will at all times be fully collateralized in an
amount at least equal to the resale price. The instruments held as collateral
are valued daily, and if the value of instruments declines, the Fund will
require additional collateral. In the event of a default, insolvency or
bankruptcy by a seller, the Fund will promptly seek to liquidate the collateral.
In such circumstances, the Fund could experience a delay or be prevented from
disposing of the collateral. To the extent that the proceeds from any sale of
such collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
BONDS
The term "bond" or "bonds" as used in the Prospectus is intended to include
all manner of fixed-income securities, debt securities, asset-backed and
mortgage-backed securities and other debt obligations unless specifically
defined or the context requires otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
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Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. The Fund will
invest in securities of such instrumentality only when the Investment Adviser is
satisfied that the credit risk with respect to any instrumentality is
acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely, either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (1) Treasury obligations from which the interest coupons
have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member bank representing ownership of Treasury obligation
components; or (4) receipts evidencing the component parts (corpus or coupons)
of Treasury obligations that have not actually been stripped. Such receipts
evidence ownership of component parts of Treasury obligations (corpus or
coupons) purchased by a third party (typically an investment banking firm) and
held on behalf of the third party in physical or book-entry form by a major
commercial bank or trust company pursuant to a custody agreement with the third
party. These custodial receipts are known by various names, including "Treasury
Receipts," "Treasury Investment Growth Receipts" ("TIGRs") and "Certificates of
Accrual on Treasury Securities" ("CATS"), and are not issued by the U.S.
Treasury; therefore they are not U.S. Government securities, although the
underlying bonds represented by these receipts are debt obligations of the U.S.
Treasury.
MUNICIPAL OBLIGATIONS
The Fund may invest in municipal obligations. The two principal
classifications of municipal bonds, notes and commercial paper are "general
obligation" and "revenue" bonds, notes or commercial paper. General obligation
bonds, notes or commercial paper are secured by the issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest.
Issuers of general obligation bonds, notes or commercial paper include states,
counties, cities, towns and other governmental units. Revenue bonds, notes and
commercial paper are payable from the revenues derived from a particular
facility or class of facilities or, in some cases, from specific revenue
sources. Revenue bonds, notes or commercial paper are issued for a wide variety
of purposes, including the financing of electric, gas, water and sewer systems
and other public utilities; industrial development and pollution control
facilities; single and multifamily housing units; public buildings and
facilities; air and marine ports; transportation facilities such as toll roads,
bridges and tunnels; and health and educational facilities such as hospitals and
dormitories. They rely primarily on user fees to pay debt service, although the
principal revenue source is often supplemented by additional security features
which are intended to enhance the creditworthiness of the issuer's obligations.
In some cases, particularly revenue bonds issued to finance housing and public
buildings, a direct or implied "moral obligation" of a governmental unit may be
pledged to the payment of debt service. In other cases, a special tax or other
charge may augment user fees.
Included within the revenue bonds category are participations in municipal
lease obligations or installment purchase contracts of municipalities
(collectively, "lease obligations"). State and local governments issue lease
obligations to acquire equipment leases and facilities. Lease obligations may
have risks not normally associated with general obligation or other revenue
bonds. Leases and installment purchase or conditional sale contracts (which may
provide for title to the leased asset to pass eventually to the issuer) have
developed as a means for governmental issuers to acquire property and equipment
without the necessity of complying with the constitutional and statutory
requirements generally applicable for the issuance of debt. Certain lease
obligations contain "non-appropriation" clauses that provide that the
governmental issuer has no obligation to make future payments under the lease or
contract unless money is appropriated for such purpose by the appropriate
legislative body on an annual or other periodic basis. Consequently, continued
lease payments on those lease obligations containing "non-appropriation" clauses
are dependent on future legislative
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actions. If such legislative actions do not occur, the holders of the lease
obligations may experience difficulty in exercising their rights, including
disposition of the property.
Private activity obligations are issued to finance, among other things,
privately operated housing facilities, pollution control facilities, convention
or trade show facilities, mass transit, airport, port or parking facilities and
certain facilities for water supply, gas, electricity, sewage or solid waste
disposal. Private activity obligations are also issued to privately held or
publicly owned corporations in the financing of commercial or industrial
facilities. The principal and interest on these obligations may be payable from
the general revenues of the users of such facilities. Shareholders, depending on
their individual tax status, may be subject to the federal alternative minimum
tax on the portion of a distribution attributable to these obligations. Interest
on private activity obligations will be considered exempt from federal income
taxes; however, shareholders should consult their own tax advisors to determine
whether they may be subject to the federal alternative minimum tax.
Resource recovery obligations are a type of municipal revenue obligation
issued to build facilities such as solid waste incinerators or waste-to-energy
plants. Usually, a private corporation will be involved and the revenue cash
flow will be supported by fees or units paid by municipalities for the use of
the facilities. The viability of a resource recovery project, environmental
protections regulations and project operator tax incentives may affect the value
and credit quality of these obligations.
Tax, revenue or bond anticipation notes are issued by municipalities in
expectation of future tax or other revenues which are payable from these
specific taxes or revenues. Bond anticipation notes usually provide interim
financing in advance of an issue of bonds or notes, the proceeds of which are
used to repay the anticipation notes. Tax-exempt commercial paper is issued by
municipalities to help finance short-term capital or operating needs in
anticipation of future tax or other revenue.
A variable rate obligation is one whose terms provide for the adjustment of
its interest rate on set dates and which, upon such adjustment, can reasonably
be expected to have a market value that approximates its par value. A floating
rate obligation has terms which provide for the adjustment of its interest rate
whenever a specified interest rate changes and which, at any time, can
reasonably be expected to have a market value that approximates its par value.
Variable or floating rate obligations may be secured by bank letters of credit.
Variable rate auction and residual interest obligations are created when an
issuer or dealer separates the principal portion of a long-term, fixed-rate
municipal bond into two long-term, variable-rate instruments. The interest rate
on one portion reflects short-term interest rates, while the interest rate on
the other portion is typically higher than the rate available on the original
fixed-rate bond.
Yields on municipal securities are dependent on a variety of factors,
including the general conditions of the municipal bond and municipal note
markets, the size of a particular offering, the maturity of the obligation and
the rating of the issue. The achievement of the Fund's investment objective is
dependent in part on the continuing ability of the issuers of municipal
securities in which the Fund invests to meet their obligations for the payment
of principal and interest when due. Obligations of issuers of municipal
securities are subject to the provisions of bankruptcy, insolvency and other
laws affecting the rights and remedies of creditors, such as the Bankruptcy
Reform Act of 1978, as amended. Therefore, the possibility exists that, as a
result of litigation or other conditions, the ability of any issuer to pay, when
due, the principal of and interest on its municipal securities may be materially
affected.
CORPORATE DEBT SECURITIES
The Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, are in the Investment Adviser's opinion comparable
in quality to corporate debt securities in which the Fund may invest. The rate
of return or return of principal on some debt obligations may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
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CONVERTIBLE SECURITIES
The Fund may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying common stock.
The price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
MORTGAGE-RELATED SECURITIES
The Fund may invest in residential or commercial mortgage-related
securities, including mortgage pass-through securities, collateralized mortgage
obligations ("CMOs"), adjustable rate mortgage securities, CMO residuals,
stripped mortgage-related securities, floating and inverse floating rate
securities and tiered index bonds.
Mortgage Pass-Through Securities. Mortgage pass-through securities
represent interests in pools of mortgages in which payments of both principal
and interest on the securities are generally made monthly, in effect "passing
through" monthly payments made by borrowers on the residential or commercial
mortgage loans which underlie the securities (net of any fees paid to the issuer
or guarantor of the securities). Mortgage pass-through securities differ from
other forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Early repayment of principal on mortgage pass-through securities (arising
from prepayments of principal due to the sale of underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose the Fund to a lower rate of return upon reinvestment of principal. Also,
if a security subject to repayment has been purchased at a premium, in the event
of prepayment, the value of the premium would be lost.
There are currently three types of mortgage pass-through securities: (1)
those issued by the U.S. Government or one of its agencies or instrumentalities,
such as the Government National Mortgage Association ("Ginnie Mae"), the Federal
National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage
Corporation ("Freddie Mac"); (2) those issued by private issuers that represent
an interest in or are collateralized by pass-through securities issued or
guaranteed by the U.S. Government or one of its agencies or instrumentalities;
and (3) those issued by private issuers that represent an interest in or are
collateralized by whole mortgage loans or pass-through securities without a
government guarantee but usually having some form of private credit enhancement.
Ginnie Mae is a wholly-owned United States Government corporation within
the Department of Housing and Urban Development. Ginnie Mae is authorized to
guarantee, with the full faith and credit of the United States Government, the
timely payment of principal and interest on securities issued by the
institutions approved by Ginnie Mae (such as savings and loan institutions,
commercial banks and mortgage banks), and backed by pools of FHA-insured or
VA-guaranteed mortgages.
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Obligations of Fannie Mae and Freddie Mac are not backed by the full faith
and credit of the United States Government. In the case of obligations not
backed by the full faith and credit of the United States Government, the Fund
must look principally to the agency issuing or guaranteeing the obligation for
ultimate repayment. Fannie Mae and Freddie Mac may borrow from the U.S. Treasury
to meet their obligations, but the U.S. Treasury is under no obligation to lend
to Fannie Mae or Freddie Mac.
Private mortgage pass-through securities are structured similarly to Ginnie
Mae, Fannie Mae, and Freddie Mac mortgage pass-through securities and are issued
by originators of and investors in mortgage loans, including depository
institutions, mortgage banks, investment banks and special purpose subsidiaries
of the foregoing.
Pools created by private mortgage pass-through issuers generally offer a
higher rate of interest than government and government-related pools because
there are no direct or indirect government or agency guarantees of payments in
the private pools. However, timely payment of interest and principal of these
pools may be supported by various forms of insurance or guarantees, including
individual loan, title, pool and hazard insurance and letters of credit. The
insurance and guarantees are issued by governmental entities, private insurers
and the mortgage poolers. The insurance and guarantees and the creditworthiness
of the issuers thereof will be considered in determining whether a
mortgage-related security meets the Fund's investment quality standards. There
can be no assurance that the private insurers or guarantors can meet their
obligations under the insurance policies or guarantee arrangements. Private
mortgage pass-through securities may be bought without insurance or guarantees
if, through an examination of the loan experience and practices of the
originator/servicers and poolers, the Investment Adviser determines that the
securities meet the Fund's quality standards.
Collateralized Mortgage Obligations. CMOs are debt obligations
collateralized by residential or commercial mortgage loans or residential or
commercial mortgage pass-through securities. Interest and prepaid principal are
generally paid monthly. CMOs may be collateralized by whole mortgage loans or
private mortgage pass-through securities but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by Ginnie Mae,
Freddie Mac, or Fannie Mae. The issuer of a series of CMOs may elect to be
treated as a Real Estate Mortgage Investment Conduit ("REMIC"). All future
references to CMOs also include REMICs.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral which is ordinarily unrelated to the stated
maturity date. CMOs often provide for a modified form of call protection through
a de facto breakdown of the underlying pool of mortgages according to how
quickly the loans are repaid. Monthly payment of principal received from the
pool of underlying mortgages, including prepayments, is first returned to
investors holding the shortest maturity class. Investors holding the longer
maturity classes usually receive principal only after the first class has been
retired. An investor may be partially protected against a sooner than desired
return of principal because of the sequential payments.
Certain issuers of CMOs are not considered investment companies pursuant to
a rule adopted by the Commission and the Fund may invest in the securities of
such issuers without the limitations imposed by the 1940 Act on investments by
the Fund in other investment companies. In addition, in reliance on an earlier
Commission interpretation, the Fund's investments in certain other qualifying
CMOs, which cannot or do not rely on the rule, are also not subject to the
limitation of the 1940 Act on acquiring interests in other investment companies.
In order to be able to rely on the Commission's interpretation, these CMOs must
be unmanaged, fixed asset issuers, that: (1) invest primarily in mortgage-backed
securities; (2) do not issue redeemable securities; (3) operate under general
exemptive orders exempting them from all provisions of the 1940 Act; and (4) are
not registered or regulated under the 1940 Act as investment companies. To the
extent that the Fund selects CMOs that cannot rely on the rule or do not meet
the above requirements, the Fund may not invest more than 10% of its assets in
all such entities and may not acquire more than 3% of the voting securities of
any single such entity.
The Fund may also invest in, among other things, parallel pay CMOs, Planned
Amortization Class CMOs ("PAC bonds"), sequential pay CMOs, and floating rate
CMOs. Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. PAC bonds
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generally require payments of a specified amount of principal on each payment
date. Sequential pay CMOs generally pay principal to only one class while paying
interest to several classes. Floating rate CMOs are securities whose coupon rate
fluctuates according to some formula related to an existing market index or
rate. Typical indexes would include the eleventh district cost-of-funds index
("COFI"), the London Interbank Offered Rate ("LIBOR"), one-year Treasury yields,
and ten-year Treasury yields.
Adjustable Rate Mortgage Securities. Adjustable rate mortgage securities
("ARMs") are pass-through securities collateralized by mortgages with adjustable
rather than fixed rates. ARMs eligible for inclusion in a mortgage pool
generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, thirty-six, or sixty scheduled monthly
payments. Thereafter, the interest rates are subject to periodic adjustment
based on changes to a designated benchmark index.
The ARMs contain maximum and minimum rates beyond which the mortgage
interest rate may not vary over the lifetime of the security. In addition,
certain ARMs provide for additional limitations on the maximum amount by which
the mortgage interest rate may adjust for any single adjustment period. In the
event that market rates of interest rise more rapidly to levels above that of
the ARM's maximum rate, the ARM's coupon may represent a below market rate of
interest. In these circumstances, the market value of the ARM security will
likely have fallen.
Certain ARMs contain limitations on changes in the required monthly
payment. In the event that a monthly payment is not sufficient to pay the
interest accruing on an ARM, any such excess interest is added to the principal
balance of the mortgage loan, which is repaid through future monthly payments.
If the monthly payment for such an instrument exceeds the sum of the interest
accrued at the applicable mortgage interest rate and the principal payment
required at such point to amortize the outstanding principal balance over the
remaining term of the loan, the excess is then utilized to reduce the
outstanding principal balance of the ARM.
CMO Residuals. CMO residuals are derivative mortgage securities issued by
agencies or instrumentalities of the U.S. Government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks, and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
part, the yield to maturity on the CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-related securities. See
"Stripped Mortgage-Related Securities" below. In addition, if a series of a CMO
includes a class that bears interest at an adjustable rate, the yield to
maturity on the related CMO residual will also be extremely sensitive to changes
in the level of the index upon which interest rate adjustments are based. As
described below with respect to stripped mortgage-related securities, in certain
circumstances the Fund may fail to recoup fully its initial investment in a CMO
residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has recently developed and CMO residuals currently may not have
the liquidity of other more established securities trading in other markets.
Transactions in CMO residuals are generally completed only after careful review
of the characteristics of the securities in question. In addition, CMO residuals
may or, pursuant to an exemption therefrom, may not have been registered under
the Securities Act of 1933, as amended ("Securities Act"). CMO residuals,
whether or not registered under such Act, may be subject to certain restrictions
on transferability, and may be deemed "illiquid" and subject to the Fund's
limitations on investment in illiquid securities.
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Stripped Mortgage-Related Securities. Stripped mortgage-related securities
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. Government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks, and special purpose entities
of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the IO class), while
the other class will receive all of the principal (the PO class). The yield to
maturity on an IO class is extremely sensitive to the rate of principal payments
(including prepayments) on the related underlying mortgage assets, and a rapid
rate of principal payments may have a material adverse effect on the Fund's
yield to maturity from these securities. If the underlying mortgage assets
experience greater than anticipated prepayments of principal, the Fund may fail
to fully recoup its initial investment in these securities even if the security
is in one of the highest rating categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently introduced. As a result, established trading markets have not
yet been fully developed and accordingly, these securities may be deemed
"illiquid" and subject to the Fund's limitations on investment in illiquid
securities.
Inverse Floaters. An inverse floater is a debt instrument with a floating
or variable interest rate that moves in the opposite direction to the interest
rate on another security or index level. Changes in the interest rate on the
other security or index inversely affect the residual interest rate paid on the
inverse floater, with the result that the inverse floater's price will be
considerably more volatile than that of a fixed rate bond. Inverse floaters may
experience gains when interest rates fall and may suffer losses in periods of
rising interest rates. The market for inverse floaters is relatively new.
Tiered Index Bonds. Tiered index bonds are relatively new forms of
mortgage-related securities. The interest rate on a tiered index bond is tied to
a specified index or market rate. So long as this index or market rate is below
a predetermined "strike" rate, the interest rate on the tiered index bond
remains fixed. If, however, the specified index or market rate rises above the
"strike" rate, the interest rate of the tiered index bond will decrease. Thus,
under these circumstances, the interest rate on a tiered index bond, like an
inverse floater, will move in the opposite direction of prevailing interest
rates, with the result that the price of the tiered index bond may be
considerably more volatile than that of a fixed-rate bond.
ASSET-BACKED SECURITIES
The Fund may invest in various types of asset-backed securities. Through
the use of trusts and special purpose corporations, various types of assets,
primarily automobile and credit card receivables and home equity loans, are
being securitized in pass-through structures similar to the mortgage
pass-through or in a pay-through structure similar to the CMO structure.
Investments in these and other types of asset-backed securities must be
consistent with the investment objective and policies of the Fund.
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-RELATED AND ASSET-BACKED
SECURITIES
The yield characteristics of mortgage-related and asset-backed securities
differ from traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
or other assets generally may be prepaid at any time. As a result, if the Fund
purchases such a security at a premium, a prepayment rate that is faster than
expected will reduce yield to maturity, while a prepayment rate that is slower
than expected will have the opposite effect of increasing yield to maturity.
Alternatively, if the Fund purchases these securities at a discount, faster than
expected prepayments will increase, while slower than expected prepayments will
reduce, yield to maturity. The Fund may invest a portion of its assets in
derivative mortgage-related securities which are highly sensitive to changes in
prepayment and interest rates.
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The Investment Adviser will seek to manage these risks (and potential benefits)
by diversifying its investments in such securities and through hedging
techniques.
During periods of declining interest rates, prepayment of mortgages
underlying mortgage-related securities can be expected to accelerate.
Accordingly, the Fund's ability to maintain positions in high-yielding
mortgage-related securities will be affected by reductions in the principal
amount of such securities resulting from such prepayments, and its ability to
reinvest the returns of principal at comparable yields is subject to generally
prevailing interest rates at that time. Conversely, slower than expected
prepayments may effectively change a security that was considered short or
intermediate-term at the time of purchase into a long-term security. Long-term
securities tend to fluctuate more in response to interest rate changes, leading
to increased net asset value volatility. Prepayments may also result in the
realization of capital losses with respect to higher yielding securities that
had been bought at a premium or the loss of opportunity to realize capital gains
in the future from possible future appreciation.
Asset-backed securities involve certain risks that are not posed by
mortgage-related securities, resulting mainly from the fact that asset-backed
securities do not usually contain the complete benefit of a security interest in
the related collateral. For example, credit card receivables generally are
unsecured and the debtors are entitled to the protection of a number of state
and federal consumer credit laws, some of which may reduce the ability to obtain
full payment. In the case of automobile receivables, due to various legal and
economic factors, proceeds from repossessed collateral may not always be
sufficient to support payments on these securities.
DURATION
In selecting securities for the Fund, the Investment Adviser makes use of
the concept of duration for fixed-income securities. Duration is a measure of
the expected life of a fixed-income security. Duration incorporates a bond's
yield, coupon interest payments, final maturity and call features into one
measure. Most debt obligations provide interest ("coupon") payments in addition
to a final ("par") payment at maturity. Some obligations also have call
provisions. Depending on the relative magnitude of these payments, the market
values of debt obligations may respond differently to changes in the level and
structure of interest rates.
Duration is a measure of the expected life of a fixed-income security on a
present value basis. Duration takes the length of the time intervals between the
present time and the time that the interest and principal payments are scheduled
or, in the case of a callable bond, expected to be received, and weights them by
the present values of the cash to be received at each future point in time. For
any fixed-income security with interest payments occurring prior to the payment
of principal, duration is always less than maturity. In general, all other
things being the same, the lower the stated or coupon rate of interest of a
fixed-income security, the longer the duration of the security; conversely, the
higher the stated or coupon rate of interest of a fixed-income security, the
shorter the duration of the security.
Futures, options and options on futures have durations which, in general,
are closely related to the duration of the securities which underlie them.
Holding long futures or call option positions (backed by a segregated account of
cash and cash equivalents) will lengthen the Fund's duration by approximately
the same amount that holding an equivalent amount of the underlying securities
would.
Short futures or put options positions have durations roughly equal to the
negative duration of the securities that underlie those positions, and have the
effect of reducing portfolio duration by approximately the same amount that
selling an equivalent amount of the underlying securities would.
There are some situations where even the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by duration is the case of mortgage pass-through securities. The stated
final maturity of such securities is generally 30 years, but current prepayment
rates are more critical in determining the securities' interest rate exposure.
In these and
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other similar situations, the Investment Adviser will use more sophisticated
analytical techniques that incorporate the economic life of a security into the
determination of its interest rate exposure.
DERIVATIVE INSTRUMENTS
As indicated in the prospectus, to the extent consistent with its
investment objective and policies and the investment restrictions listed in this
Statement of Additional Information, the Fund may purchase and write call and
put options on securities, securities indexes and foreign currencies and enter
into forward contracts, futures contracts and use options on futures contracts.
The Fund also may enter into swap agreements with respect to foreign currencies,
interest rates and securities indexes. The Fund may use these techniques to
hedge against changes in interest rates, foreign currency exchange rates, or
securities prices or as part of its overall investment strategies. The Fund may
also purchase and sell options relating to foreign currencies for the purpose of
increasing exposure to a foreign currency or to shift exposure to foreign
currency fluctuations from one country to another. The Fund will mark as
segregated cash, U.S. Government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily (or, as permitted by applicable
regulation, enter into certain offsetting positions), to cover its obligations
under forward contracts, futures contracts, swap agreements and options to avoid
leveraging of the Fund.
Options on Securities and on Securities Indexes. The Fund may purchase put
options on securities to protect holdings in an underlying or related security
against a substantial decline in market value. The Fund may purchase call
options on securities to protect against substantial increases in prices of
securities the Fund intends to purchase pending its ability to invest in such
securities in an orderly manner. The Fund may sell put or call options it has
previously purchased, which could result in a net gain or loss depending on
whether the amount realized on the sale is more or less than the premium and
other transaction costs paid on the put or call option which is sold. The Fund
may write a call or put option only if the option is "covered" by the Fund
holding a position in the underlying securities or by other means which would
permit immediate satisfaction of the Fund's obligation as writer of the option.
Prior to exercise or expiration, an option may be closed out by an offsetting
purchase or sale of an option of the same series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes,
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during the option's life, the opportunity to profit from increases in the market
value of the security covering the call option above the sum of the premium and
the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
Futures Contracts and Options on Futures Contracts. The Fund may use
interest rate, foreign currency or index futures contracts, as specified for the
Fund in its prospectus. An interest rate, foreign currency or index futures
contract provides for the future sale by one party and purchase by another party
of a specified quantity of a financial instrument, foreign currency or the cash
value of an index at a specified price and time. A futures contract on an index
is an agreement pursuant to which two parties agree to take or make delivery of
an amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. Although the value of an index might be a
function of the value of certain specified securities, no physical delivery of
these securities is made.
The Fund may purchase and write call and put options on futures. Options on
futures possess many of the same characteristics as options on securities and
indexes (discussed above). An option on a futures contract gives the holder the
right, in return for the premium paid, to assume a long position (call) or short
position (put) in a futures contract at a specified exercise price at any time
during the period of the option. Upon exercise of a call option, the holder
acquires a long position in the futures contract and the writer is assigned the
opposite short position. In the case of a put option, the opposite is true.
The Fund will use futures contracts and options on futures contracts in
accordance with the rules of the Commodity Futures Trading Commission ("CFTC").
For example, the Fund might use futures contracts to hedge against anticipated
changes in interest rates that might adversely affect either the value of the
Fund's securities or the price of the securities which the Fund intends to
purchase. The Fund's hedging activities may include sales of futures contracts
as an offset against the effect of expected increases in interest rates, and
purchases of futures contracts as an offset against the effect of expected
declines in interest rates. Although other techniques could be used to reduce
the Fund's exposure to interest rate fluctuations, the Fund may be able to hedge
its exposure more effectively and perhaps at a lower cost by using futures
contracts and options on futures contracts.
The Fund will only enter into futures contracts and options on futures
contracts which are standardized and traded on a U.S. or foreign exchange, board
of trade, or similar entity, or quoted on an automated quotation system.
When a purchase or sale of a futures contract is made by the Fund, the Fund
is required to deposit with its custodian or future commission merchant a
specified amount of cash or U.S. government securities ("initial margin"). The
margin required for a futures contract is set by the exchange on which the
contract is traded and may be modified during the term of the contract. The
initial margin is in the nature of a performance bond or good faith deposit on
the futures contract which is returned to the Fund upon termination of the
contract, assuming all contractual obligations have been satisfied. The Fund
expects to earn interest income on its initial margin deposits. A futures
contract held by the Fund is valued daily at the official settlement price of
the exchange on which it is traded. Each day the Fund pays or receives cash,
called "variation margin", equal to the daily change in value of the futures
contract. This process is known as "marking to market". Variation margin does
not represent a borrowing or loan by the Fund but is instead a settlement
between the Fund and the broker of the amount one would owe the other if the
futures contract expired. In computing daily net asset value, the Fund will mark
to market its open futures positions.
The Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures
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<PAGE> 497
contract (and the related initial margin requirements), the current market value
of the option, and other futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying security or index and delivery month). If an offsetting
purchase price is less than the original sale price, the Fund realizes a capital
gain, or if it is more, the Fund realizes a capital loss. Conversely, if an
offsetting sale price is more than the original purchase price, the Fund
realizes a capital gain, or if it is less, the Fund realizes a capital loss. The
transaction costs must also be included in these calculations.
Limitations on Use of Futures and Options Thereon. When purchasing a
futures contract, the Fund will maintain with its custodian (and mark-to-market
on a daily basis) cash, U.S. Government securities, equity securities or other
liquid, unencumbered assets that, when added to the amounts deposited as margin
with a futures commission merchant as the custodian, are equal to the market
value of the futures contract. Alternatively, the Fund may "cover" its position
by purchasing a put option on the same futures contract with a strike price as
high or higher than the price of the contract held by the Fund.
When selling a futures contract, the Fund will maintain with its custodian
(and mark-to-market on a daily basis) liquid assets that, when added to the
amount deposited as margin with a futures commission merchant as the custodian,
are equal to the market value of the instruments underlying the contract.
Alternatively, the Fund may "cover" its position by owning the instruments
underlying the contract (or, in the case of an index futures contract, a
portfolio with a volatility substantially similar to that of the index on which
the futures contract is based), or by holding a call option permitting the Fund
to purchase the same futures contract at a price no higher than the price of the
contract written by the Fund (or at a higher price if the difference is
maintained in liquid assets with the Trust's custodian).
When selling a call option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets that, when
added to the amounts deposited as margin with a futures commission merchant as
the custodian, equal the total market value of the futures contract underlying
the call option. Alternatively, the Fund may cover its position by entering into
a long position in the same futures contract at a price no higher than the
strike price of the call option, by owning the instruments underlying the
futures contract, or by holding a separate call option permitting the Fund to
purchase the same futures contract at a price not higher than the strike price
of the call option sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets that equal
the purchase price of the futures contract, less any margin on deposit.
Alternatively, the Fund may cover the position either by entering into a short
position in the same futures contract, or by owning a separate put option
permitting it to sell the same futures contract so long as the strike price of
the purchased put option is the same or higher than the strike price of the put
option sold by the Fund.
In order to comply with current applicable regulations of the CFTC pursuant
to which the Trust avoids being deemed a "commodity pool operator," the Fund is
limited in its futures trading activities to positions which constitute "bona
fide hedging" positions within the meaning and intent of applicable CFTC rules,
or to non-hedging positions for which the aggregate initial margin and premiums
will not exceed 5% of the liquidation value of the Fund's assets.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not completely offset by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures
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contracts. Conversely, the Fund may purchase or sell fewer futures contracts if
the volatility of the price of the hedged securities is historically less than
that of the futures contracts.
The particular securities comprising the index underlying the index
financial futures contract may vary from the securities held by the Fund. As a
result, the Fund's ability to hedge effectively all or a portion of the value of
its securities through the use of such financial futures contracts will depend
in part on the degree to which price movements in the index underlying the
financial futures contract correlate with the price movements of the securities
held by the Fund. The correlation may be affected by disparities in the Fund's
investments as compared to those comprising the index and general economic or
political factors. In addition, the correlation between movements in the value
of the index may be subject to change over time as additions to and deletions
from the index alter its structure. The correlation between futures contracts on
U.S. Government securities and the securities held by the Fund may be adversely
affected by similar factors and the risk of imperfect correlation between
movements in the prices of such futures contracts and the prices of securities
held by the Fund may be greater. The trading of futures contracts also is
subject to certain market risks, such as inadequate trading activity, which
could at times make it difficult or impossible to liquidate existing positions.
The Fund expects to liquidate a majority of the futures contracts it enters
into through offsetting transactions on the applicable contract market. There
can be no assurance, however, that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close out a futures position. In the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. In such situations, if the Fund has insufficient cash, it may be
required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability to
close out futures positions also could have an adverse impact on the Fund's
ability to hedge effectively its investments. 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. Prices have in the past moved beyond the daily limit on a number of
consecutive trading days. The Fund will enter into a futures position only if,
in the judgment of the Investment Adviser, there appears to be an actively
traded secondary market for such futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Investment Adviser to forecast correctly the
direction and extent of interest rate movements within a given time frame. To
the extent interest rates remain stable during the period in which a futures
contract or option is held by the Fund or such rates move in a direction
opposite to that anticipated, the Fund may realize a loss on a hedging
transaction which is not fully or partially offset by an increase in the value
of portfolio securities. As a result, the Fund's total return for such period
may be less than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made upon the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. There is also the risk of loss by the
Fund of margin deposits in the event of the bankruptcy of a broker with whom the
Fund has an open position in a financial futures contract.
The amount of risk the Fund assumes when it purchases an option on a
futures contract is the premium paid for the option plus related transaction
costs. In addition to the correlation risks discussed above, the purchase of an
option on a futures contract 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.
FOREIGN SECURITIES
The Fund may invest in American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") or other securities convertible into securities of
issuers based in foreign countries. These securities may not necessarily be
denominated in the same currency as the securities into which they may be
converted.
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ADRs are receipts, usually issued by a U.S. bank or trust company, evidencing
ownership of the underlying securities; EDRs are European receipts evidencing a
similar arrangement. Generally, ADRs are issued in registered form, denominated
in U.S. dollars, and are designed for use in the U.S. securities markets; EDRs
are issued in bearer form, denominated in other currencies, and are designed for
use in European securities markets.
The Fund may also invest in fixed-income securities of issuers located in
emerging foreign markets. Emerging markets generally include every country in
the world other than the United States, Canada, Japan, Australia, Malaysia, New
Zealand, Hong Kong, South Korea, Singapore and most Western European countries.
In determining what countries constitute emerging markets, the Investment
Adviser will consider, among other things, data, analysis and classification of
countries published or disseminated by the International Bank for Reconstruction
and Development (commonly known as the World Bank) and the International Finance
Corporation. Currently, investing in many emerging markets may not be desirable
or feasible, because of the lack of adequate custody arrangements for the Fund's
assets, overly burdensome repatriation and similar restrictions, the lack of
organized and liquid securities markets, unacceptable political risks or other
reasons. As opportunities to invest in securities in emerging markets develop,
the Fund expects to expand and further broaden the group of emerging markets in
which it invests.
From time to time, emerging markets have offered the opportunity for higher
returns in exchange for a higher level of risk. Accordingly, the Investment
Adviser believes that the Fund's ability to invest in emerging markets
throughout the world can assist in the overall diversification of the Fund's
portfolio.
The Fund may invest in the following types of emerging market fixed-income
securities: (1) fixed-income securities issued or guaranteed by governments,
their agencies, instrumentalities or political subdivisions, or by government
owned, controlled or sponsored entities, including central banks (collectively,
"Sovereign Debt"), including Brady Bonds (described below); (2) interests in
issuers organized and operated for the purpose of restructuring the investment
characteristics of Sovereign Debt; (3) fixed-income securities issued by banks
and other business entities; and (4) fixed-income securities denominated in or
indexed to the currencies of emerging markets. Fixed-income securities held by
the Fund may take the form of bonds, notes, bills, debentures, bank debt
obligations, short-term paper, loan participations, assignments and interests
issued by entities organized and operated for the purpose of restructuring the
investment characteristics of any of the foregoing. There is no requirement with
respect to the maturity of fixed-income securities in which the Fund may invest.
The Fund may invest in Brady Bonds and other Sovereign Debt of countries
that have restructured or are in the process of restructuring Sovereign Debt
pursuant to the Brady Plan. "Brady Bonds" are debt securities issued under the
framework of the Brady Plan, an initiative announced by former U.S. Treasury
Secretary Nicholas F. Brady in 1989 as a mechanism for debtor nations to
restructure their outstanding external commercial bank indebtedness. In
restructuring its external debt under the Brady Plan framework, a debtor nation
negotiates with its existing bank lenders as well as multilateral institutions
such as the World Bank and the International Monetary Fund ("IMF"). The Brady
Plan framework, as it has developed, contemplates the exchange of commercial
bank debt for newly issued Brady Bonds. Brady Bonds may also be issued in
respect of new money being advanced by existing lenders in connection with the
debt restructuring. The World Bank and/or the IMF support the restructuring by
providing funds pursuant to loan agreements or other arrangements which enable
the debtor nation to collateralize the new Brady Bonds or to repurchase
outstanding bank debt at a discount.
Emerging market fixed-income securities generally are considered to be of a
credit quality below investment grade, even though they often are not rated by
any nationally recognized statistical rating organizations. Investment in
emerging market fixed-income securities will be allocated among various
countries based upon the Investment Adviser's analysis of credit risk and its
consideration of a number of factors, including: (1) prospects for relative
economic growth among the different countries in which the Fund may invest; (2)
expected levels of inflation; (3) government policies influencing business
conditions; (4) the outlook for currency relationships; and (5) the range of the
individual investment opportunities available to international investors. The
Investment Adviser's emerging market sovereign credit analysis includes an
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evaluation of the issuing country's total debt levels, currency reserve levels,
net exports/imports, overall economic growth, level of inflation, currency
fluctuation, political and social climate and payment history. Particular
fixed-income securities will be selected based upon a credit risk analysis of
potential issuers, the characteristics of the security, the interest rate
sensitivity of the various debt issues available with respect to a particular
issuer, an analysis of the anticipated volatility and liquidity of the
particular debt instruments, and the tax implications to the Fund. The emerging
market fixed-income securities in which the Fund may invest are not subject to
any minimum credit quality standards.
FOREIGN CURRENCY OPTIONS AND RELATED RISKS
The Fund may take positions in options on foreign currencies to hedge
against the risk that foreign exchange rate fluctuations will affect the value
of foreign securities the Fund holds in its portfolio or intends to purchase.
For example, if the Fund were to enter into a contract to purchase securities
denominated in a foreign currency, it could effectively fix the maximum U.S.
dollar cost of the securities by purchasing call options on that foreign
currency. Similarly, if the Fund held securities denominated in a foreign
currency and anticipated a decline in the value of that currency against the
U.S. dollar, it could hedge against such a decline by purchasing a put option on
the currency involved. The markets in foreign currency options are relatively
new, and the Fund's ability to establish and close out positions in such options
is subject to the maintenance of a liquid secondary market. There can be no
assurance that a liquid secondary market will exist for a particular option at
any specific time. In addition, options on foreign currencies are affected by
all of those factors that influence foreign exchange rates and investments
generally.
The quantities of currencies underlying option contracts represent odd lots
in a market dominated by transactions between banks, and as a result extra
transaction costs may be incurred upon exercise of an option.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations be firm or revised on a
timely basis. Quotation information is generally representative of very large
transactions in the interbank market and may not reflect smaller transactions
where rates may be less favorable. Option markets may be closed while
round-the-clock interbank currency markets are open, and this can create price
and rate discrepancies.
Risks of Options Trading. The Fund may effectively terminate its rights or
obligations under options by entering into closing transactions. Closing
transactions permit the Fund to realize profits or limit losses on its options
positions prior to the exercise or expiration of the option. The value of a
foreign currency option depends on the value of the underlying currency relative
to the U.S. dollar. Other factors affecting the value of an option are the time
remaining until expiration, the relationship of the exercise price to market
price, the historical price volatility of the underlying currency and general
market conditions. As a result, changes in the value of an option position may
have no relationship to the investment merit of a foreign security. Whether a
profit or loss is realized on a closing transaction depends on the price
movement of the underlying currency and the market value of the option.
Options normally have expiration dates of up to nine months. The exercise
price may be below, equal to or above the current market value of the underlying
currency. Options that expire unexercised have no value, and the Fund will
realize a loss of any premium paid and any transaction costs. Closing
transactions may be effected only by negotiating directly with the other party
to the option contract, unless a secondary market for the options develops.
Although the Fund intends to enter into foreign currency options only with
dealers which agree to enter into, and which are expected to be capable of
entering into, closing transactions with the Fund, there can be no assurance
that the Fund will be able to liquidate an option at a favorable price at any
time prior to expiration. In the event of insolvency of the counter-party, the
Fund may be unable to liquidate a foreign currency option. Accordingly, it may
not be possible to effect closing transactions with respect to certain options,
with the result that the Fund would have to exercise those options that it had
purchased in order to realize any profit.
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FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may use forward contracts to protect against uncertainty in the
level of future exchange rates. The Fund will not speculate with forward
contracts or foreign currency exchange rates.
The Fund may enter into forward contracts with respect to specific
transactions. For example, when the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, or when the Fund
anticipates the receipt in a foreign currency of dividend or interest payments
on a security that it holds, the Fund may desire to "lock in" the U.S. dollar
price of the security or the U.S. dollar equivalent of the payment, by entering
into a forward contract for the purchase or sale, for a fixed amount of U.S.
dollars or foreign currency, of the amount of foreign currency involved in the
underlying transaction. The Fund will thereby be able to protect itself against
a possible loss resulting from an adverse change in the relationship between the
currency exchange rates during the period between the date on which the security
is purchased or sold, or on which the payment is declared, and the date on which
such payments are made or received.
The Fund also may use forward contracts in connection with portfolio
positions to lock in the U.S. dollar value of those positions, to increase the
Fund's exposure to foreign currencies that the Investment Adviser believes may
rise in value relative to the U.S. dollar or to shift the Fund's exposure to
foreign currency fluctuations from one country to another. For example, when the
Investment Adviser believes that the currency of a particular foreign country
may suffer a substantial decline relative to the U.S. dollar or another
currency, it may enter into a forward contract to sell the amount of the former
foreign currency approximating the value of some or all of the Fund's portfolio
securities denominated in such foreign currency. This investment practice
generally is referred to as "cross-hedging" when another foreign currency is
used.
The precise matching of the forward contract amounts and the value of the
securities involved will not generally be possible because the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Accordingly, it may be necessary for
the Fund to purchase additional foreign currency on the spot (that is, cash)
market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Fund is obligated to
deliver and if a decision is made to sell the security and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio security if
its market value exceeds the amount of foreign currency the Fund is obligated to
deliver. The projection of short-term currency market movements is extremely
difficult, and the successful execution of a short-term hedging strategy is
highly uncertain. Forward contracts involve the risk that anticipated currency
movements will not be accurately predicted, causing the Fund to sustain losses
on these contracts and transaction costs. The Fund may enter into forward
contracts or maintain a net exposure to such contracts only if (1) the
consummation of the contracts would not obligate the Fund to deliver an amount
of foreign currency in excess of the value of the Fund's portfolio securities or
other assets denominated in that currency, or (2) the Fund marks as segregated
cash, U.S. government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily, in an amount not less than the
value of the Fund's total assets committed to the consummation of the contracts.
Under normal circumstances, consideration of the prospect for currency parities
will be incorporated into the longer term investment decisions made with regard
to overall diversification strategies. However, the Investment Adviser believes
it is important to have the flexibility to enter into such forward contracts
when it determines that the best interests of the Fund will be served.
At or before the maturity date of a forward contract that requires the Fund
to sell a currency, the Fund may either sell a portfolio security and use the
sale proceeds to 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 that it is obligated to deliver. Similarly, the Fund
may close out a forward contract requiring it to purchase a specified currency
by entering into a second contract entitling it to sell the same amount of the
same currency on the maturity date of the first contract. The Fund would realize
a gain or loss as a result of entering into such an offsetting forward contract
under either circumstance to the extent the exchange rate between the currencies
involved moved between the execution dates of the first and second contracts.
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<PAGE> 502
The cost to the Fund of engaging in forward contracts varies with factors
such as the currencies involved, the length of the contract period and the
market conditions then prevailing. Because forward contracts are usually entered
into on a principal basis, no fees or commissions are involved. The use of
forward contracts does not eliminate fluctuations in the prices of the
underlying securities the Fund owns or intends to acquire, but it does fix a
rate of exchange in advance. In addition, although forward contracts limit the
risk of loss due to a decline in the value of the hedged currencies, at the same
time they limit any potential gain that might result should the value of the
currencies increase.
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend to convert holdings of foreign currencies into U.S. dollars on a
daily basis. The Fund may convert foreign currency from time to time, and
investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit
based on the difference between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to the
Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
Swap Agreements. The Fund may enter into interest rate, index and currency
exchange rate swap agreements for purposes of attempting to obtain a particular
desired return at a lower cost to the Fund than if the Fund had invested
directly in an instrument that yielded the desired return. Swap agreements are
two party contracts entered into primarily by institutional investors for
periods ranging from a few weeks to more than one year. In a standard "swap"
transaction, two parties agree to exchange the returns (or differentials in
rates of return) earned or realized on particular predetermined investments or
instruments. The gross returns to be exchanged or "swapped" between the parties
are calculated with respect to a "notional amount," i.e., the return on or
increase in value of a particular dollar amount invested at a particular
interest rate, in a particular foreign currency, or in a "basket" of securities
representing a particular index. The "notional amount" of the swap agreement is
only a fictive basis on which to calculate the obligations which the parties to
a swap agreement have agreed to exchange. The Fund's obligations (or rights)
under a swap agreement will generally be equal only to the net amount to be paid
or received under the agreement based on the relative values of the positions
held by each party to the agreement (the "net amount"). The Fund's obligations
under a swap agreement will be accrued daily (offset against any amounts owing
to the Fund) and any accrued but unpaid net amounts owed to a swap counter-party
will be covered by marking as segregated cash, U.S. government securities,
equity securities or other liquid, unencumbered assets, marked-to-market daily,
to avoid any potential leveraging of the Fund's portfolio. The Fund will not
enter into a swap agreement with any single party if the net amount owed or to
be received under existing contracts with that party would exceed 5% of the
Fund's assets.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Investment Adviser's
ability to correctly predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, the Fund bears the risk
of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counter-party.
Restrictions imposed by the Internal Revenue Code may limit the Fund's ability
to use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps market,
including potential government regulation, could adversely affect the Fund's
ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
FOREIGN INVESTMENT RISKS
Foreign Market Risk. The Fund may invest a portion of its assets in foreign
securities. Foreign security investment involves special risks not present in
U.S. investments that can increase the chances that the Fund will lose money.
Prices of foreign securities may fluctuate more than prices of securities traded
in the United States.
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of
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<PAGE> 503
capital, resources, and balance of payments position. Certain such economies may
rely heavily on particular industries or foreign capital and are more vulnerable
to diplomatic developments, the imposition of economic sanctions against a
particular country or countries, changes in international trading patterns,
trade barriers, and other protectionist or retaliatory measures. Investments in
foreign markets may also be adversely affected by governmental actions such as
the imposition of capital controls, nationalization of companies or industries,
expropriation of assets, or the imposition of punitive taxes. In addition, the
governments of certain countries may prohibit or impose substantial restrictions
on foreign investing in their capital markets or in certain industries. Any of
these actions could severely affect security prices, impair the Fund's ability
to purchase or sell foreign securities or transfer the Fund's assets or income
back into the United States, or otherwise adversely affect the Fund's
operations. Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government securities,
difficulties in enforcing favorable legal judgments in foreign courts, and
political and social instability. Legal remedies available to investors in
certain foreign countries may be less extensive than those available to
investors in the United States or other foreign countries.
Currency Risk and Exchange Risk. Securities in which the Fund invests may
be denominated or quoted in currencies other than the U.S. dollar. Changes in
foreign currency exchange rates will affect the value of the securities of the
Fund. Generally, when the U.S. dollar rises in value against a foreign currency,
your investment in a security denominated in that currency loses value because
the currency is worth fewer U.S. dollars. Similarly when the U.S. dollar
decreases in value against a foreign currency, your investment in a security
denominated in that currency gains value because the currency is worth more U.S.
dollars. This risk is generally known as "currency risk" which is the
possibility that a stronger U.S. dollar will reduce returns for U.S. investors
investing overseas and a weak U.S. dollar will increase returns for U.S.
investors investing overseas.
For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU established a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU participants by July 1, 2002. Upon implementation of EMU,
certain securities issued in participating EU countries (beginning with
government and corporate bonds) were redenominated in the euro, and are now
listed, traded, declaring dividends and making other payments only in euros.
No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on the Fund's investments
in Europe generally or in specific countries participating in EMU.
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some countries may not have laws
to protect investors the way that the United States securities laws do.
Accounting
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<PAGE> 504
standards in other countries are not necessarily the same as in the United
States. If the accounting standards in another country do not require as much
disclosure or detail as U.S. accounting standards, it may be harder for the
Fund's portfolio managers to completely and accurately determine a company's
financial condition.
Certain Risks of Holding Fund Assets Outside the United States. The Fund
generally holds the foreign securities in which it invests outside the United
States in foreign banks and securities depositories. These foreign banks and
securities depositories may be recently organized or new to the foreign custody
business. They may also have operations subject to limited or no regulatory
oversight. Also, the laws of certain countries may put limits on the Fund's
ability to recover its assets if a foreign bank or depository or issuer of a
security or any of their agents goes bankrupt. In addition, it can be expected
that it will be more expensive for the Fund to buy, sell and hold securities in
certain foreign markets than it is in the U.S. market due to higher brokerage,
transaction, custody and/or other costs. The increased expense of investing in
foreign markets reduces the amount the Fund can earn on its investments.
Settlement and clearance procedures in certain foreign markets differ
significantly from those in the United States. Foreign settlement and clearance
procedures and trade regulations also may involve certain risks (such as delays
in payment for or delivery of securities) not typically involved with the
settlement of U.S. investments. Communications between the United States and
emerging market countries may be unreliable, increasing the risk of delayed
settlements or losses of security certificates. Settlements in certain foreign
countries at times have not kept pace with the number of securities
transactions. These problems may make it difficult for a Fund to carry out
transactions. If the Fund cannot settle or is delayed in settling a purchase of
securities, it may miss attractive investment opportunities and certain of its
assets may be uninvested with no return earned thereon for some period. If the
Fund cannot settle or is delayed in settling a sale of securities, it may lose
money if the value of the security then declines or, if it has contracted to
sell the security to another party, the Fund could be liable to that party for
any losses incurred.
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
RISK FACTORS RELATING TO INVESTING IN HIGH YIELD SECURITIES
A description of security ratings is attached as an Appendix. Lower-rated
or unrated (that is, high yield) securities are more likely to react to
developments affecting market risk (such as interest rate sensitivity, market
perception of the creditworthiness of the issuer and general market liquidity)
and credit risk (such as the issuer's inability to meet its obligations) than
are more highly rated securities, which react primarily to movements in the
general level of interest rates. The Investment Adviser considers both credit
risk and market risk in making investment decisions for the Fund.
The amount of high yield securities outstanding proliferated in the 1980's
in conjunction with the increase in merger and acquisition and leveraged buyout
activity. Under adverse economic conditions, there is a risk that highly
leveraged issuers may be unable to service their debt obligations upon maturity.
In addition, the secondary market for high yield securities, which is
concentrated in relatively few market makers, may not be as liquid as the
secondary market for more highly rated securities. Under adverse market or
economic conditions, the secondary market for high yield securities could
contract further, independent of any specific adverse changes in the condition
of a particular issuer. As a result, the Investment Adviser could find it more
difficult to sell these securities or may be able to sell the securities only at
prices lower than if such securities were widely traded. Prices realized upon
the sale of such lower-rated or unrated securities, under these circumstances,
may be less than the prices used in calculating the Fund's net asset value prior
to the sale.
Lower-rated or unrated debt obligations also present risks based on payment
expectations. If an issuer calls the obligation for redemption, the Fund may
have to replace the security with a lower yielding security, resulting in a
decreased return for investors. If the Fund experiences unexpected net
redemptions, it may be forced to sell its higher-rated securities, resulting in
a decline in the overall credit quality of the Fund's portfolio and increasing
the exposure of the Fund to the risks of high yield securities.
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<PAGE> 505
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions of
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act, securities which are otherwise not readily
marketable and repurchase agreements that have a maturity of longer than seven
days. Securities which have not been registered under the Securities Act are
referred to as private placements or restricted securities and are purchased
directly from the issuer or in the secondary market. Limitations on resale may
have an adverse effect on the marketability of portfolio securities and a mutual
fund might be unable to dispose of restricted or other illiquid securities
promptly or at reasonable prices and might thereby experience difficulty
satisfying redemption within seven days. The absence of a trading market can
make it difficult to ascertain a market value for illiquid investments. Also
market quotations are less readily available. The judgment of the Investment
Adviser may at times play a greater role in valuing these securities than in the
case of unrestricted securities. A mutual fund might also have to register such
restricted securities in order to dispose of them resulting in additional
expense and delay. Adverse market conditions could impede such a public offering
of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Investment Adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least one nationally recognized statistical
rating organization ("NRSRO") or, if unrated, be of comparable quality in the
view of the Investment Adviser; and (2) it must not be in default as to
principal or interest. Investing in Rule 144A securities could have the effect
of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
REVERSE REPURCHASE AGREEMENTS
The Fund may enter into reverse repurchase agreements, whereby the Fund
sells securities concurrently with entering into an agreement to repurchase
those securities at a later date at a fixed price. During the reverse repurchase
agreement period, the Fund continues to receive principal and interest payments
on those
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<PAGE> 506
securities. Reverse repurchase agreements are speculative techniques involving
leverage and are considered borrowings by the Fund for purposes of the limit
applicable to borrowings.
DOLLAR ROLLS
The Fund may use dollar rolls as part of its investment strategy. In a
dollar roll, the Fund sells securities for delivery in the current month and
simultaneously contracts to repurchase substantially similar securities (same
type and coupon) on a specified future date from the same party. During the roll
period, the Fund forgoes principal and interest paid on the securities. The Fund
is compensated by the difference between the current sales price and the forward
price for the future purchase (often referred to as the "drop") as well as by
the interest earned on the cash proceeds of the initial sale. A "covered roll"
is a specific type of dollar roll for which there is an offsetting cash position
or cash equivalent security position that matures on or before the forward
settlement date of the dollar roll transaction.
The Fund will mark as segregated cash, U.S. government securities, equity
securities or other liquid, unencumbered assets, marked-to-market daily, equal
in value to their obligations with respect to dollar rolls. Dollar rolls involve
the risk that the market value of the securities retained by the Fund may
decline below the price of the securities the Fund has sold but is obligated to
repurchase under the agreement. If the buyer of the securities under a dollar
roll files for bankruptcy or becomes insolvent, the Fund's use of the proceeds
of the agreement may be restricted pending a determination by the other party,
or its trustee or receiver, whether to enforce the Fund's obligation to
repurchase the securities. Dollar rolls are speculative techniques involving
leverage and are considered borrowings by the Fund for purposes of the limit
applicable to borrowings.
BORROWING
The Fund may borrow for temporary, emergency or investment purposes. This
borrowing may be unsecured. The 1940 Act requires the Fund to maintain
continuous asset coverage (that is, total assets including borrowings, less
liabilities exclusive of borrowings) of 300% of the amount borrowed. Borrowing
subjects the Fund to interest costs which may or may not be recovered by
appreciation of the securities purchased, and can exaggerate the effect on net
asset value of any increase or decrease in the market value of the Fund's
portfolio. This is the speculative factor known as leverage.
LOANS OF PORTFOLIO SECURITIES
For the purpose of achieving income, the Fund may lend its portfolio
securities, provided: (1) the loan is secured continuously by collateral
consisting of short-term, high quality debt securities, including U.S.
government securities, negotiable certificates of deposit, bankers' acceptances
or letters of credit, maintained on a daily marked-to-market basis in an amount
at least equal to the current market value of the securities loaned; (2) the
Fund may at any time call the loan and obtain the return of the securities
loaned; (3) the Fund will receive any interest or dividends paid on the loaned
securities; and (4) the aggregate market value of securities loaned will not at
any time exceed one-third of the total assets of the Fund.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value of the security each day in determining the Fund's net asset
value. The Fund will also mark as segregated with its custodian cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, equal in value to its obligations for when-issued
securities.
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<PAGE> 507
REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain Internal Revenue Code requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties, as well as
greater income potential than an investment in common stocks. Like any
investment in real estate, though, a REIT's performance depends on several
factors, such as its ability to find tenants for its properties, to renew leases
and to finance property purchases and renovations.
SHARES OF OTHER INVESTMENT COMPANIES
The Fund can invest in securities of other investment companies except to
the extent prohibited by law. Like all equity investments, these investments may
go up or down in value. They also may not perform in correlation with the Fund's
principal strategies. The Fund will pay additional fees through its investments
in other investment companies.
SHORT SALES AGAINST-THE-BOX
The Fund can borrow and sell "short" securities when it also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund's
total assets can be held as collateral for short sales at any one time.
CORPORATE LOANS
The Fund can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Fund may not
recover its investment, or there might be a delay in the Fund's recovery. By
investing in a corporate loan, the Fund becomes a member of the syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, the Fund may invest
all or part of its assets in short-term investment grade debt obligations of the
U.S. government, its agencies and instrumentalities, bank certificates of
deposit, bankers' acceptances, high quality commercial paper, demand notes and
repurchase agreements.
MANAGEMENT OF THE FUND
The Trustees oversee the actions of the Fund's Investment Adviser and other
service providers and decide upon matters of general policy. The Trustees also
review the actions of the Trust's officers, who conduct and supervise the daily
business operations of the Trust. The same individuals serve as Trustees of the
Master Trust. The Trustees (* denotes "interested" Trustee as defined in the
1940 Act, due to the relationship with the Investment Adviser) and officers of
the Trust are:
MICHAEL BAXTER* (37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since 1999);
Managing Director of the Investment Adviser (since 1996); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
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<PAGE> 508
ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since 1994); Chairman, Gamma Services Corp.
(venture capital) (since 1968); Principal, Gavin, Dailey & Partners (consulting)
(since 1993); U.S. Ambassador to Mexico (1981 - 1986); Director, Apex Mortgage
Capital, Inc., Atlantic Richfield Co., International Wire Corp. and Krause's
Furniture.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (since 1986); Member of CIEBA's Executive Committee (since
1988) and its Chairman (from 1991 - 1992); Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds (1986 - 1993); Member of the Investment Advisory Committees of
the State of New York Common Retirement Fund and the Howard Hughes Medical
Institute (since 1997); Director, Duke Management Company (since 1992) and Vice
Chairman (since 1998); Director, Kimco Realty Corporation (since 1997);
Director, LaSalle Street Fund (since 1995); Member of the Investment Advisory
Committee of the Virginia Retirement System (since 1998); Director, Montpelier
Foundation (since 1998); Trustee or Director of 24 registered investment
companies (consisting of 56 portfolios) for which the Investment Adviser or an
advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since
1999); Managing Director of the Investment Adviser (since 1998); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (49) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 62 registered investment companies
(consisting of 86 portfolios) for which the Investment Adviser or an advisory
affiliate is the adviser.
NANCY D. CELICK (49) -- President -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Chief Administrative Officer of the Investment
Adviser (since 1998); Chief Financial Officer of the Investment Adviser
(1993 - 1998); Chief Financial Officer of Kennedy-Wilson, Inc. (auction
marketing services) (1992 - 1993); Chief Financial Officer of First National
Corporation (bank holding company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-9011. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services,
Inc. (since 1999); Vice President of FAM Distributors, Inc. (since 1999); First
Vice President of the Investment Adviser (1990 - 1997).
ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
25
<PAGE> 509
GRACIE FERMELIA (38) -- Vice President and Assistant Secretary -- 725 South
Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Director of the
Investment Adviser since 2000; Vice President of the Investment Adviser
(1994 - 2000); Senior Manager, Price Waterhouse (1985 - 1994).
The Trust does not pay salaries to any of its officers or fees to any of
its Trustees affiliated with the Investment Adviser. The following table sets
forth the aggregate compensation paid to the Trustees during the Trust's fiscal
year ended June 30, 2000 and the aggregate compensation paid to the Trustees for
service on the Trust's Board and that of any other fund for which the Investment
Adviser serves as investment adviser or which has an investment adviser that is
an affiliated person of the Investment Adviser ("Fund Complex") for the year
ended December 31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $ $ 34,000
John A. G. Gavin................................... $ $ 25,000
Joe Grills......................................... $ $232,333
Nigel Hurst-Brown.................................. $ -0- $ -0-
Robert B. Hutchinson**............................. $ $ 34,000
Madeleine A. Kleiner............................... $ $ 18,000
Merle T. Welshans**................................ $ $ 34,000
Richard R. West.................................... $ $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of the Mercury HW Variable Trust, the
Master Trust and Merrill Lynch Investment Managers Funds, Inc. Messrs. Grills
and West also serve on the boards of other investment companies advised by
the Investment Adviser and its advisory affiliates.
** Messrs. Hutchinson and Welshans retired on November 12, 1999.
The Trustees may be eligible for reduced sales charges on purchases of
Class I shares. See "Reduced Initial Sales Charges -- Purchase Privileges of
Certain Persons."
For information as to ownership of shares, see "General
Information -- Principal Holders."
MANAGEMENT AND ADVISORY ARRANGEMENTS
Investment Advisory Services and Fee. The Fund currently invests all of its
assets in shares of the Portfolio. Accordingly, the Fund does not invest
directly in portfolio securities and does not require investment advisory
services. All portfolio management occurs at the level of the Master Trust. The
Master Trust has entered into an investment advisory agreement for the Portfolio
with the Investment Adviser as investment adviser (the "Advisory Agreement").
Subject to the supervision of the Trustees, the Investment Adviser is
responsible for the actual management of the Portfolio and constantly reviews
the Portfolio's holdings in light of its own research analysis and that from
other relevant sources. The responsibility for making decisions to buy, sell or
hold a particular security rests with the Investment Adviser. The Investment
Adviser performs certain of the other administrative services and provides all
office space, facilities, equipment and necessary personnel for management of
the Master Trust. The Investment Adviser receives for its services to the
Portfolio a monthly fee at an annual rate of 0.30% of the Portfolio's average
daily net assets. For purposes of this calculation, average daily net assets is
determined at the end of each month on the basis of the average net assets of
the Portfolio for each day during the month.
Prior to October , 2000, the Fund did not invest its shares in the
Portfolio and was party to an investment advisory agreement under which it paid
Merrill Lynch Investment Managers, L.P., an affiliate of the Investment Adviser,
a fee at the annual rate of 0.55% of its average daily net assets. For the
fiscal years
26
<PAGE> 510
ended June 30, 2000, 1999 and 1998, the Fund paid Merrill Lynch Investment
Managers, L.P. $ , $342,503 and $39,539, respectively. As a result of
its agreement to limit Fund expenses, for these years Merrill Lynch Investment
Managers, L.P. waived a portion of its fee in the amount of $ , $125,162,
and $86,499, respectively.
Securities held by the Portfolio may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients of the Investment Adviser or an affiliate when one or more clients of
the Investment Adviser or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Payment of Master Trust Expenses. The Advisory Agreement obligates the
Investment Adviser to provide investment advisory services and to pay, or cause
an affiliate to pay, for maintaining its staff and personnel and to provide
office space, facilities and necessary personnel for the Master Trust. The
Investment Adviser is also obligated to pay, or cause an affiliate to pay, the
fees of all officers and Trustees who are affiliated persons of the Investment
Adviser or any sub-adviser or of an affiliate of the Investment Adviser or any
sub-adviser. The Portfolio pays, or causes to be paid, all other expenses
incurred in the operation of the Portfolio (except to the extent paid by FAM
Distributors, Inc. (the "Distributor")), including, among other things, taxes,
expenses for legal and auditing services, costs of printing proxies, shareholder
reports, copies of the Registration Statement, charges of the custodian, any
sub-custodian and the transfer agent, expenses of portfolio transactions,
expenses of redemption of shares, Commission fees, expenses of registering the
shares under Federal, state or non-U.S. laws, fees and actual out-of-pocket
expenses of non-interested Trustees, accounting and pricing costs (including the
daily calculation of net asset value), insurance, interest, brokerage costs,
litigation and other extraordinary or non-recurring expenses, and other expenses
properly payable by the Portfolio. Accounting services are provided to the
Portfolio by the Investment Adviser or an affiliate of the Investment Adviser,
and the Portfolio reimburses the Investment Adviser or an affiliate of the
Investment Adviser for its costs in connection with such services.
Organization of the Investment Adviser. The Investment Adviser is a limited
partnership, the partners of which are Merrill Lynch & Co., Inc. ("ML & Co."), a
financial services holding company and the parent of Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch") and Princeton Services, Inc., ML &
Co. and Princeton Services, Inc. are "controlling persons" of the Investment
Adviser as defined under the 1940 Act because of their ownership of its voting
securities and their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Advisory Agreement will continue in effect for two years from its effective
date. Thereafter, it will remain in effect from year to year if approved
annually (a) by the Board of Trustees of the Master Trust or by a majority of
the outstanding shares of the Portfolio and (b) by a majority of the Trustees of
the Master Trust who are not parties to the Advisory Agreement or interested
persons (as defined in the 1940 Act) of any such party. The Advisory Agreement
is not assignable and will automatically terminate in the event of its
assignment. In addition, such contract may be terminated by the vote of a
majority of the outstanding voting securities of the Portfolio or by the
Investment Adviser without penalty on 60 days' written notice to the other
party.
ADMINISTRATION ARRANGEMENTS
The Fund has entered into an Administration Agreement (the "Administration
Agreement") with the Investment Adviser acting as Administrator (the
"Administrator"). The Administrator receives for its services to the Fund
monthly compensation at the annual rate of % of the average daily net assets
of the Fund.
27
<PAGE> 511
The Administration Agreement obligates the Administrator to provide certain
administrative services to the Fund and to pay, or cause its affiliates to pay,
for maintaining its staff and personnel and to provide office space, facilities
and necessary personnel for the Fund. The Administrator is also obligated to
pay, or cause its affiliates to pay, the fees of those officers and Trustees who
are affiliated persons of the Administrator or any of its affiliates. The Fund
pays, or causes to be paid, all other expenses incurred in the operation of the
Fund (except to the extent paid by the Distributor), including, among other
things, taxes, expenses for legal and auditing services, costs of printing
proxies, shareholder reports and prospectuses and statements of additional
information, charges of the custodian, any sub-custodian and Financial Data
Services, Inc. (the "Transfer Agent"), expenses of portfolio transactions,
expenses of redemption of shares, Commission fees, expenses of registering the
shares under Federal, state or non-U.S. laws, fees and actual out-of-pocket
expenses of Trustees who are not affiliated persons of the Administrator, or of
an affiliate of the Administrator, accounting and pricing costs (including the
daily calculation of the net asset value), insurance, interest, brokerage costs,
litigation and other extraordinary or non-recurring expenses, and other expenses
properly payable by the Fund. The Distributor will pay certain of the expenses
of the Fund incurred in connection with the continuous offering of its shares.
Certain expenses will be financed by the Fund pursuant to distribution plans in
compliance with Rule 12b-1 under the 1940 Act. See "Purchase of
Shares -- Distribution Plan." Accounting services are provided to the Fund by
the Investment Adviser, and the Fund reimburses the Investment Adviser for its
costs in connection with such services.
Duration and Termination. Unless earlier terminated as described below, the
Administration Agreement will remain in effect for two years from its effective
date. Thereafter it will remain in effect from year to year if approved annually
(a) by the Board of Trustees and (b) by a majority of the Trustees who are not
parties to such contract or interested persons (as defined in the 1940 Act) of
any such party. Such contract is not assignable and may be terminated without
penalty on 60 days' written notice at the option of either party thereto or by
the vote of the shareholders of the Fund.
Transfer Agency Services. The Transfer Agent, a subsidiary of ML & Co.,
acts as the Fund's Transfer Agent pursuant to a Transfer Agency, Dividend
Disbursing Agency and Shareholder Servicing Agency Agreement (the "Transfer
Agency Agreement"). Pursuant to the Transfer Agency Agreement, the Transfer
Agent is responsible for the issuance, transfer and redemption of shares and the
opening and maintenance of shareholder accounts. Pursuant to the Transfer Agency
Agreement, the Transfer Agent receives a fee ranging from $16.00 to $20.00 per
account (depending on the level of services required), and certain other fees
relating to special processing of sub-transfer agency relationships. The
Transfer Agent is entitled to reimbursement for certain transaction charges and
out-of-pocket expenses incurred by the Transfer Agent under the Transfer Agency
Agreement. For purposes of the Transfer Agency Agreement, the term "account"
includes a shareholder account maintained directly by the Transfer Agent and any
other account representing the beneficial interest of a person in the relevant
share class on a recordkeeping system.
Distribution Expenses. The Fund has entered into a distribution agreement
with the Distributor in connection with the continuous offering of shares of the
Fund (the "Distribution Agreement"). The Distribution Agreement obligates the
Distributor to pay certain expenses in connection with the offering of the
shares of the Fund. After the prospectuses, statements of additional information
and periodic reports have been prepared, set in type and mailed to shareholders,
the Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to dealers and investors. The Distributor also pays
for other supplementary sales literature and advertising costs. The Distribution
Agreement is subject to the same renewal requirements and termination provisions
as the Advisory Agreement described above.
CODE OF ETHICS
The Board of Trustees of the Master Trust and the Trust each have adopted a
Code of Ethics under Rule 17j-1 of the 1940 Act that covers the Master Trust,
the Fund, the Investment Adviser and the Distributor (the "Code of Ethics"). The
Code of Ethics significantly restricts the personal investing activities of all
employees of the Investment Adviser and the Distributor and, as described below,
imposes additional more onerous restrictions on fund investment personnel.
28
<PAGE> 512
The Code of Ethics requires that all employees of the Investment Adviser
and the Distributor pre-clear any personal securities investments (with limited
exceptions, such as mutual funds, high-quality short-term securities and direct
obligations of the U.S. government). The pre-clearance requirement and
associated procedures are designed to identify any substantive prohibition or
limitation applicable to the proposed investment. The substantive restrictions
applicable to all employees of the Investment Adviser and the Distributor
include a ban on acquiring any securities in a "hot" initial public offering. In
addition, investment personnel are prohibited from profiting on short-term
trading in securities. No employee may purchase or sell any security that at the
time is being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Investment Adviser. Furthermore, the Code of Ethics provides for trading
"blackout periods" which prohibit trading by investment personnel of the Fund
within seven calendar days, before or after, of trading by the Fund in the same
or equivalent security.
PURCHASE OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus for certain information as to the purchase of
Fund shares.
The Fund issues four classes of shares: shares of Class I and Class A are
sold to investors choosing the initial sales charge alternatives and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. Each Class I, Class A, Class B and Class C share of the Fund
represents an identical interest in the investment portfolio of the Fund, and
has the same rights, except that Class A, Class B and Class C shares bear the
expenses of the ongoing account maintenance fees (also known as service fees)
and Class B and Class C shares bear the expenses of the ongoing distribution
fees and the additional incremental transfer agency costs resulting from the
deferred sales charge arrangements. The contingent deferred sales charges
("CDSCs"), distribution fees and account maintenance fees that are imposed on
Class B and Class C shares, as well as the account maintenance fees that are
imposed on Class A shares, are imposed directly against those classes and not
against all assets of the Fund, and, accordingly, such charges do not affect the
net asset value of any other class or have any impact on investors choosing
another sales charge option. Dividends paid by the Fund for each class of shares
are calculated in the same manner at the same time and differ only to the extent
that account maintenance and distribution fees and any incremental transfer
agency costs in relation to a particular class are borne exclusively by that
class. Class A, Class B and Class C shares each have exclusive voting rights
with respect to the Rule 12b-1 distribution plan adopted with respect to such
class pursuant to which the account maintenance and/or distribution fees are
paid (except that Class B shareholders may vote upon any material changes to
expenses charged under the Distribution Plan for Class A shares). Each class has
different exchange privileges. See "Shareholder Services -- Exchange Privilege."
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class I and Class A shares are the same as
those of the CDSCs and distribution fees with respect to the Class B and Class C
shares in that the sales charges and distribution fees applicable to each class
provide for the financing of the distribution of the shares of the Fund. The
distribution-related revenues paid with respect to a class will not be used to
finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share plus any sales charge applicable to the
class of shares selected by the investor. The applicable offering price for
purchase orders is based upon the net asset value of the Fund next determined
after receipt of the purchase order by the Distributor. As to purchase orders
received by selected securities dealers or other financial intermediaries prior
to the close of regular trading on the New York Stock Exchange (the "NYSE")
(generally 4:00 p.m., Eastern time) which includes orders received after the
determination of net asset value on the previous day, the applicable offering
price will be based on the net asset value on the day the order is placed with
the Distributor, provided that the orders are received by the Distributor prior
to 30 minutes after the close of regular trading on the NYSE on that day. If the
purchase orders are not received prior to 30 minutes after the close of regular
trading on the NYSE on that day, such orders shall be deemed received
29
<PAGE> 513
on the next business day. Selected securities dealers or other financial
intermediaries have the responsibility of submitting purchase orders to the Fund
not later than 30 minutes after the close of regular trading on the NYSE in
order to purchase shares at that day's offering price.
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Any order may be rejected by the Fund or the Distributor. Neither
the Distributor nor the selected securities dealers or other financial
intermediaries are permitted to withhold placing orders to benefit themselves by
a price change. Certain selected securities dealers or other financial
intermediaries may charge a processing fee to confirm a sale of shares. For
example, the fee currently charged by Merrill Lynch is $5.35. Purchases made
directly through the Transfer Agent are not subject to the processing fee.
INITIAL SALES CHARGE ALTERNATIVES -- CLASS I AND CLASS A SHARES
Investors who prefer an initial sales charge alternative may elect to
purchase Class A shares or, if an eligible investor, Class I shares.
Investors choosing the initial sales charge alternative who are eligible to
purchase Class I shares should purchase Class I shares rather than Class A
shares, because there is an account maintenance fee imposed on Class A shares.
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class I and Class A
shares of the Fund, refers to a single purchase by an individual or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his or her spouse and their children under
the age of 21 years purchasing shares for his, her or their own account and to
single purchases by a trustee or other fiduciary purchasing shares for a single
trust estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company," as that
term is defined in the 1940 Act, but does not include purchases by any such
company that has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
Class I shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class I shares. Investors
who owned Investor Class shares or who currently own Class I shares of the Fund
in a shareholder account are entitled to purchase additional Class I shares of
the Fund in that account. Certain employer-sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class I shares at net asset
value provided such plans meet the required minimum number of eligible employees
or required amount of assets advised by the Investment Adviser or any of its
affiliates. Also eligible to purchase Class I shares at net asset value are
participants in certain investment programs including certain managed accounts
for which a trust institution, thrift or bank trust department provides
discretionary trustee services, certain collective investment trusts for which a
trust institution, thrift, or bank trust department serves as trustee, certain
purchases made in connection with certain fee-based programs and certain
purchases made through certain financial advisers that meet and adhere to
standards established by the Investment Adviser. Class I shares are available at
net asset value to corporate warranty insurance reserve fund programs and U.S.
branches of foreign banking institutions, provided that the participant has $3
million or more initially invested in affiliate-advised investment companies. In
addition, Class I shares are offered at net asset value to ML & Co. and its
subsidiaries and their directors and employees, to members of the Boards of
investment companies advised by the Investment Adviser or its affiliates,
including the Fund, and to employees of certain selected securities dealers or
other financial intermediaries. Class I shares may also be offered at net asset
value to certain accounts over which the Investment Adviser or an affiliate
exercises investment discretion. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative particularly
attractive, because similar sales charge reductions are not available with
respect to the deferred sales charges imposed in connection with purchases of
Class B or Class C shares.
30
<PAGE> 514
Investors not qualifying for reduced initial sales charges who expect to
maintain their investment for an extended period of time also may elect to
purchase Class I or Class A shares, because over time the accumulated ongoing
account maintenance and distribution fees on Class B or Class C shares may
exceed the initial sales charges, and, in the case of Class A shares, the
account maintenance fee. Although some investors who previously purchased Class
I shares may no longer be eligible to purchase Class I shares of other
affiliate-advised funds, those previously purchased Class I shares, together
with Class A, Class B and Class C share holdings, will count toward a right of
accumulation which may qualify the investor for a reduced initial sales charge
on new initial sales charge purchases. In addition, the ongoing Class B and
Class C account maintenance and distribution fees will cause Class B and Class C
shares to have higher expense ratios, pay lower dividends and have lower total
returns than the initial sales charge shares. The ongoing Class A account
maintenance fees will cause Class A shares to have a higher expense ratio, pay
lower dividends and have a lower total return than Class I shares.
The Distributor may reallow discounts to selected securities dealers or
other financial intermediaries and retain the balance over such discounts. At
times the Distributor may reallow the entire sales charge to such selected
securities dealers or other financial intermediaries. Since selected securities
dealers or other financial intermediaries selling Class I and Class A shares of
the Fund will receive a concession equal to most of the sales charge, they may
be deemed to be underwriters under the Securities Act.
REDUCED INITIAL SALES CHARGES
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
to obtain such investments.
Reinvested Dividends. No initial sales charges are imposed upon Class I and
Class A shares issued as a result of the automatic reinvestment of dividends.
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other Mercury mutual funds. For any such right of accumulation to be
made available, the Distributor must be provided at the time of purchase, by the
purchaser or the purchaser's selected securities dealer or other financial
intermediary, with sufficient information to permit confirmation of
qualification. Acceptance of the purchase order is subject to such confirmation.
The right of accumulation may be amended or terminated at any time. Shares held
in the name of a nominee or custodian under pension, profit-sharing, or other
employee benefit plans may not be combined with other shares to qualify for the
right of accumulation.
Letter of Intent. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class I or Class A shares of the Fund or any
other Mercury mutual funds made within a 13-month period starting with the first
purchase pursuant to the Letter of Intent. The Letter of Intent is available
only to investors whose accounts are established and maintained at the Fund's
Transfer Agent. The Letter of Intent is not available to employee benefit plans
for which affiliates of the Investment Adviser provide plan participant
record-keeping services. The Letter of Intent is not a binding obligation to
purchase any amount of Class I or Class A shares; however, its execution will
result in the purchaser paying a lower sales charge at the appropriate quantity
purchase level. A purchase not originally made pursuant to a Letter of Intent
may be included under a subsequent Letter of Intent executed within 90 days of
such purchase if the Distributor is informed in writing of this intent within
such 90-day period. The value of Class I and Class A shares of the Fund and of
other Mercury mutual funds presently held, at cost or maximum offering price
(whichever is higher), on the date of the first purchase under the Letter of
Intent, may be included as a credit toward the completion of such Letter, but
the reduced sales charge applicable to the amount covered by such Letter will be
applied only to new purchases. If the total amount of shares does not equal the
amount stated in the Letter of Intent (minimum of $25,000), the investor will be
notified and must pay, within 20 days of the execution of such Letter, the
difference between the sales charge on the Class I or Class A shares purchased
at the reduced
31
<PAGE> 515
rate and the sales charge applicable to the shares actually purchased through
the Letter. Class I or Class A shares equal to 5.0% of the intended amount will
be held in escrow during the 13-month period (while remaining registered in the
name of the purchaser) for this purpose. The first purchase under the Letter of
Intent must be at least 5.0% of the dollar amount of such Letter. If a purchase
during the term of such Letter would otherwise be subject to a further reduced
sales charge based on the right of accumulation, the purchaser will be entitled
on that purchase and subsequent purchases to that further reduced percentage
sales charge but there will be no retroactive reduction of the sales charges on
any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intent will be deducted from
the total purchases made under such Letter. An exchange from the Summit Cash
Reserves Fund ("Summit") into the Fund that creates a sales charge will count
toward completing a new or existing Letter of Intent from the Fund.
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and certain
other arrangements may purchase Class I or Class A shares at net asset value,
based on the number of employees or number of employees eligible to participate
in the plan and/or the aggregate amount invested by the plan in specified
investments. Certain other plans may purchase Class B shares with a waiver of
the CDSC upon redemption, based on similar criteria. Such Class B shares will
convert into Class A shares approximately ten years after the plan purchases the
first share of any Mercury mutual fund. Minimum purchase requirements may be
waived or varied for such plans. For additional information regarding purchases
by employer-sponsored retirement or savings plans and certain other
arrangements, call your plan administrator or your selected securities dealer or
other financial intermediary.
Managed Trusts. Class I shares are offered at net asset value to certain
trusts to which trust institutions, thrifts, and bank trust departments provide
discretionary trustee services.
Purchase Privileges of Certain Persons. Trustees of the Trust and Trustees
of the Master Trust and of other investment companies advised by the Investment
Adviser or its affiliates, directors and employees of ML & Co. and its
subsidiaries (the term "subsidiaries," when used herein with respect to ML &
Co., includes the Investment Adviser, Merrill Lynch Investment Managers, L.P.,
Merrill Lynch Investment Managers International Limited and certain other
entities directly or indirectly wholly owned and controlled by ML & Co.),
employees of certain selected securities dealers, and any trust, pension,
profit-sharing or other benefit plan for such persons, may purchase Class I
shares of the Fund at net asset value. The Fund realizes economies of scale and
reduction of sales-related expenses by virtue of the familiarity of these
persons with the Fund. Employees and Trustees wishing to purchase shares of the
Fund must satisfy the Fund's suitability standards.
Class I and Class A shares are also offered at net asset value to certain
accounts over which the Investment Adviser or an affiliate exercises investment
discretion.
Acquisition of Certain Investment Companies. Class A shares may be offered
at net asset value in connection with the acquisition of the assets of or merger
or consolidation with a personal holding company or a public or private
investment company.
Purchases Through Certain Financial Intermediaries. Reduced sales charges
may be applicable for purchases of Class I or Class A shares of the Fund through
certain financial advisers, selected securities dealers and other financial
intermediaries that meet and adhere to standards established by the Investment
Adviser from time to time.
A waived sales charge on a purchase of Class I shares will apply to current
beneficial shareholders who were also beneficial shareholders of the Fund as of
the opening of business of the Fund on October , 2000.
32
<PAGE> 516
DEFERRED SALES CHARGE ALTERNATIVES -- CLASS B AND CLASS C SHARES
Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in Mercury mutual funds.
Because no initial sales charges are deducted at the time of the purchase,
Class B and Class C shares provide the benefit of putting all of the investor's
dollars to work from the time the investment is made. The deferred sales charge
alternatives may be particularly appealing to investors that do not qualify for
the reduction in initial sales charges. Both Class B and Class C shares are
subject to ongoing account maintenance fees and distribution fees; however, the
ongoing account maintenance and distribution fees potentially may be offset to
the extent any return is realized on the additional funds initially invested in
Class B or Class C shares. In addition, Class B shares will be converted into
Class A shares of the Fund after a conversion period of approximately ten years,
and thereafter investors will be subject to lower ongoing fees.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net asset
value per share without the imposition of a sales charge at the time of
purchase. See "Pricing of Shares -- Determination of Net Asset Value" below.
Class B shares that are redeemed within six years of purchase may be
subject to a CDSC at the rates set forth below charged as a percentage of the
dollar amount subject thereto. In determining whether a CDSC is applicable to a
redemption, the calculation will be determined in the manner that results in the
lowest applicable rate being charged. The charge will be assessed on an amount
equal to the lesser of the proceeds of redemption or the cost of the shares
being redeemed. Accordingly, no CDSC will be imposed on increases in net asset
value above the initial purchase price. In addition, no CDSC will be assessed on
shares derived from reinvestment of dividends. It will be assumed that the
redemption is first of shares held for over six years or shares acquired
pursuant to reinvestment of dividends and then of shares held longest during the
six-year period. A transfer of shares from a shareholder's account to another
account will be assumed to be made in the same order as a redemption.
The following table sets forth the Class B CDSC:
<TABLE>
<CAPTION>
CDSC AS A PERCENTAGE
OF DOLLAR AMOUNT
YEAR SINCE PURCHASE PAYMENT MADE SUBJECT TO CHARGE
-------------------------------- --------------------
<S> <C>
0-1....................................... --%
1-2....................................... --%
2-3....................................... --%
3-4....................................... --%
4-5....................................... --%
5-6....................................... --%
6 and thereafter.......................... None
</TABLE>
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired 10
additional shares upon dividend reinvestment. If at such time the investor makes
his or her first redemption of 50 shares (proceeds of $600), 10 shares will not
be subject to a CDSC because of dividend reinvestment. With respect to the
remaining 40 shares, the charge is applied only to the original cost of $10 per
share and not to the increase in net asset value of $2 per share. Therefore,
$400 of the $600 redemption proceeds will be charged at a rate of % (the
applicable rate in the third year after purchase).
As discussed in the Prospectus under "Account Choices -- Pricing of
Shares -- Class B and C Shares -- Deferred Sales Charge Options," while Class B
shares redeemed within six years of purchase are subject to a CDSC under most
circumstances, the charge may be reduced or waived in certain instances. These
include certain post-retirement withdrawals from an individual retirement
account ("IRA") or other retirement plan or redemption of Class B shares in
certain circumstances following the death of a Class B shareholder. In the case
of such withdrawal, the reduction or waiver applies to: (a) any partial or
complete redemption in
33
<PAGE> 517
connection with a distribution following retirement under a tax-deferred
retirement plan on attaining age 59 1/2 in the case of an IRA or other
retirement plan, or part of a series of equal periodic payments (not less
frequently than annually) made for life (or life expectancy) or any redemption
resulting from the tax-free return of an excess contribution to an IRA (certain
legal documentation may be required at the time of liquidation establishing
eligibility for qualified distribution); or (b) any partial or complete
redemption following the death or disability (as defined in the Internal Revenue
Code of 1986, as amended (the "Code")) of a Class B shareholder (including one
who owns the Class B shares as joint tenant with his or her spouse), provided
the redemption is requested within one year of the death or initial
determination of disability, or if later, reasonably promptly following
completion of probate or in connection with involuntary termination of an
account in which Fund shares are held (certain legal documentation may be
required at the time of liquidation establishing eligibility for qualified
distribution).
The charge may also be reduced or waived in other instances, such as: (a)
redemptions by certain eligible 401(a) and 401(k) plans and certain retirement
plan rollovers; (b) redemptions in connection with participation in certain
fee-based programs of the Investment Adviser or its affiliates; (c) redemptions
in connection with participation in certain fee-based programs of selected
securities dealers and other financial intermediaries that have agreements with
the Investment Adviser or Distributor; or (d) withdrawals through the Systematic
Withdrawal Plan of up to 10% per year of your account value at the time the plan
is established. See "Shareholder Services -- Fee-Based Programs" and
"-- Systematic Withdrawal Plan."
Conversion of Class B Shares to Class A Shares. After approximately ten
years (the "Conversion Period"), Class B shares of the Fund will be converted
automatically into Class A shares of the Fund. Class A shares are subject to an
ongoing account maintenance fee of % of the average daily net assets of the
Fund but are not subject to the distribution fee that is borne by Class B
shares. Automatic conversion of Class B shares into Class A shares will occur at
least once each month (on the "Conversion Date") on the basis of the relative
net asset value of the shares of the two classes on the Conversion Date, without
the imposition of any sales load, fee or other charge. Conversion of Class B
shares to Class A shares will not be deemed a purchase or sale of the shares for
Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class A shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at the Conversion Date the conversion of Class B shares to Class
A shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class A shares
of the Fund.
The Conversion Period may be modified for investors that participate in
certain fee-based programs. See "Shareholder Services -- Fee-Based Programs."
Class B shareholders of the Fund exercising the exchange privilege
described under "Shareholder Services -- Exchange Privilege" will continue to be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares acquired as a result of the exchange.
Class C shares that are redeemed within one year of purchase may be subject
to a % CDSC charged as a percentage of the dollar amount subject thereto. In
determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. The charge will be assessed on an amount equal to the lesser
of the proceeds of redemption or the cost of the shares being redeemed.
Accordingly, no Class C CDSC will be imposed on increases in net asset value
above the initial purchase price. In addition, no Class C CDSC will be assessed
on shares derived from reinvestment of dividends. It will be assumed that the
redemption is first of shares held for over one year or shares acquired pursuant
to reinvestment of dividends and then of shares held longest during the one-year
period. A transfer of shares from a shareholder's account to another account
will be assumed to be made in the same order as a redemption. The Class C CDSC
may be waived in connection with involuntary termination of an account in which
Fund shares are held and withdrawals through the Systematic Withdrawal Plans.
See "Shareholder Services -- Systematic Withdrawal Plan."
34
<PAGE> 518
Proceeds from the CDSC and the distribution fee are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers and other financial intermediaries (including Merrill Lynch) related to
providing distribution-related services to the Fund in connection with the sale
of the Class B and Class C shares, such as the payment of compensation to
financial consultants for selling Class B and Class C shares from the dealer's
own funds. The combination of the CDSC and the ongoing distribution fee
facilitates the ability of the Fund to sell the Class B and Class C shares
without a sales charge being deducted at the time of purchase. See "Distribution
Plans" below. Imposition of the CDSC and the distribution fee on Class B and
Class C shares is limited by the National Association of Securities Dealers,
Inc. (the "NASD") asset-based sales charge rule. See "Limitations on the Payment
of Deferred Sales Charges" below.
DISTRIBUTION PLANS
Reference is made to "Account Choices -- Pricing of Shares" in the
Prospectus for certain information with respect to separate distribution plans
for Class A, Class B, and Class C shares pursuant to Rule 12b-1 under the 1940
Act (each a "Distribution Plan") with respect to the account maintenance and/or
distribution fees paid by the Fund to the Distributor with respect to such
classes.
The Distribution Plans for each of the Class A, Class B and Class C shares
provide that the Fund pays the Distributor an account maintenance fee relating
to the shares of the relevant class, accrued daily and paid monthly, at the
annual rate of % of the average daily net assets of the Fund attributable to
shares of the relevant class in order to compensate the Distributor and selected
securities dealers or other financial intermediaries (pursuant to
sub-agreements) in connection with account maintenance activities with respect
to Class A, Class B and Class C shares. Each of those classes has exclusive
voting rights with respect to the Distribution Plan adopted with respect to such
class pursuant to which account maintenance and/or distribution fees are paid
(except that Class B shareholders may vote on any material changes to expenses
charged under the Class A Distribution Plan).
The Distribution Plans for each of the Class B and Class C shares provide
that the Fund also pays the Distributor a distribution fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual rate
of % of the average daily net assets of the Class B shares and % of the
average daily net assets of the Class C shares in order to compensate the
Distributor and selected securities dealers or other financial intermediaries
(pursuant to sub-agreements) for providing shareholder and distribution
services, and bearing certain distribution-related expenses of the Fund,
including payments to securities dealers and other financial intermediaries for
selling Class B and Class C shares of the Fund. The Distribution Plans relating
to Class B and Class C shares are designed to permit an investor to purchase
Class B and Class C shares through securities dealers and other financial
intermediaries without the assessment of an initial sales charge and at the same
time permit the Distributor to compensate securities dealers and other financial
intermediaries in connection with the sale of the Class B and Class C shares. In
this regard, the purpose and function of the ongoing distribution fees and the
CDSC are the same as those of the initial sales charge with respect to the Class
I and Class A shares of the Fund in that the ongoing distribution fees and
deferred sales charges provide for the financing of the distribution of the
Fund's Class B and Class C shares.
The Fund's Distribution Plans are subject to the provisions of Rule 12b-1
under the 1940 Act. In their consideration of each Distribution Plan, the
Trustees must consider all factors they deem relevant, including information as
to the benefits of each Distribution Plan to the Fund and the related class of
shareholders. Each Distribution Plan further provides that, so long as the
Distribution Plan remains in effect, the selection and nomination of
non-interested Trustees shall be committed to the discretion of the
non-interested Trustees then in office. In approving each Distribution Plan in
accordance with Rule 12b-1, the non-interested Trustees concluded that there is
a reasonable likelihood that such Distribution Plan will benefit the Fund and
its related class of shareholders. Each Distribution Plan can be terminated at
any time, without penalty, by the vote of a majority of the non-interested
Trustees or by the vote of the holders of a majority of the outstanding related
class of voting securities of the Fund. A Distribution Plan cannot be amended to
increase materially the amount to be spent by the Fund without the approval of
the related class of shareholders, and all material amendments are required to
be approved by the vote of Trustees, including a majority of the non-interested
Trustees who have no direct or indirect financial interest in such Distribution
Plan, cast in person at a meeting
35
<PAGE> 519
called for that purpose. Rule 12b-1 further requires that the Fund preserve
copies of its Distribution Plans and any report made pursuant to such plan for a
period of not less than six years from the date of such Distribution Plan or
such report, the first two years in an easily accessible place.
Among other things, each Distribution Plan provides that the Distributor
shall provide and the Trustees shall review quarterly reports of the
disbursement of the account maintenance and/or distribution fees paid to the
Distributor. Payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred and, accordingly, distribution-related revenues from each
Distribution Plan may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Trustees for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. This information will be presented annually as of December 31 of each
year on a "fully allocated accrual" basis and quarterly on a "direct expense and
revenue/cash" basis. On the fully allocated basis, revenues consist of the
account maintenance fees, the distribution fees, the CDSCs and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and marketing expenses, corporate
overhead and interest expense. On the direct expense and revenue/cash basis,
revenues consist of the account maintenance fees, the distribution fees and
CDSCs and the expenses consist of financial consultant compensation.
For the fiscal year ended June 30, 2000, the Fund made payments of $46,828
to the Distributor under the Rule 12b-1 Plan for the Distributor Class shares
(which were redesignated as Class A shares).
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee and
the CDSC borne by the Class B and Class C shares, but not the account
maintenance fee. The maximum sales charge rule is applied separately to each
class. As applicable to the Fund, the maximum sales charge rule limits the
aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges), plus (2) interest on the unpaid balance for the respective
class, computed separately, at the prime rate plus 1% (the unpaid balance being
the maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC).
REDEMPTION OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Except for any CDSC that may be applicable, there will be no charge
for redemption if the redemption request is sent directly to the Transfer Agent.
Shareholders liquidating their holdings will receive upon redemption all
dividends reinvested through the date of redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists, as defined by the
Commission, as a result of which disposal of portfolio securities or
determination of the net asset value of the Fund is not reasonably practicable,
and for such other periods as the Commission may by order permit for the
protection of shareholders of the Fund.
The value of shares of the Fund at the time of redemption may be more or
less than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
36
<PAGE> 520
The Master Trust has entered into a joint committed line of credit with
other investment companies advised by the Investment Adviser and its affiliates
and a syndicate of banks that is intended to provide the Master Trust and the
Fund with a temporary source of cash to be used to meet redemption requests from
Fund shareholders in extraordinary or emergency circumstances.
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so by tendering the shares directly to the Fund's Transfer Agent, Financial Data
Services, Inc., P.O. Box 41621, Jacksonville, Florida 32232-1621. Redemption
requests delivered other than by mail should be delivered to Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting redemption. Redemption
requests should not be sent to the Fund. The redemption request in either event
requires the signature(s) of all persons in whose name(s) the shares are
registered, signed exactly as such name(s) appear(s) on the Transfer Agent's
register. The signature(s) on the redemption request may require a guarantee by
an "eligible guarantor institution" as defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications. In the
event a signature guarantee is required, notarized signatures are not
sufficient. In general, signature guarantees are waived on redemptions of less
than $50,000 as long as the following requirements are met: (i) all requests
require the signature(s) of all persons in whose name(s) shares are recorded on
the Transfer Agent's register; (ii) all checks must be mailed to the stencil
address of record on the Transfer Agent's register and (iii) the stencil address
must not have changed within 30 days. Certain rules may apply regarding certain
account types such as but not limited to UGMA/UTMA accounts, Joint Tenancies
with Rights of Survivorship, contra broker transactions and institutional
accounts. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority.
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the Transfer
Agent at 1-800-236-4479. The request must be made by the shareholder of record
and be for an amount less than $50,000. Before telephone requests will be
honored, signature approval from all shareholders of record on the account must
be obtained. The shares being redeemed must have been held for at least 15 days.
Telephone redemption requests will not be honored in the following situations:
the accountholder is deceased, the proceeds are to be sent to someone other than
the shareholder of record, funds are to be wired to the client's bank account, a
systematic withdrawal plan is in effect, the request is by an individual other
than the accountholder of record, the account is held by joint tenants who are
divorced, the address has changed within the last 30 days or share certificates
have been issued on the account.
Since this account feature involves a risk of loss from unauthorized or
fraudulent transactions, the Transfer Agent will take certain precautions to
protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address registered
on the account and the social security number registered on the account. The
Fund or the Transfer Agent may temporarily suspend telephone transactions at any
time.
For shareholders redeeming directly with the Transfer Agent, payments will
be mailed within seven days of receipt of a proper notice of redemption. At
various times the Fund may be requested to redeem shares for which it has not
yet received good payment (e.g., cash, Federal funds or certified check drawn on
a U.S. bank). The Fund may delay or cause to be delayed the mailing of a
redemption check until such time as good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank) has been collected for the purchase of
such Fund shares, which usually will not exceed 10 days. In the event that a
shareholder account held directly with the Transfer Agent contains a fractional
share balance, such fractional share balance will be automatically redeemed by
the Fund.
37
<PAGE> 521
REPURCHASE
The Fund also will repurchase its shares through a shareholder's listed
selected securities dealer or other financial intermediary. The Fund normally
will accept orders to repurchase shares by wire or telephone from dealers for
their customers at the net asset value next computed after the order is placed.
Shares will be priced at the net asset value calculated on the day the request
is received, provided that the request for repurchase is submitted to the
selected securities dealer or other financial intermediary prior to the close of
regular trading on the NYSE (generally, regular trading on the NYSE closes at
4:00 p.m., Eastern time) and such request is received by the Fund from such
selected securities dealer or other financial intermediary not later than 30
minutes after the close of regular trading on the NYSE on the same day.
Selected securities dealers and other financial intermediaries have the
responsibility of submitting such repurchase requests to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to obtain
that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any applicable
CDSC). Securities firms that do not have agreements with the Distributor,
however, may impose a transaction charge on the shareholder for transmitting the
notice of repurchase to the Fund. Certain selected securities dealers and other
financial intermediaries may charge a processing fee to confirm a repurchase of
shares. For example, the fee currently charged by Merrill Lynch is $5.35. Fees
charged by other selected securities dealers may be higher or lower. Repurchases
made through the Transfer Agent, on accounts held at the Transfer Agent, are not
subject to the processing fee. The Fund reserves the right to reject any order
for repurchase, which right of rejection might adversely affect shareholders
seeking redemption through the repurchase procedure. A shareholder whose order
for repurchase is rejected by the Fund, however, may redeem Fund shares as set
forth above.
REINSTATEMENT PRIVILEGE -- CLASS I AND CLASS A SHARES
Shareholders of the Fund who have redeemed their Class I and Class A shares
have a privilege to reinstate their accounts by purchasing Class I or Class A
shares of the Fund, as the case may be, at the net asset value without a sales
charge up to the dollar amount redeemed. The reinstatement privilege may be
exercised by sending a notice of exercise along with a check for the amount to
be reinstated to the Transfer Agent within 30 days after the date the request
for redemption was accepted by the Transfer Agent or the Distributor.
Alternatively, the reinstatement privilege may be exercised through the
investor's financial consultant within 30 days after the date the request for
redemption was accepted by the Transfer Agent or the Distributor. The
reinstatement will be made at the net asset value per share next determined
after the notice of reinstatement is received and cannot exceed the amount of
the redemption proceeds.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "Account Choices -- How Shares are Priced" in the
Prospectus.
The net asset value of the shares of all classes of the Fund is determined
once daily Monday through Friday as of the close of regular trading on the NYSE
on each day the NYSE is open for trading based on prices at the time of closing.
Regular trading on the NYSE generally closes at 4:00 p.m., Eastern time. Any
assets or liabilities initially expressed in terms of non-U.S. dollar currencies
are translated into U.S. dollars at the prevailing market rates as quoted by one
or more banks or dealers on the day of valuation. The NYSE is not open for
trading on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
Net asset value of the Fund is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Administrator and Distributor, are accrued daily.
38
<PAGE> 522
The principal assets of the Fund will normally be its interest in the
underlying Portfolio, which will be valued at its net asset value. Net asset
value of the Portfolio is computed by dividing the value of the securities held
by the Portfolio plus any cash or other assets (including interest and dividends
accrued but not yet received) minus all liabilities (including accrued expenses)
by the total number of shares outstanding at such time. Expenses, including the
investment advisory fees, are accrued daily.
The per share net asset value of Class A, Class B and Class C shares
generally will be lower than the per share net asset value of Class I shares,
reflecting the daily expense accruals of the account maintenance, distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares, and the daily expense accruals of the account maintenance fees
applicable with respect to Class A shares. Moreover, the per share net asset
value of the Class B and Class C shares of the Fund generally will be lower than
the per share net asset value of Class A shares of the Fund, reflecting the
daily expense accruals of the distribution fees and higher transfer agency fees
applicable with respect to Class B and Class C shares of the Fund. It is
expected, however, that the per share net asset value of the four classes of the
Fund will tend to converge (although not necessarily meet) immediately after the
payment of dividends which will differ by approximately the amount of the
expense accrual differentials between the classes.
Portfolio securities, including ADRs, EDRs or GDRs, that are traded on
stock exchanges are valued at the last sale price (regular way) on the exchange
on which such securities are traded, as of the close of regular trading on the
day the securities are being valued or, lacking any sales, at the last available
bid price for long positions, and at the last available ask price for short
positions. In cases where securities are traded on more than one exchange, the
securities are valued on the exchange designated by or under the authority of
the Board of Trustees as the primary market. Long positions in securities traded
in the OTC market are valued at the last available bid price in the OTC market
prior to the time of valuation. Short positions in securities traded in the OTC
market are valued at the last available ask price in the OTC market prior to the
time of valuation. Portfolio securities that are traded both in the OTC market
and on a stock exchange are valued according to the broadest and most
representative market. When the Portfolio writes an option, the amount of the
premium received is recorded on the books of the Master Trust as an asset and an
equivalent liability. The amount of the liability is subsequently valued to
reflect the current market value of the option written, based upon the last sale
price in the case of exchange-traded options or, in the case of options traded
in the OTC market, the last ask price. Options purchased by the Portfolio are
valued at their last sale price in the case of exchange-traded options or, in
the case of options traded in the OTC market, the last bid price. Other
investments, including financial futures contracts and related options, are
stated at market value. Securities and assets for which market quotations are
not readily available are valued at fair value as determined in good faith by or
under the direction of the Board of Trustees of the Master Trust. Such
valuations and procedures will be reviewed periodically by the Board of Trustees
of the Master Trust.
Generally, trading in non-U.S. securities, as well as U.S. Government
securities and money market instruments, is substantially completed each day at
various times prior to the close of regular trading on the NYSE. The values of
such securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of regular trading on the NYSE. Occasionally,
events affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of regular trading
on the NYSE that may not be reflected in the computation of the Fund's net asset
value.
Each investor in the Portfolio may add to or reduce its investment in the
Portfolio on each day the NYSE is open for trading. The value of each investor's
(including the Fund's) interest in the Portfolio will be determined as of the
close of regular trading on the NYSE by multiplying the net asset value of the
Portfolio by the percentage, effective for that day, that represents that
investor's share of the aggregate interests in the Portfolio. The close of
regular trading on the NYSE is generally 4:00 p.m., Eastern time. Any additions
or withdrawals to be effected on that day will then be effected. The investor's
percentage of the aggregate beneficial interests in the Portfolio will then be
recomputed as the percentage equal to the fraction (i) the numerator of which is
the value of such investor's investment in the Portfolio as of the time of
determination on such day plus or minus, as the case may be, the amount of any
additions to or withdrawals from the investor's investment in the Portfolio
effected on such day, and (ii) the denominator of which is the aggregate
39
<PAGE> 523
net asset value of the Portfolio as of such time on such day plus or minus, as
the case may be, the amount of the net additions to or withdrawals from the
aggregate investments in the Portfolio by all investors in the Portfolio. The
percentage so determined will then be applied to determine the value of the
investor's interest in the Portfolio after the close of regular trading on the
NYSE on the next determination of net asset value of the Portfolio.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class I, Class
A, Class B and Class C shares of the Fund based on the net asset value of the
Fund's shares on June 30, 2000 is as follows:
<TABLE>
<CAPTION>
CLASS I CLASS A CLASS B CLASS C
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net Assets................................................ $ $ $ $
------- ------- ------- -------
Number of Shares Outstanding..............................
------- ------- ------- -------
Net Asset Value Per Share (net assets divided by number of
shares outstanding)..................................... $ $ $ $
------- ------- ------- -------
Sales Charge (for Class I and Class A Shares; % of
Offering Price; ( % of net amount invested))*....... ** **
------- ------- ------- -------
Offering Price............................................ $ $ $ $
------- ------- ------- -------
</TABLE>
---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
** Class B and Class C shares are not subject to an initial sales charge but may
be subject to a CDSC on redemption. See "Purchase of Shares -- Deferred Sales
Charge Alternatives -- Class B and Class C Shares" herein. No Class B and
Class C shares were outstanding on June 30, 2000.
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Because the Fund will invest exclusively in shares of the Portfolio, it is
expected that all transactions in portfolio securities will be entered into by
the Master Trust. Subject to policies established by the Board of Trustees of
the Master Trust, the Investment Adviser is primarily responsible for the
execution of the Master Trust's portfolio transactions and the allocation of
brokerage. The Master Trust has no obligation to deal with any broker or group
of brokers in the execution of transactions in portfolio securities and does not
use any particular broker or dealer. In executing transactions with brokers and
dealers, the Investment Adviser seeks to obtain the best net results for the
Portfolio, taking into account such factors as price (including the applicable
brokerage commission or dealer spread), size of order, difficulty of execution
and operational facilities of the firm and the firm's risk in positioning a
block of securities. While the Investment Adviser generally seeks reasonably
competitive commission rates, the Portfolio does not necessarily pay the lowest
spread or commission available. In addition, consistent with the Conduct Rules
of the NASD and policies established by the Board of Trustees of the Master
Trust, the Investment Adviser may consider sales of Fund shares as a factor in
the selection of brokers or dealers to execute portfolio transactions for the
Portfolio; however, whether or not a particular broker or dealer sells shares of
the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Portfolio.
Subject to obtaining the best net results, brokers who provide supplemental
investment research to the Investment Adviser may receive orders for
transactions by the Portfolio. Such supplemental research services ordinarily
consist of assessments and analyses of the business or prospects of a company,
industry or economic sector. Information so received will be in addition to and
not in lieu of the services required to be performed by the Investment Adviser
under the Investment Advisory Agreement and the expenses of the Investment
Adviser will not necessarily be reduced as a result of the receipt of such
supplemental information. If in the judgment of the Investment Adviser the
Portfolio will benefit from supplemental research services, the Investment
Adviser is authorized to pay brokerage commissions to a broker furnishing such
services that are in excess of commissions that another broker may have charged
for effecting the same transactions. Certain
40
<PAGE> 524
supplemental research services may primarily benefit one or more other
investment companies or other accounts for which the Investment Adviser
exercises investment discretion. Conversely, the Portfolio may be the primary
beneficiary of the supplemental research services received as a result of
portfolio transactions effected for such other accounts or investment companies.
The Master Trust anticipates that its brokerage transactions involving
securities of issuers domiciled in countries other than the United States
generally will be conducted primarily on the principal stock exchanges of such
countries. Brokerage commissions and other transaction costs on foreign stock
exchange transactions generally are higher than in the United States, although
the Master Trust will endeavor to achieve the best net results in effecting its
portfolio transactions. There generally is less governmental supervision and
regulation of foreign stock exchanges and brokers than in the United States.
Foreign equity securities may be held by the Master Trust in the form of
ADRs, EDRs, GDRs or other securities convertible into foreign equity securities.
ADRs, EDRs and GDRs may be listed on stock exchanges, or traded in
over-the-counter markets in the United States or Europe, as the case may be.
ADRs, like other securities traded in the United States, will be subject to
negotiated commission rates. The Master Trust's ability and decisions to
purchase or sell portfolio securities of foreign issuers may be affected by laws
or regulations relating to the convertibility and repatriation of assets.
Because the shares of the Fund are redeemable on a daily basis in U.S. dollars,
the Master Trust intends to manage the Portfolio so as to give reasonable
assurance that it will be able to obtain U.S. dollars to the extent necessary to
meet anticipated redemptions. Under present conditions, it is not believed that
these considerations will have significant effect on the Master Trust's
portfolio strategies.
The Master Trust may invest in certain securities traded in the OTC market
and intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Master
Trust and persons who are affiliated with such affiliated persons are prohibited
from dealing with the Portfolio as principal in the purchase and sale of
securities unless a permissive order allowing such transactions is obtained from
the Commission. Since transactions in the OTC market usually involve
transactions with the dealers acting as principal for their own accounts, the
Portfolio will not deal with affiliated persons, including Merrill Lynch and its
affiliates, in connection with such transactions. However, an affiliated person
of the Portfolio may serve as its broker in OTC transactions conducted on an
agency basis provided that, among other things, the fee or commission received
by such affiliated broker is reasonable and fair compared to the fee or
commission received by non-affiliated brokers in connection with comparable
transactions. In addition, the Portfolio may not purchase securities during the
existence of any underwriting syndicate for such securities of which Merrill
Lynch or an affiliate is a member or in a private placement in which Merrill
Lynch or an affiliate serves as placement agent except pursuant to procedures
approved by the Board of Trustees of the Master Trust that either comply with
rules adopted by the Commission or with interpretations of the Commission staff.
See "Investment Objective and Policies -- Investment Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch or its affiliates acting as a
broker for the Master Trust in any of its portfolio transactions executed on any
such securities exchange of which it is a member, appropriate consents have been
obtained from the Master Trust and annual statements as to aggregate
compensation will be provided to the Master Trust. Securities may be held by, or
be appropriate investments for, the Master Trust as well as other funds or
investment advisory clients of the Investment Adviser or its affiliates.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or its affiliates
when one or more clients of the Investment Adviser or its affiliates are selling
the same security. If purchases or sales of securities arise for consideration
at or about the
41
<PAGE> 525
same time that would involve the Portfolio or other clients or funds for which
the Investment Adviser or an affiliate acts as investment adviser, transactions
in such securities will be made, insofar as feasible, for the respective funds
and clients in a manner deemed equitable to all. To the extent that transactions
on behalf of more than one client of the Investment Adviser or its affiliates
during the same period may increase the demand for securities being purchased or
the supply of securities being sold, there may be an adverse effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below that are
designed to facilitate investment in its shares. Full details as to each such
service and copies of the various plans or how to change options with respect
thereto, can be obtained from the Fund by calling the telephone number on the
cover page hereof, or from the Distributor or your selected securities dealer or
other financial intermediary. Certain of these services are available only to
U.S. investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of dividends. The statements
also will show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
dividends. A shareholder with an account held at the Transfer Agent may make
additions to his or her Investment Account at any time by mailing a check
directly to the Transfer Agent. The Fund does not issue share certificates.
Shareholders considering transferring their Class I or Class A shares from
a selected securities dealer to another brokerage firm or financial institution
should be aware that, if the firm to which the Class I or Class A shares are to
be transferred will not take delivery of shares of the Fund, a shareholder
either must redeem the Class I or Class A shares so that the cash proceeds can
be transferred to the account at the new firm or such shareholder must continue
to maintain an Investment Account at the Transfer Agent for those Class I or
Class A shares.
Shareholders interested in transferring their Class B or Class C shares
from a selected securities dealer or other financial intermediary and who do not
wish to have an Investment Account maintained for such shares at the Transfer
Agent may request their new brokerage firm to maintain such shares in an account
registered in the name of the brokerage firm for the benefit of the shareholder
at the Transfer Agent.
Certain shareholder services may not be available for the transferred
shares. After the transfer, the shareholder may purchase additional shares of
funds owned before the transfer, and all future trading of these assets must be
coordinated by the new firm.
Shareholders considering transferring a tax-deferred retirement account,
such as an individual retirement account, from a selected securities dealer or
other financial intermediary to another brokerage firm or financial institution
should be aware that, if the firm to which the retirement account is to be
transferred will not take delivery of shares of the Fund, a shareholder must
either redeem the shares (paying any applicable CDSC) so that the cash proceeds
can be transferred to the account at the new firm, or such shareholder must
continue to maintain a retirement account at a selected securities dealer or
other financial intermediary for those shares.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other Mercury mutual funds and Summit, a series of Financial
Institutions Series Trust, which is a Merrill Lynch-sponsored money market fund
specifically designated as available for exchange by holders of Class I, Class
A, Class B and Class C shares. Shares with a net asset value of at least $100
are required to qualify for the exchange privilege and any shares used in an
exchange must have been held by the shareholder for at least 15 days.
42
<PAGE> 526
Before effecting an exchange, shareholders should obtain a currently effective
prospectus of the fund into which the exchange is to be made. Exercise of the
exchange privilege is treated as a sale of the exchanged shares and a purchase
of the acquired shares for Federal income tax purposes.
Exchanges of Class I and Class A Shares. Under the Fund's pricing system,
Class I shareholders may exchange Class I shares of the Fund for Class I shares
of a second Mercury mutual fund. If the Class I shareholder wants to exchange
Class I shares for shares of a second Mercury mutual fund, but does not hold
Class I shares of the second fund in his or her account at the time of exchange
and is not otherwise eligible to acquire Class I shares of the second fund, the
shareholder will receive Class A shares of the second fund as a result of the
exchange. Class A shares also may be exchanged for Class I shares of a second
Mercury mutual fund at any time as long as, at the time of the exchange, the
shareholder is eligible to acquire Class I shares of any Mercury mutual fund.
Exchanges of Class I or Class A shares outstanding ("outstanding Class I or
Class A shares") for Class I or Class A shares of another Mercury mutual fund,
or for Class A shares of Summit ("new Class I or Class A shares") are transacted
on the basis of relative net asset value per Class I or Class A share,
respectively, plus an amount equal to the difference, if any, between the sales
charge previously paid on the outstanding Class I or Class A shares and the
sales charge payable at the time of the exchange on the new Class I or Class A
shares. With respect to outstanding Class I or Class A shares as to which
previous exchanges have taken place, the "sales charge previously paid" shall
include the aggregate of the sales charges paid with respect to such Class I or
Class A shares in the initial purchase and any subsequent exchange. Class I or
Class A shares issued pursuant to dividend reinvestment are sold on a no-load
basis. For purposes of the exchange privilege, Class I and Class A shares
acquired through dividend reinvestment shall be deemed to have been sold with a
sales charge equal to the sales charge previously paid on the Class I or Class A
shares on which the dividend was paid. Based on this formula, Class I and Class
A shares of the Fund generally may be exchanged into the Class I and Class A
shares, respectively, of the other funds with a reduced or without a sales
charge.
Exchanges of Class B and Class C Shares. In addition, the funds with Class
B or Class C shares outstanding ("outstanding Class B or Class C shares") offer
to exchange their Class B or Class C shares for Class B or Class C shares,
respectively, of another Mercury mutual fund or for Class B shares of Summit
("new Class B or Class C shares") on the basis of relative net asset value per
Class B or Class C share, without the payment of any CDSC that might otherwise
be due on redemption of the outstanding shares. Class B shareholders of the Fund
exercising the exchange privilege will continue to be subject to the Fund's CDSC
schedule if such schedule is higher than the CDSC schedule relating to the new
Class B shares acquired through use of the exchange privilege. In addition,
Class B shares of the Fund acquired through use of the exchange privilege will
be subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the fund from which the exchange was
made. For purposes of computing the CDSC that may be payable on a disposition of
the new Class B or Class C shares, the holding period for the outstanding Class
B shares is "tacked" to the holding period of the new Class B or Class C shares.
For example, an investor may exchange Class B shares of the Fund for those of
another Mercury fund ("new Mercury Fund") after having held the Fund's Class B
shares for two-and-a-half years. The % CDSC that generally would apply to a
redemption would not apply to the exchange. Four years later the investor may
decide to redeem the Class B shares of new Mercury Fund and receive cash. There
will be no CDSC due on this redemption since by "tacking" the
two-and-a-half-year holding period of the Fund's Class B shares to the four-year
holding period for the new Mercury Fund Class B shares, the investor will be
deemed to have held the new Mercury Fund Class B shares for more than six years.
Exchanges for Shares of a Money Market Fund. Class I and Class A shares are
exchangeable for Class A shares of Summit and Class B and Class C shares are
exchangeable for Class B shares of Summit. Class A shares of Summit have an
exchange privilege back into Class I or Class A shares of affiliate-advised
Funds; Class B shares of Summit have an exchange privilege back into Class B or
Class C shares of affiliate-advised Funds and, in the event of such an exchange,
the period of time that Class B shares of Summit are held will count toward
satisfaction of the holding period requirement for purposes of reducing any CDSC
and toward satisfaction of any Conversion Period with respect to Class B shares.
Class B shares of Summit will be subject to a distribution fee at an annual rate
of 0.50% of average daily net assets of such Class B shares. This
43
<PAGE> 527
exchange privilege does not apply with respect to certain fee-based programs for
which alternative exchange arrangements may exist. Please see your financial
consultant for further information.
Prior to October 12, 1998, exchanges from other affiliate-advised Funds
into a money market fund were directed to certain affiliate-advised money market
funds other than Summit. Shareholders who exchanged affiliate-advised Fund
shares for such other money market funds and subsequently wish to exchange those
money market fund shares for shares of the Fund will be subject to the CDSC
schedule applicable to such Fund shares, if any. The holding period for those
money market fund shares will not count toward satisfaction of the holding
period requirement for reduction of the CDSC imposed on such shares, if any,
and, with respect to Class B shares, toward satisfaction of the Conversion
Period. However, the holding period for Class B or Class C shares of the Fund
received in exchange for such money market fund shares will be aggregated with
the holding period for the fund shares originally exchanged for such money
market fund shares for purposes of reducing the CDSC or satisfying the
Conversion Period.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her financial consultant, who will advise the
relevant Fund of the exchange. Shareholders of the Fund and shareholders of the
other funds described above with shares for which certificates have not been
issued may exercise the exchange privilege by wire through their selected
securities dealers or other financial intermediaries. The Fund reserves the
right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated in accordance with the rules of the
Commission. The Fund reserves the right to limit the number of times an investor
may exercise the exchange privilege. Certain funds may suspend the continuous
offering of their shares to the general public at any time and may thereafter
resume such offering from time to time. The exchange privilege is available only
to U.S. shareholders in states where the exchange legally may be made. It is
contemplated that the exchange privilege may be applicable to other new mutual
funds whose shares may be distributed by the Distributor.
FEE-BASED PROGRAMS
Certain fee-based programs, including pricing alternatives for securities
transactions (each referred to in this paragraph as a "Program"), may permit the
purchase of Class I shares at net asset value. Under specified circumstances,
participants in certain Programs may deposit other classes of shares, which will
be exchanged for Class I shares. Initial or deferred sales charges otherwise due
in connection with such exchanges may be waived or modified, as may the
Conversion Period applicable to the deposited shares. Termination of
participation in certain Programs may result in the redemption of shares held
therein or the automatic exchange thereof to another class at net asset value.
In addition, upon termination of participation in a Program, shares that have
been held for less than specified periods within such Program may be subject to
a fee based on the current value of such shares. These Programs also generally
prohibit such shares from being transferred to another account, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and distribution and account maintenance fees)
in order for the investment not to be subject to Program fees. Additional
information regarding certain specific Programs offered through particular
selected securities dealers or other financial intermediaries (including charges
and limitations on transferability applicable to shares that may be held in such
Programs) is available in each such Program's client agreement and from the
Transfer Agent at 1-800-236-4479.
RETIREMENT PLANS
The minimum initial purchase to establish a retirement plan is $100.
Dividends received in retirement plans are exempt from Federal taxation until
distributed from the plans. Different tax rules apply to Roth IRA plans and
educational savings plans. Investors considering participation in any retirement
or education savings plan should review specific tax laws relating thereto and
should consult their attorneys or tax advisers with respect to the establishment
and maintenance of any such plan.
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<PAGE> 528
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class I shares (if he or she is an eligible Class I investor) or
Class A, Class B or Class C shares at the applicable public offering price.
These purchases may be made either through the shareholder's securities dealer
or by mail directly to the Transfer Agent, acting as agent for such securities
dealer. You may also add to your account by automatically investing a specific
amount in the Fund on a periodic basis through your selected securities dealer
or other financial intermediary. The current minimum for such automatic
additional investments is $100. This minimum may be waived or revised under
certain circumstances.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Shareholders may, at any time, by written notification to their selected
securities dealer or other financial intermediary if their account is maintained
with a selected securities dealer or other financial intermediary, or by written
notification or by telephone (1-800-236-4479) to the Transfer Agent, if their
account is maintained with the Transfer Agent, elect to have subsequent
dividends of ordinary income and/or capital gains paid with respect to shares of
the Fund in cash, rather than reinvested in shares of the Fund (provided that,
in the event that a payment on an account maintained at the Transfer Agent would
amount to $10.00 or less, a shareholder will not receive such payment in cash
and such payment will automatically be reinvested in additional shares).
Commencing ten days after the receipt by the Transfer Agent of such notice,
those instructions will be effected. The Fund is not responsible for any failure
of delivery to the shareholder's address of record and no interest will accrue
on amounts represented by uncashed dividend checks. Cash payments can also be
directly deposited to the shareholder's bank account.
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals are available for shareholders with
shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed from
those on deposit in the shareholder's account to provide the withdrawal payment
specified by the shareholder. The shareholder may specify the dollar amount and
class of shares to be redeemed. Redemptions will be made at net asset value as
of the close of regular trading on the NYSE (generally, the NYSE closes at 4:00
p.m., Eastern time) on the 24th day of each month or the 24th day of the last
month of each quarter, whichever is applicable. If the NYSE is not open for
business on such date, the shares will be redeemed at the net asset value
determined after the close of regular trading on the NYSE on the following
business day. The check for the withdrawal payment will be mailed, or the direct
deposit for withdrawal payment will be made, on the next business day following
redemption. When a shareholder is making systematic withdrawals, dividends on
all shares in the Investment Account are reinvested automatically in Fund
shares. A shareholder's systematic withdrawal plan may be terminated at any
time, without a charge or penalty, by the shareholder, the Fund, the Transfer
Agent or the Distributor.
With respect to redemptions of Class B and Class C shares pursuant to a
systematic withdrawal plan, the maximum number of Class B or Class C shares that
can be redeemed from an account annually shall not exceed 10% of the value of
shares of such class in that account at the time the election to join the
systematic withdrawal plan was made. Any CDSC that otherwise might be due on
such redemption of Class B or Class C shares will be waived. Shares redeemed
pursuant to a systematic withdrawal plan will be redeemed in the same order as
Class B or Class C shares are otherwise redeemed. See "Purchase of
Shares -- Deferred Sales Charge Alternatives -- Class B and C Shares." Where the
systematic withdrawal plan is applied to Class B shares, upon conversion of the
last Class B shares in an account to Class A shares, a shareholder must make a
new election to join the systematic withdrawal program with respect to the Class
A shares. If an investor
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<PAGE> 529
wishes to change the amount being withdrawn in a systematic withdrawal plan the
investor should contact his or her financial consultant.
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax liabilities.
The Fund will not knowingly accept purchase orders for shares of the Fund from
investors who maintain a systematic withdrawal plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
DIVIDENDS AND TAX STATUS
The Fund has qualified as a regulated investment company. Qualification as
a regulated investment company requires, among other things, that (1) at least
90% of the Fund's annual gross income, without offset for losses from the sale
or other disposition of securities, be derived from payments with respect to
securities loans, interest, dividends and gains from the sale or other
disposition of stock, securities, or foreign currencies or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities, or currencies; and (2) the Fund diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of the Fund's assets is represented by cash, U.S. government securities,
securities of other regulated investment companies, and other securities limited
in respect of any one issuer to an amount not greater than 5% of the Fund's
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. government securities or the securities of other
regulated investment companies). In addition, in order not to be subject to
federal taxation, the Fund must distribute to its shareholders at least 90% of
its investment company taxable income earned in each year.
The Fund is required to pay an excise tax to the extent it does not
distribute to its shareholders during any calendar year at least 98% of its
ordinary income for that calendar year, 98% of the excess of its capital gains
over its capital losses for the one-year period ending October 31 in such
calendar year, and all undistributed ordinary income and capital gains for the
preceding respective one-year period. The Fund intends to meet these
distribution requirements to avoid excise tax liability. The Fund also intends
to continue distributing to shareholders all of the excess of net long-term
capital gain over net short-term capital loss on sales of securities. If the net
asset value of shares of the Fund should, by reason of a distribution of
realized capital gains, be reduced below a shareholder's cost, such distribution
would to that extent be a return of capital to that shareholder even though
taxable to the shareholder, and a sale of shares by a shareholder at net asset
value at that time would establish a capital loss for federal tax purposes.
In determining the extent to which the Fund's dividends may be eligible for
the 70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisors regarding other requirements applicable to the dividends received
deduction.
Special rules apply to the treatment of certain forward foreign currency
exchange contracts (Section 1256 contracts). At the end of each year, such
investments held by the Fund must be "marked to market" for federal income tax
purposes; that is, treated as having been sold at market value. Except to the
extent that such gains or losses are treated as "Section 988" gains or losses,
as described below, sixty percent of any gain or loss recognized on these
"deemed sales" and on actual dispositions may be treated as long-term capital
gain or loss, and the remainder will be treated as short-term capital gain or
loss.
Under the Internal Revenue Code, gains or losses attributable to
fluctuations in exchange rates which occur between the time the Fund accrues
interest or other receivables or accrues expenses or other liabilities
46
<PAGE> 530
denominated in a foreign currency and the time the Fund actually collects such
receivables or pays such liabilities are treated as ordinary income or loss.
Similarly, gains or losses on forward foreign currency exchange contracts or
dispositions of debt securities denominated in a foreign currency attributable
to fluctuations in the value of the foreign currency between the date of
acquisition of the security and the date of disposition are also treated as
ordinary gain or loss. These gains, referred to as "Section 988" gains or
losses, increase or decrease the amount of the Fund's investment company taxable
income available to be distributed to its shareholders as ordinary income,
rather than increasing or decreasing the Fund's net capital gain. If Section 988
losses exceed other investment company taxable income during a taxable year, the
Fund would not be able to make any ordinary dividend distributions, and any
ordinary dividend distributions made before the losses were realized would be
recharacterized as a return of capital to shareholders, rather than as an
ordinary dividend, reducing the basis of each shareholder's shares.
Any loss realized on a sale, redemption or exchange of shares of the Fund
by a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by the Fund constitute a
replacement of shares.
The per share dividends on Class B and Class C shares will be lower than
the per share dividends on Class I and Class A shares as a result of the account
maintenance, distribution and higher transfer agency fees applicable with
respect to the Class B and Class C shares; similarly, the per share dividends on
Class A shares will be lower than the per share dividends on Class I shares as a
result of the account maintenance fees applicable with respect to the Class A
shares. See "Pricing of Shares -- Determination of Net Asset Value."
Because the Portfolio will be classified as a partnership for tax purposes,
the Fund will be entitled to look to the underlying assets of the Portfolio in
which it has invested for purposes of satisfying various requirements of the
Code applicable to regulated investment companies. If any of the facts upon
which this classification is premised change in any material respect then the
Board of Trustees will determine, in its discretion, the appropriate course of
action for the Fund. One possible course of action would be to withdraw the
Fund's investment from the Portfolio and to retain an investment adviser to
manage the Fund's assets in accordance with the investment policies applicable
to the Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined separately for Class I, Class A, Class
B and Class C shares in accordance with a formula specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class I and Class A
shares and the CDSC that would be applicable to a complete redemption of the
investment at the end of the specified period as in the case of Class B and
Class C shares. Dividends paid by the Fund with respect to all shares, to the
extent any dividends are paid, will be calculated in the same manner at the same
time on the same day and will be in the same amount, except that account
maintenance and the distribution charges and any incremental transfer agency
costs relating to each class of shares will be borne exclusively by that class.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than
47
<PAGE> 531
average annual data, may be quoted and (2) the maximum applicable sales charges
will not be included with respect to annual or annualized rates of return
calculations. Aside from the impact on the performance data calculations of
including or excluding the maximum applicable sales charges, actual annual or
annualized total return data generally will be lower than average annual total
return data since the average rates of return reflect compounding of return;
aggregate total return data generally will be higher than average annual total
return data since the aggregate rates of return reflect compounding over a
longer period of time. The Fund's total return may be expressed either as a
percentage or as a dollar amount in order to illustrate such total return on a
hypothetical $1,000 investment in the Fund at the beginning of each specified
period.
Average annual total returns for the periods ended June 30, 2000 are as
follows:
<TABLE>
<CAPTION>
ONE FIVE SINCE
YEAR YEARS INCEPTION
----- ----- ---------
<S> <C> <C> <C> <C>
Investor Class........................ (Since 12/6/94)
Distributor Class..................... N/A (Since 6/21/99)
</TABLE>
In order to reflect the reduced sales charges in the case of Class I or
Class A shares or the waiver of the CDSC in the case of Class B or Class C
shares applicable to certain investors, as described under "Purchase of Shares"
and "Redemption of Shares," respectively, the total return data quoted by the
Fund in advertisements directed to such investors may take into account the
reduced, and not the maximum, sales charge or may take into account the CDSC and
therefore may reflect greater total return since, due to the reduced sales
charges or the waiver of sales charges, a lower amount of expenses is deducted.
Yield. Annualized yield quotations used in the Fund's advertising and
promotional materials are calculated by dividing the Fund's interest income for
a specified thirty-day period, net of expenses, by the average number of shares
outstanding during the period, and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the net asset value per share
at the end of the period. Yield quotations are calculated according to the
following formula:
YIELD = 2 [((a - b) + 1)(6) - 1]
-----
cd
where "a" equals dividends and interest earned during the period; "b" equals
expenses accrued for the period, net of reimbursements; "c" equals the average
daily number of shares outstanding during the period that are entitled to
receive dividends; and "d" equals the maximum offering price per share on the
last day of the period.
Except as noted below, in determining net investment income earned during
the period ("a" in the above formula), the Fund calculates interest earned on
each debt obligation held by it during the period by (1) computing the
obligation's yield to maturity, based on the market value of the obligation
(including actual accrued interest) on the last business day of the period or,
if the obligation was purchased during the period, the purchase price plus
accrued interest; (2) dividing the yield to maturity by 360 and multiplying the
resulting quotient by the market value of the obligation (including actual
accrued interest). Once interest earned is calculated in this fashion for each
debt obligation held by the Fund, net investment income is then determined by
totaling all such interest earned.
For purposes of these calculations, the maturity of an obligation with one
or more call provisions is assumed to be the next date on which the obligation
reasonably can be expected to be called or, if none, the maturity date.
The 30-day yields for the Fund for the period ended June 30, 2000 were
% (Investor Class) and % (Distributor Class).
48
<PAGE> 532
In advertising and sales literature, the Fund may compare its performance
to that of various broad market indexes, including without limitation the Lehman
Brothers Aggregate Bond Index, Standard & Poor's 500 Composite Stock Price Index
and other published indexes. When comparing its performance to a market index,
the Fund may refer to various statistical measures derived from the historic
performance of the Fund and the index, such as standard deviation and beta. In
addition, the Fund may refer in advertising or sales literature to (i) mutual
fund performance ratings, rankings and comparisons (including risk-adjusted
ratings, rankings and comparisons, (ii) other comparisons of mutual fund data
including assets, expenses, fees and other data, and (iii) other discussions
reported in or assigned by Barron's, Business Week, CDA Investment Technology,
Inc., Financial World, Forbes Magazine, Fortune Magazine, Lipper Inc., Money
Magazine, U.S. News & World Report, The Wall Street Journal and other industry
publications. The Fund may also make reference to awards that may be given to
the Investment Adviser. As with other performance data, performance comparisons
should not be considered indicative of the Fund's relative performance for any
future period.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Fund is a "feeder" fund that invests in the Portfolio. Investors in the
Fund will acquire an indirect interest in the Portfolio. The Portfolio accepts
investments from other feeder funds, and all of the feeders of the Portfolio
bear the Portfolio's expenses in proportion to their assets. This structure may
enable the Fund to reduce costs through economies of scale. A larger investment
portfolio also may reduce certain transaction costs to the extent that
contributions to and redemptions from the Master Trust from different feeders
may offset each other and produce a lower net cash flow. However, each feeder
can set its own transaction minimums, fund-specific expenses, and other
conditions. This means that one feeder could offer access to the same Portfolio
on more attractive terms, or could experience better performance, than another
feeder.
The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest and to divide or combine
the shares into a greater or lesser number of shares without thereby changing
the proportionate beneficial interest in the Fund. Each share represents an
interest in the Fund proportionately equal to the interest of each other share,
except that the Class B and C shares are subject to distribution fees payable
under the Plans of Distribution. Upon the Trust's liquidation, all shareholders
would share pro rata in the net assets of the Fund available for distribution to
shareholders. If they deem it advisable and in the best interest of
shareholders, the Board of Trustees may create additional classes of shares. The
Board of Trustees has created ten series of shares, and may create additional
series in the future, which have separate assets and liabilities.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a
Fund's shares may advise the Trustees in writing that they wish to communicate
with other shareholders for the purpose of requesting a meeting to remove a
Trustee. The Trustees will then, if requested by the applicants, mail at the
applicants' expense the applicants' communication to all other shareholders.
The Trust or any Fund may be terminated if approved by the vote of a
majority of the Trustees or by the approval of the holders of a majority of the
Trust's outstanding shares, as defined in the 1940 Act. If not so terminated,
the Trust will continue indefinitely.
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to
49
<PAGE> 533
have been effectively acted upon unless approved by the holders of a "majority"
(as defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Trust or its Trustees. The Declaration of Trust provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for its obligations. While Massachusetts
law permits a shareholder of a trust such as this to be held personally liable
as a partner under certain circumstances, the risk of a shareholder incurring
financial loss on account of shareholder liability is unlikely and is limited to
the relatively remote circumstances in which the Trust would be unable to meet
its obligations.
Common expenses incurred by the Trust are allocated among the portfolios
based upon: (1) relative net assets; (2) as incurred on a specific
identification basis; or (3) evenly among the portfolios, depending on the
nature of the expenditure.
Except for (1) changes which do not adversely affect the rights of Trust
shareholders; (2) a change in the name of the Trust, or a series or class
thereof; (3) authorization of a new series or class; (4) changes to supply any
omission or correct any ambiguous or defective provision; or (5) changes
required by any federal, state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust without the affirmative vote of the holders of at least 67%
of the Trust's outstanding shares at a meeting at which more than 50% of its
outstanding shares are present in person or represented by proxy. The holders of
shares have no preemptive or conversion rights. Shares when issued are fully
paid and non-assessable, except as set forth above.
Whenever the Master Trust holds a vote of its feeder funds, the Fund will
pass the vote through to its own shareholders. Smaller feeder funds may be
harmed by the actions of larger feeder funds. For example, a larger feeder fund
could have more voting power than the Fund over the operations of the Portfolio.
The Fund may withdraw from the Portfolio at any time and may invest all of its
assets in another pooled investment vehicle or retain an investment adviser to
manage the Fund's assets directly.
The Master Trust is organized as a Delaware business trust. Whenever the
Fund is requested to vote on any matter relating to the Master Trust, the Trust
will hold a meeting of the Fund's shareholders and will cast its vote as
instructed by the Fund's shareholders.
ISSUANCE OF FUND SHARES FOR SECURITIES
Investors may purchase Fund shares for consideration consisting of
securities rather than cash when, in the judgment of the Investment Adviser, the
securities: (a) meet the investment objective and policies of the Fund, (b) are
liquid and not subject to restrictions on resale, and (c) have a value that is
readily ascertainable via listing on or trading in a recognized United States or
international exchange or market.
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment wholly
in cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of the Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund during
any 90 day period for any one shareholder. Should redemptions by any shareholder
exceed such
50
<PAGE> 534
limitation the Fund will have the option of redeeming the excess in cash or in
kind. If shares are redeemed in kind, the redeeming shareholder would incur
brokerage costs in converting the assets into cash.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202, has been selected as the independent auditors of the Fund and the Master
Trust. The independent auditors are responsible for auditing the annual
financial statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109-3661, acts as custodian of the Portfolio's assets and the Fund's assets
(the "Custodian"). Under its contract with the Trust and the Fund, the Custodian
is authorized to establish separate accounts in foreign currencies and to cause
foreign securities owned by the Trust and the Fund to be held in its offices
outside the United States and with certain foreign banks and securities
depositories. The Custodian is responsible for safeguarding and controlling the
Trust's and the Fund's cash and securities, handling the receipt and delivery of
securities and collecting interest and dividends on the Trust's and the Fund's
investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly owned subsidiary of ML & Co., acts as the
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement (the "Transfer Agency Agreement").
The Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts.
LEGAL COUNSEL
Gardner, Carton & Douglas, 321 North Clark Street, Chicago, Illinois 60610,
is counsel for the Master Trust and the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio and
other information. An annual report containing financial statements audited by
independent auditors is sent to shareholders each year. After the end of each
year, shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
PRINCIPAL HOLDERS
[to come]
51
<PAGE> 535
APPENDIX -- DESCRIPTION OF RATINGS
MOODY'S INVESTORS SERVICE
BOND RATINGS:
"Aaa" -- Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
"Aa" -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
Moody's applies numerical modifiers "1," "2" and "3" in each generic rating
classification from Aa through B. The modifier "1" indicates that the obligation
ranks in the higher end of its generic rating category; the modifier "2"
indicates a mid-range ranking; and the modifier "3" indicates that the company
ranks in the lower end of that generic rating category.
"A" -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
"Baa" -- Bonds which are rated Baa are considered as medium-grade obligations
(that is, 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 which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
"B" -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
SHORT-TERM DEBT RATINGS:
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
"PRIME-1" -- Issuers rated "Prime-1" (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of these characteristics:
- Leading market positions in well-established industries.
- High rates of return on funds employed.
- Conservative capitalization structure with moderate reliance on debt and
ample asset protection.
- Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
- Well-established access to a range of financial markets and assured
sources of alternate liquidity.
"PRIME-2" -- Issuers rated "Prime-2" (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above,
A-1
<PAGE> 536
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. Adequate alternate
liquidity is maintained.
MUNICIPAL BOND RATINGS:
Moody's ratings for state and municipal short-term obligations are designated
Moody's Investment Grade or "MIG" with variable rate demand obligations being
designated as "VMIG." A VMIG rating may also be assigned to commercial paper
programs which are characterized as having variable short-term maturities, but
having neither a variable rate nor demand feature. Factors used in determining
ratings include liquidity of the borrower and short-term cyclical elements.
STANDARD & POOR'S RATING GROUP
BOND RATINGS:
"AAA" -- An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong.
"AA" -- An obligation rated AA differs from the highest rated obligations only
in small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
"A" -- An obligation rated A is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
"BBB" -- An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its commitment on the
obligation.
Obligations rated BB and B are regarded as having significant speculative
characteristics. While such obligations will likely have some quality and
protective characteristics, these may be outweighed by large uncertainties or
major exposures to adverse conditions.
COMMERCIAL PAPER RATINGS:
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market.
"A-1" -- This designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
"A-2" -- Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
MUNICIPAL BOND RATINGS:
S&P uses SP-1, SP-2 and SP-3 to rate short-term municipal obligations. A rating
of SP-1 denotes a strong capacity to pay principal and interest. An issue
determined to possess a very strong capacity to pay debt service is given a (+)
designation.
FITCH INVESTORS SERVICE, INC.
BOND RATINGS:
The following summarizes the ratings used by Fitch for corporate bonds:
"AAA" -- Highest credit quality. "AAA" ratings denote the lowest expectation of
credit risk. They 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.
A-2
<PAGE> 537
"AA" -- Very high credit quality. "AA" ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
"A" -- High credit quality. "A" ratings denote a low expectation of credit risk.
The capacity for timely payment of financial commitments is considered strong.
This capacity may, nevertheless, be more vulnerable to changes in circumstances
or in economic conditions than is the case for higher ratings.
"BBB" -- Good credit quality. "BBB" ratings indicate 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" -- Speculative. "BB" 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" -- Highly speculative. "B" 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.
PLUS (+) MINUS (--) -- Plus and minus signs may be appended to a rating to
denote relative status within major rating categories. Such suffixes are not
added to the "AAA" long-term rating category or to short-term ratings other than
"F1."
SHORT-TERM DEBT RATINGS:
"F1" -- Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
"F2" -- Good credit quality. 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.
"F3" -- Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
DUFF & PHELPS CREDIT RATING CO.
BOND RATINGS:
The following summarizes the ratings used by Duff & Phelps for long-term debt:
"AAA" -- Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
"AA+," "AA," "AA--" -- High credit quality. Protection factors are strong. Risk
is modest but may vary slightly from time to time because of economic
conditions.
"A+," "A," "A--" -- Protection factors are average but adequate. However, risk
factors are more variable and greater in periods of economic stress.
"BBB+," "BBB," "BBB--" -- Below-average protection factors but still considered
sufficient for prudent investment. Considerable variability in risk during
economic cycles.
"BB+," "BB," "BB--" -- Below investment grade but deemed likely to meet
obligations when due. Present or prospective financial protection factors
fluctuate according to industry conditions or company fortunes. Overall quality
may move up or down frequently within this category.
"B+," "B," "B--" -- Below investment grade and possessing risk that obligations
will not be met when due. Financial protection factors will fluctuate widely
according to economic cycles, industry conditions and/or
A-3
<PAGE> 538
company fortunes. Potential exists for frequent changes in the rating within
this category or into a higher or lower rating grade.
SHORT-TERM DEBT RATINGS:
"D-1+" -- Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of funds, is
outstanding and safety is just below risk-free U.S. Treasury short-term
obligations.
"D-1" -- Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are minor.
"D-1--" -- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
"D-2" -- Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small.
A-4
<PAGE> 539
STATEMENT OF ADDITIONAL INFORMATION
MERCURY LOW DURATION FUND
OF MERCURY HW FUNDS
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017 - Phone No.
(800) 236-4479
------------------------
Mercury Low Duration Fund (the "Fund") is a fund of the Mercury HW Funds
(the "Trust"). The Trust is a diversified, open-end management investment
company which is organized as a Massachusetts business trust. The investment
objective of the Fund is to seek to maximize long-term total return, consistent
with preservation of capital. The Fund seeks to achieve its investment objective
by investing primarily in a diversified portfolio of bonds of different
maturities. No assurance can be given that the investment objective of the Fund
will be realized. For more information on the Fund's investment objective and
policies, see "Investment Objective and Policies."
The Fund is a "feeder" fund that invests all of its assets in the Low
Duration Master Portfolio (the "Portfolio") of the Fund Asset Management Master
Trust (the "Master Trust"). The Portfolio has the same objective as the Fund.
All investments will be made at the Master Trust level. The Fund's investment
results will correspond directly to the investment results of the Portfolio.
There can be no assurance that the Fund will achieve its investment objective.
The Fund offers four classes of shares, each with a different combination
of sales charges, ongoing fees and other features. These alternatives permit an
investor to choose the method of purchasing shares that the investor believes is
most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances. See
"Purchase of Shares."
------------------------
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the prospectus of the Fund, dated October , 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Fund at
1-800-236-4479 or your financial consultant or other financial intermediary, or
by writing to the Fund at Financial Data Services, Inc., P.O. Box 41621,
Jacksonville, Florida 32232-1621. The Prospectus is incorporated by reference
into this Statement of Additional Information, and this Statement of Additional
Information is incorporated by reference into the Prospectus. The Fund's
financial statements are incorporated by reference to its annual report for the
fiscal year ended June 30, 2000. You may request copies of the annual report at
no charge by calling 1-800-236-4479 between 8:00 a.m. and 8:00 p.m. on any
business day.
------------------------
MERCURY ADVISORS -- INVESTMENT ADVISER
FAM DISTRIBUTORS, INC. -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is October , 2000
<PAGE> 540
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Trust History............................................... 3
Investment Objective and Policies........................... 3
Investment Restrictions................................... 3
Repurchase Agreements..................................... 4
Bonds..................................................... 4
U.S. Government Securities................................ 4
Municipal Obligations..................................... 5
Corporate Debt Securities................................. 6
Convertible Securities.................................... 7
Mortgage-Related Securities............................... 7
Asset-Backed Securities................................... 10
Risk Factors Relating to Investing in Mortgage-Related and
Asset-Backed Securities................................. 10
Duration.................................................. 11
Derivative Instruments.................................... 12
Foreign Securities........................................ 15
Foreign Currency Options and Related Risks................ 17
Forward Foreign Currency Exchange Contracts............... 18
Foreign Investment Risks.................................. 19
Risk Factors Relating to Investing in High Yield
Securities.............................................. 21
Illiquid Securities....................................... 22
Reverse Repurchase Agreements............................. 22
Dollar Rolls.............................................. 23
Borrowing................................................. 23
Loans of Portfolio Securities............................. 23
When-Issued Securities.................................... 23
Real Estate Investment Trusts............................. 24
Shares of Other Investment Companies...................... 24
Short Sales Against-the-Box............................... 24
Corporate Loans........................................... 24
Temporary Defensive Position.............................. 24
Management of the Fund...................................... 24
Management and Advisory Arrangements...................... 26
Administration Arrangements............................... 27
Code of Ethics............................................ 28
Purchase of Shares.......................................... 29
Initial Sales Charge Alternatives -- Class I and Class A
Shares.................................................. 30
Reduced Initial Sales Charges............................. 31
Deferred Sales Charge Alternatives -- Class B and Class C
Shares.................................................. 33
Distribution Plans........................................ 35
Limitations on the Payment of Deferred Sales Charges...... 36
Redemption of Shares........................................ 36
Redemption................................................ 37
Repurchase................................................ 38
Reinstatement Privilege -- Class I and Class A Shares..... 38
Pricing of Shares........................................... 38
Determination of Net Asset Value.......................... 38
Computation of Offering Price Per Share................... 40
Portfolio Transactions and Brokerage........................ 40
Transactions in Portfolio Securities...................... 40
Shareholder Services........................................ 42
Investment Account........................................ 42
Exchange Privilege........................................ 42
Fee-Based Programs........................................ 44
Retirement Plans.......................................... 44
Automatic Investment Plans................................ 45
Automatic Dividend Reinvestment Plan...................... 45
Systematic Withdrawal Plans............................... 45
Dividends and Tax Status.................................... 46
Performance Data............................................ 47
General Information......................................... 49
Description of Shares..................................... 49
Issuance of Fund Shares for Securities.................... 50
Redemption in Kind........................................ 50
Independent Auditors...................................... 51
Custodian................................................. 51
Transfer Agent............................................ 51
Legal Counsel............................................. 51
Reports to Shareholders................................... 51
Shareholder Inquiries..................................... 51
Additional Information.................................... 51
Principal Holders......................................... 52
Appendix--Description of Ratings............................ A-1
</TABLE>
2
<PAGE> 541
TRUST HISTORY
The Trust was organized on August 22, 1984 as a Massachusetts business
trust. Before October 7, 1994, the Trust was called "Olympic Trust," and before
October , 2000, the Trust was called "Hotchkis and Wiley Funds." The Trust is
a diversified, open-end, management investment company currently consisting of
ten separate funds. Prior to October , 2000, the Fund was called the Low
Duration Fund.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to maximize long-term total return,
consistent with preservation of capital.
The Fund is a "feeder" fund that invests all of its assets in the
Portfolio, which has the same investment objective as the Fund. All investments
will be made at the Portfolio level. This structure is sometimes called a
"master/feeder" structure. The Fund's investment results will correspond
directly to the investment results of the Portfolio. For simplicity, however,
this Statement of Additional Information, like the Prospectus, uses the term
"Fund" to include the Portfolio. There can be no assurance that the investment
objective of the Fund or the investment objective of the Portfolio will be
realized. The investment objective of the Fund is a fundamental policy of the
Fund and may not be changed without the approval of a majority of the Fund's
outstanding voting securities as defined in the Investment Company Act of 1940,
as amended (the "1940 Act"). The investment objective of the Portfolio is a
fundamental policy of the Portfolio and may not be changed without the approval
of a majority of the Portfolio's outstanding voting securities as defined in the
1940 Act. Reference is made to the discussion under "How the Fund Invests" and
"Investment Risks" in the Prospectus for information with respect to the Fund's
and the Portfolio's investment objective and policies.
Mercury Advisors (the "Investment Adviser"), the Fund's investment adviser,
is responsible for the management of the Fund's portfolio.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of the Fund's outstanding
voting securities, as defined in the 1940 Act. Under the 1940 Act, the vote of
the holders of a "majority" of the Fund's outstanding voting securities means
the vote of the holders of the lesser of (1) 67% of the shares of the Fund
represented at a meeting at which the holders of more than 50% of its
outstanding shares are represented or (2) more than 50% of the outstanding
shares.
Except as noted, the Fund may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Fund's total assets (determined at the time of investment) would
then be invested in securities of a single issuer; or (ii) more than
25% of the Fund's total assets (determined at the time of investment)
would be invested in one or more issuers having their principal
business activities in a single industry; provided that the Fund may
invest all of its assets in an open-end, management investment company,
or portfolio thereof, with substantially the same investment objective
and policies as the Fund, without regard to the limitations set forth
in this paragraph.
2. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions),
provided that the deposit or payment by the Fund of initial or
maintenance margin in connection with futures or options is not
considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in
3
<PAGE> 542
amount to, the securities sold short (short sale against-the-box), and
unless not more than 25% of the Fund's net assets (taken at current
value) is held as collateral for such sales at any one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Fund may borrow from a bank for temporary or emergency purposes in
amounts not exceeding 10% (taken at the lower of cost or current value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings. (The Fund may borrow from banks or
enter into reverse repurchase agreements and pledge assets in
connection therewith, but only if immediately after each borrowing
there is asset coverage of 300%.)
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would
then hold more than 10% of the outstanding voting securities of an
issuer; provided that the Fund may invest all of its assets in an
open-end management investment company, or portfolio thereof, with
substantially the same investment objective and policies as the Fund,
without regard to the limitations set forth in this paragraph.
6. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws; provided that the
purchase by the Fund of securities issued by an open-end management
investment company, or portfolio thereof, with substantially the same
investment objective and policies as the Fund shall not constitute an
underwriting for purposes of this paragraph.
7. Make investments for the purpose of exercising control or management;
provided that the Fund may invest all of its assets in an open-end
management investment company, or portfolio thereof, with substantially
the same investment objective and policies as the Fund, without regard
to the limitations set forth in this paragraph.
8. Participate on a joint or joint and several basis in any trading
account in securities.
Any percentage limitation on the Fund's investments is determined when the
investment is made, unless otherwise noted.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement where the seller agrees to
repurchase a security from the Fund at a mutually agreed-upon time and price.
The period of maturity is usually quite short, possibly overnight or a few days,
although it may extend over a number of months. The resale price is more than
the purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Fund's money is invested in the repurchase agreement. The
Fund's repurchase agreements will at all times be fully collateralized in an
amount at least equal to the resale price. The instruments held as collateral
are valued daily, and if the value of instruments declines, the Fund will
require additional collateral. In the event of a default, insolvency or
bankruptcy by a seller, the Fund will promptly seek to liquidate the collateral.
In such circumstances, the Fund could experience a delay or be prevented from
disposing of the collateral. To the extent that the proceeds from any sale of
such collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
BONDS
The term "bond" or "bonds" as used in the Prospectus is intended to include
all manner of fixed-income securities, debt securities, asset-backed and
mortgage-backed securities and other debt obligations unless specifically
defined or the context requires otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
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Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. The Fund will
invest in securities of such instrumentality only when the Investment Adviser is
satisfied that the credit risk with respect to any instrumentality is
acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely, either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (1) Treasury obligations from which the interest coupons
have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member bank representing ownership of Treasury obligation
components; or (4) receipts evidencing the component parts (corpus or coupons)
of Treasury obligations that have not actually been stripped. Such receipts
evidence ownership of component parts of Treasury obligations (corpus or
coupons) purchased by a third party (typically an investment banking firm) and
held on behalf of the third party in physical or book-entry form by a major
commercial bank or trust company pursuant to a custody agreement with the third
party. These custodial receipts are known by various names, including "Treasury
Receipts," "Treasury Investment Growth Receipts" ("TIGRs") and "Certificates of
Accrual on Treasury Securities" ("CATS"), and are not issued by the U.S.
Treasury; therefore they are not U.S. Government securities, although the
underlying bonds represented by these receipts are debt obligations of the U.S.
Treasury.
MUNICIPAL OBLIGATIONS
The Fund may invest in municipal obligations. The two principal
classifications of municipal bonds, notes and commercial paper are "general
obligation" and "revenue" bonds, notes or commercial paper. General obligation
bonds, notes or commercial paper are secured by the issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest.
Issuers of general obligation bonds, notes or commercial paper include states,
counties, cities, towns and other governmental units. Revenue bonds, notes and
commercial paper are payable from the revenues derived from a particular
facility or class of facilities or, in some cases, from specific revenue
sources. Revenue bonds, notes or commercial paper are issued for a wide variety
of purposes, including the financing of electric, gas, water and sewer systems
and other public utilities; industrial development and pollution control
facilities; single and multifamily housing units; public buildings and
facilities; air and marine ports; transportation facilities such as toll roads,
bridges and tunnels; and health and educational facilities such as hospitals and
dormitories. They rely primarily on user fees to pay debt service, although the
principal revenue source is often supplemented by additional security features
which are intended to enhance the creditworthiness of the issuer's obligations.
In some cases, particularly revenue bonds issued to finance housing and public
buildings, a direct or implied "moral obligation" of a governmental unit may be
pledged to the payment of debt service. In other cases, a special tax or other
charge may augment user fees.
Included within the revenue bonds category are participations in municipal
lease obligations or installment purchase contracts of municipalities
(collectively, "lease obligations"). State and local governments issue lease
obligations to acquire equipment leases and facilities. Lease obligations may
have risks not normally associated with general obligation or other revenue
bonds. Leases and installment purchase or conditional sale contracts (which may
provide for title to the leased asset to pass eventually to the issuer) have
developed as a means for governmental issuers to acquire property and equipment
without the necessity of complying with the constitutional and statutory
requirements generally applicable for the issuance of debt. Certain lease
obligations contain "non-appropriation" clauses that provide that the
governmental issuer has no obligation to make future payments under the lease or
contract unless money is appropriated for such purpose
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by the appropriate legislative body on an annual or other periodic basis.
Consequently, continued lease payments on those lease obligations containing
"non-appropriation" clauses are dependent on future legislative actions. If such
legislative actions do not occur, the holders of the lease obligations may
experience difficulty in exercising their rights, including disposition of the
property.
Private activity obligations are issued to finance, among other things,
privately operated housing facilities, pollution control facilities, convention
or trade show facilities, mass transit, airport, port or parking facilities and
certain facilities for water supply, gas, electricity, sewage or solid waste
disposal. Private activity obligations are also issued to privately held or
publicly owned corporations in the financing of commercial or industrial
facilities. The principal and interest on these obligations may be payable from
the general revenues of the users of such facilities. Shareholders, depending on
their individual tax status, may be subject to the federal alternative minimum
tax on the portion of a distribution attributable to these obligations. Interest
on private activity obligations will be considered exempt from federal income
taxes; however, shareholders should consult their own tax advisors to determine
whether they may be subject to the federal alternative minimum tax.
Resource recovery obligations are a type of municipal revenue obligation
issued to build facilities such as solid waste incinerators or waste-to-energy
plants. Usually, a private corporation will be involved and the revenue cash
flow will be supported by fees or units paid by municipalities for the use of
the facilities. The viability of a resource recovery project, environmental
protections regulations and project operator tax incentives may affect the value
and credit quality of these obligations.
Tax, revenue or bond anticipation notes are issued by municipalities in
expectation of future tax or other revenues which are payable from these
specific taxes or revenues. Bond anticipation notes usually provide interim
financing in advance of an issue of bonds or notes, the proceeds of which are
used to repay the anticipation notes. Tax-exempt commercial paper is issued by
municipalities to help finance short-term capital or operating needs in
anticipation of future tax or other revenue.
A variable rate obligation is one whose terms provide for the adjustment of
its interest rate on set dates and which, upon such adjustment, can reasonably
be expected to have a market value that approximates its par value. A floating
rate obligation has terms which provide for the adjustment of its interest rate
whenever a specified interest rate changes and which, at any time, can
reasonably be expected to have a market value that approximates its par value.
Variable or floating rate obligations may be secured by bank letters of credit.
Variable rate auction and residual interest obligations are created when an
issuer or dealer separates the principal portion of a long-term, fixed-rate
municipal bond into two long-term, variable-rate instruments. The interest rate
on one portion reflects short-term interest rates, while the interest rate on
the other portion is typically higher than the rate available on the original
fixed-rate bond.
Yields on municipal securities are dependent on a variety of factors,
including the general conditions of the municipal bond and municipal note
markets, the size of a particular offering, the maturity of the obligation and
the rating of the issue. The achievement of the Fund's investment objective is
dependent in part on the continuing ability of the issuers of municipal
securities in which the Fund invests to meet their obligations for the payment
of principal and interest when due. Obligations of issuers of municipal
securities are subject to the provisions of bankruptcy, insolvency and other
laws affecting the rights and remedies of creditors, such as the Bankruptcy
Reform Act of 1978, as amended. Therefore, the possibility exists that, as a
result of litigation or other conditions, the ability of any issuer to pay, when
due, the principal of and interest on its municipal securities may be materially
affected.
CORPORATE DEBT SECURITIES
The Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, are in the Investment Adviser's opinion comparable
in quality to corporate debt securities in which
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the Fund may invest. The rate of return or return of principal on some debt
obligations may be linked or indexed to the level of exchange rates between the
U.S. dollar and a foreign currency or currencies.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying common stock.
The price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
MORTGAGE-RELATED SECURITIES
The Fund may invest in residential or commercial mortgage-related
securities, including mortgage pass-through securities, collateralized mortgage
obligations ("CMOs"), adjustable rate mortgage securities, CMO residuals,
stripped mortgage-related securities, floating and inverse floating rate
securities and tiered index bonds.
Mortgage Pass-Through Securities. Mortgage pass-through securities
represent interests in pools of mortgages in which payments of both principal
and interest on the securities are generally made monthly, in effect "passing
through" monthly payments made by borrowers on the residential or commercial
mortgage loans which underlie the securities (net of any fees paid to the issuer
or guarantor of the securities). Mortgage pass-through securities differ from
other forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Early repayment of principal on mortgage pass-through securities (arising
from prepayments of principal due to the sale of underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose the Fund to a lower rate of return upon reinvestment of principal. Also,
if a security subject to repayment has been purchased at a premium, in the event
of prepayment, the value of the premium would be lost.
There are currently three types of mortgage pass-through securities: (1)
those issued by the U.S. Government or one of its agencies or instrumentalities,
such as the Government National Mortgage Association ("Ginnie Mae"), the Federal
National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage
Corporation ("Freddie Mac"); (2) those issued by private issuers that represent
an interest in or are collateralized by pass-through securities issued or
guaranteed by the U.S. Government or one of its agencies or instrumentalities;
and (3) those issued by private issuers that represent an interest in or are
collateralized by whole mortgage loans or pass-through securities without a
government guarantee but usually having some form of private credit enhancement.
Ginnie Mae is a wholly-owned United States Government corporation within
the Department of Housing and Urban Development. Ginnie Mae is authorized to
guarantee, with the full faith and credit of the United States Government, the
timely payment of principal and interest on securities issued by the
institutions
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approved by Ginnie Mae (such as savings and loan institutions, commercial banks
and mortgage banks), and backed by pools of FHA-insured or VA-guaranteed
mortgages.
Obligations of Fannie Mae and Freddie Mac are not backed by the full faith
and credit of the United States Government. In the case of obligations not
backed by the full faith and credit of the United States Government, the Fund
must look principally to the agency issuing or guaranteeing the obligation for
ultimate repayment. Fannie Mae and Freddie Mac may borrow from the U.S. Treasury
to meet their obligations, but the U.S. Treasury is under no obligation to lend
to Fannie Mae or Freddie Mac.
Private mortgage pass-through securities are structured similarly to Ginnie
Mae, Fannie Mae, and Freddie Mac mortgage pass-through securities and are issued
by originators of and investors in mortgage loans, including depository
institutions, mortgage banks, investment banks and special purpose subsidiaries
of the foregoing.
Pools created by private mortgage pass-through issuers generally offer a
higher rate of interest than government and government-related pools because
there are no direct or indirect government or agency guarantees of payments in
the private pools. However, timely payment of interest and principal of these
pools may be supported by various forms of insurance or guarantees, including
individual loan, title, pool and hazard insurance and letters of credit. The
insurance and guarantees are issued by governmental entities, private insurers
and the mortgage poolers. The insurance and guarantees and the creditworthiness
of the issuers thereof will be considered in determining whether a
mortgage-related security meets the Fund's investment quality standards. There
can be no assurance that the private insurers or guarantors can meet their
obligations under the insurance policies or guarantee arrangements. Private
mortgage pass-through securities may be bought without insurance or guarantees
if, through an examination of the loan experience and practices of the
originator/servicers and poolers, the Investment Adviser determines that the
securities meet the Fund's quality standards.
Collateralized Mortgage Obligations. CMOs are debt obligations
collateralized by residential or commercial mortgage loans or residential or
commercial mortgage pass-through securities. Interest and prepaid principal are
generally paid monthly. CMOs may be collateralized by whole mortgage loans or
private mortgage pass-through securities but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by Ginnie Mae,
Freddie Mac, or Fannie Mae. The issuer of a series of CMOs may elect to be
treated as a Real Estate Mortgage Investment Conduit ("REMIC"). All future
references to CMOs also include REMICs.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral which is ordinarily unrelated to the stated
maturity date. CMOs often provide for a modified form of call protection through
a de facto breakdown of the underlying pool of mortgages according to how
quickly the loans are repaid. Monthly payment of principal received from the
pool of underlying mortgages, including prepayments, is first returned to
investors holding the shortest maturity class. Investors holding the longer
maturity classes usually receive principal only after the first class has been
retired. An investor may be partially protected against a sooner than desired
return of principal because of the sequential payments.
Certain issuers of CMOs are not considered investment companies pursuant to
a rule adopted by the Commission, and the Fund may invest in the securities of
such issuers without the limitations imposed by the 1940 Act on investments by
the Fund in other investment companies. In addition, in reliance on an earlier
Commission interpretation, the Fund's investments in certain other qualifying
CMOs, which cannot or do not rely on the rule, are also not subject to the
limitation of the 1940 Act on acquiring interests in other investment companies.
In order to be able to rely on the Commission's interpretation, these CMOs must
be unmanaged, fixed asset issuers, that: (1) invest primarily in mortgage-backed
securities; (2) do not issue redeemable securities; (3) operate under general
exemptive orders exempting them from all provisions of the 1940 Act; and (4) are
not registered or regulated under the 1940 Act as investment companies. To the
extent that the Fund selects CMOs that cannot rely on the rule or do not meet
the above requirements, the Fund may not invest more than 10% of its assets in
all such entities and may not acquire more than 3% of the voting securities of
any single such entity.
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The Fund may also invest in, among other things, parallel pay CMOs, Planned
Amortization Class CMOs ("PAC bonds"), sequential pay CMOs, and floating rate
CMOs. Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. PAC bonds generally require payments of a
specified amount of principal on each payment date. Sequential pay CMOs
generally pay principal to only one class while paying interest to several
classes. Floating rate CMOs are securities whose coupon rate fluctuates
according to some formula related to an existing market index or rate. Typical
indexes would include the eleventh district cost-of-funds index ("COFI"), the
London Interbank Offered Rate ("LIBOR"), one-year Treasury yields, and ten-year
Treasury yields.
Adjustable Rate Mortgage Securities. Adjustable rate mortgage securities
("ARMs") are pass-through securities collateralized by mortgages with adjustable
rather than fixed rates. ARMs eligible for inclusion in a mortgage pool
generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, thirty-six, or sixty scheduled monthly
payments. Thereafter, the interest rates are subject to periodic adjustment
based on changes to a designated benchmark index.
The ARMs contain maximum and minimum rates beyond which the mortgage
interest rate may not vary over the lifetime of the security. In addition,
certain ARMs provide for additional limitations on the maximum amount by which
the mortgage interest rate may adjust for any single adjustment period. In the
event that market rates of interest rise more rapidly to levels above that of
the ARM's maximum rate, the ARM's coupon may represent a below market rate of
interest. In these circumstances, the market value of the ARM security will
likely have fallen.
Certain ARMs contain limitations on changes in the required monthly
payment. In the event that a monthly payment is not sufficient to pay the
interest accruing on an ARM, any such excess interest is added to the principal
balance of the mortgage loan, which is repaid through future monthly payments.
If the monthly payment for such an instrument exceeds the sum of the interest
accrued at the applicable mortgage interest rate and the principal payment
required at such point to amortize the outstanding principal balance over the
remaining term of the loan, the excess is then utilized to reduce the
outstanding principal balance of the ARM.
CMO Residuals. CMO residuals are derivative mortgage securities issued by
agencies or instrumentalities of the U.S. Government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks, and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
part, the yield to maturity on the CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-related securities. See
"Stripped Mortgage-Related Securities" below. In addition, if a series of a CMO
includes a class that bears interest at an adjustable rate, the yield to
maturity on the related CMO residual will also be extremely sensitive to changes
in the level of the index upon which interest rate adjustments are based. As
described below with respect to stripped mortgage-related securities, in certain
circumstances the Fund may fail to recoup fully its initial investment in a CMO
residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has recently developed and CMO residuals currently may not have
the liquidity of other more established securities trading in other markets.
Transactions in CMO residuals are generally completed only after careful review
of the characteristics of the securities in question. In addition, CMO residuals
may or, pursuant to an exemption therefrom, may not have been registered under
the Securities Act of 1933, as amended ("Securities Act"). CMO residuals,
whether or
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not registered under such Act, may be subject to certain restrictions on
transferability, and may be deemed "illiquid" and subject to the Fund's
limitations on investment in illiquid securities.
Stripped Mortgage-Related Securities. Stripped mortgage-related securities
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. Government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks, and special purpose entities
of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the IO class), while
the other class will receive all of the principal (the PO class). The yield to
maturity on an IO class is extremely sensitive to the rate of principal payments
(including prepayments) on the related underlying mortgage assets, and a rapid
rate of principal payments may have a material adverse effect on the Fund's
yield to maturity from these securities. If the underlying mortgage assets
experience greater than anticipated prepayments of principal, the Fund may fail
to fully recoup its initial investment in these securities even if the security
is in one of the highest rating categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently introduced. As a result, established trading markets have not
yet been fully developed and accordingly, these securities may be deemed
"illiquid" and subject to the Fund's limitations on investment in illiquid
securities.
Inverse Floaters. An inverse floater is a debt instrument with a floating
or variable interest rate that moves in the opposite direction to the interest
rate on another security or index level. Changes in the interest rate on the
other security or index inversely affect the residual interest rate paid on the
inverse floater, with the result that the inverse floater's price will be
considerably more volatile than that of a fixed rate bond. Inverse floaters may
experience gains when interest rates fall and may suffer losses in periods of
rising interest rates. The market for inverse floaters is relatively new.
Tiered Index Bonds. Tiered index bonds are relatively new forms of
mortgage-related securities. The interest rate on a tiered index bond is tied to
a specified index or market rate. So long as this index or market rate is below
a predetermined "strike" rate, the interest rate on the tiered index bond
remains fixed. If, however, the specified index or market rate rises above the
"strike" rate, the interest rate of the tiered index bond will decrease. Thus,
under these circumstances, the interest rate on a tiered index bond, like an
inverse floater, will move in the opposite direction of prevailing interest
rates, with the result that the price of the tiered index bond may be
considerably more volatile than that of a fixed-rate bond.
ASSET-BACKED SECURITIES
The Fund may invest in various types of asset-backed securities. Through
the use of trusts and special purpose corporations, various types of assets,
primarily automobile and credit card receivables and home equity loans, are
being securitized in pass-through structures similar to the mortgage
pass-through or in a pay-through structure similar to the CMO structure.
Investments in these and other types of asset-backed securities must be
consistent with the investment objective and policies of the Fund.
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-RELATED AND ASSET-BACKED
SECURITIES
The yield characteristics of mortgage-related and asset-backed securities
differ from traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
or other assets generally may be prepaid at any time. As a result, if the Fund
purchases such a security at a premium, a prepayment rate that is faster than
expected will reduce yield to maturity, while a prepayment rate that is slower
than expected will have the opposite effect of increasing yield to maturity.
Alternatively, if the Fund purchases these securities at a discount, faster than
expected prepayments will increase, while slower
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than expected prepayments will reduce, yield to maturity. The Fund may invest a
portion of its assets in derivative mortgage-related securities which are highly
sensitive to changes in prepayment and interest rates. The Investment Adviser
will seek to manage these risks (and potential benefits) by diversifying its
investments in such securities and through hedging techniques.
During periods of declining interest rates, prepayment of mortgages
underlying mortgage-related securities can be expected to accelerate.
Accordingly, the Fund's ability to maintain positions in high-yielding
mortgage-related securities will be affected by reductions in the principal
amount of such securities resulting from such prepayments, and its ability to
reinvest the returns of principal at comparable yields is subject to generally
prevailing interest rates at that time. Conversely, slower than expected
prepayments may effectively change a security that was considered short or
intermediate-term at the time of purchase into a long-term security. Long-term
securities tend to fluctuate more in response to interest rate changes, leading
to increased net asset value volatility. Prepayments may also result in the
realization of capital losses with respect to higher yielding securities that
had been bought at a premium or the loss of opportunity to realize capital gains
in the future from possible future appreciation.
Asset-backed securities involve certain risks that are not posed by
mortgage-related securities, resulting mainly from the fact that asset-backed
securities do not usually contain the complete benefit of a security interest in
the related collateral. For example, credit card receivables generally are
unsecured and the debtors are entitled to the protection of a number of state
and federal consumer credit laws, some of which may reduce the ability to obtain
full payment. In the case of automobile receivables, due to various legal and
economic factors, proceeds from repossessed collateral may not always be
sufficient to support payments on these securities.
DURATION
In selecting securities for the Fund, the Investment Adviser makes use of
the concept of duration for fixed-income securities. Duration is a measure of
the expected life of a fixed-income security. Duration incorporates a bond's
yield, coupon interest payments, final maturity and call features into one
measure. Most debt obligations provide interest ("coupon") payments in addition
to a final ("par") payment at maturity. Some obligations also have call
provisions. Depending on the relative magnitude of these payments, the market
values of debt obligations may respond differently to changes in the level and
structure of interest rates.
Duration is a measure of the expected life of a fixed-income security on a
present value basis. Duration takes the length of the time intervals between the
present time and the time that the interest and principal payments are scheduled
or, in the case of a callable bond, expected to be received, and weights them by
the present values of the cash to be received at each future point in time. For
any fixed-income security with interest payments occurring prior to the payment
of principal, duration is always less than maturity. In general, all other
things being the same, the lower the stated or coupon rate of interest of a
fixed-income security, the longer the duration of the security; conversely, the
higher the stated or coupon rate of interest of a fixed-income security, the
shorter the duration of the security.
Futures, options and options on futures have durations which, in general,
are closely related to the duration of the securities which underlie them.
Holding long futures or call option positions (backed by a segregated account of
cash and cash equivalents) will lengthen the Fund's duration by approximately
the same amount that holding an equivalent amount of the underlying securities
would.
Short futures or put options positions have durations roughly equal to the
negative duration of the securities that underlie those positions, and have the
effect of reducing portfolio duration by approximately the same amount that
selling an equivalent amount of the underlying securities would.
There are some situations where even the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by duration is the case of mortgage pass-through securities. The stated
final maturity of such securities is generally 30 years, but
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current prepayment rates are more critical in determining the securities'
interest rate exposure. In these and other similar situations, the Investment
Adviser will use more sophisticated analytical techniques that incorporate the
economic life of a security into the determination of its interest rate
exposure.
DERIVATIVE INSTRUMENTS
As indicated in the prospectus, to the extent consistent with its
investment objective and policies and the investment restrictions listed in this
Statement of Additional Information, the Fund may purchase and write call and
put options on securities, securities indexes and foreign currencies and enter
into forward contracts, futures contracts and use options on futures contracts.
The Fund also may enter into swap agreements with respect to foreign currencies,
interest rates and securities indexes. The Fund may use these techniques to
hedge against changes in interest rates, foreign currency exchange rates, or
securities prices or as part of its overall investment strategies. The Fund may
also purchase and sell options relating to foreign currencies for the purpose of
increasing exposure to a foreign currency or to shift exposure to foreign
currency fluctuations from one country to another. The Fund will mark as
segregated cash, U.S. Government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily (or, as permitted by applicable
regulation, enter into certain offsetting positions), to cover its obligations
under forward contracts, futures contracts, swap agreements and options to avoid
leveraging of the Fund.
Options on Securities and on Securities Indexes. The Fund may purchase put
options on securities to protect holdings in an underlying or related security
against a substantial decline in market value. The Fund may purchase call
options on securities to protect against substantial increases in prices of
securities the Fund intends to purchase pending its ability to invest in such
securities in an orderly manner. The Fund may sell put or call options it has
previously purchased, which could result in a net gain or loss depending on
whether the amount realized on the sale is more or less than the premium and
other transaction costs paid on the put or call option which is sold. The Fund
may write a call or put option only if the option is "covered" by the Fund
holding a position in the underlying securities or by other means which would
permit immediate satisfaction of the Fund's obligation as writer of the option.
Prior to exercise or expiration, an option may be closed out by an offsetting
purchase or sale of an option of the same series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying
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security unless the option expired without exercise. As the writer of a covered
call option, the Fund forgoes, during the option's life, the opportunity to
profit from increases in the market value of the security covering the call
option above the sum of the premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
Futures Contracts and Options on Futures Contracts. The Fund may use
interest rate, foreign currency or index futures contracts, as specified for the
Fund in its prospectus. An interest rate, foreign currency or index futures
contract provides for the future sale by one party and purchase by another party
of a specified quantity of a financial instrument, foreign currency or the cash
value of an index at a specified price and time. A futures contract on an index
is an agreement pursuant to which two parties agree to take or make delivery of
an amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. Although the value of an index might be a
function of the value of certain specified securities, no physical delivery of
these securities is made.
The Fund may purchase and write call and put options on futures. Options on
futures possess many of the same characteristics as options on securities and
indexes (discussed above). An option on a futures contract gives the holder the
right, in return for the premium paid, to assume a long position (call) or short
position (put) in a futures contract at a specified exercise price at any time
during the period of the option. Upon exercise of a call option, the holder
acquires a long position in the futures contract and the writer is assigned the
opposite short position. In the case of a put option, the opposite is true.
The Fund will use futures contracts and options on futures contracts in
accordance with the rules of the Commodity Futures Trading Commission ("CFTC").
For example, the Fund might use futures contracts to hedge against anticipated
changes in interest rates that might adversely affect either the value of the
Fund's securities or the price of the securities which the Fund intends to
purchase. The Fund's hedging activities may include sales of futures contracts
as an offset against the effect of expected increases in interest rates, and
purchases of futures contracts as an offset against the effect of expected
declines in interest rates. Although other techniques could be used to reduce
the Fund's exposure to interest rate fluctuations, the Fund may be able to hedge
its exposure more effectively and perhaps at a lower cost by using futures
contracts and options on futures contracts.
The Fund will only enter into futures contracts and options on futures
contracts which are standardized and traded on a U.S. or foreign exchange, board
of trade, or similar entity, or quoted on an automated quotation system.
When a purchase or sale of a futures contract is made by the Fund, the Fund
is required to deposit with its custodian or futures commission merchant a
specified amount of cash or U.S. government securities ("initial margin"). The
margin required for a futures contract is set by the exchange on which the
contract is traded and may be modified during the term of the contract. The
initial margin is in the nature of a performance bond or good faith deposit on
the futures contract which is returned to the Fund upon termination of the
contract, assuming all contractual obligations have been satisfied. The Fund
expects to earn interest income on its initial margin deposits. A futures
contract held by the Fund is valued daily at the official settlement price of
the exchange on which it is traded. Each day the Fund pays or receives cash,
called "variation margin", equal to the daily change in value of the futures
contract. This process is known as "marking to market". Variation margin does
not represent a borrowing or loan by the Fund but is instead a settlement
between the Fund and the broker of the amount one would owe the other if the
futures contract expired. In computing daily net asset value, the Fund will mark
to market its open futures positions.
The Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures
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contract (and the related initial margin requirements), the current market value
of the option, and other futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying security or index and delivery month). If an offsetting
purchase price is less than the original sale price, the Fund realizes a capital
gain, or if it is more, the Fund realizes a capital loss. Conversely, if an
offsetting sale price is more than the original purchase price, the Fund
realizes a capital gain, or if it is less, the Fund realizes a capital loss. The
transaction costs must also be included in these calculations.
Limitations on Use of Futures and Options Thereon. When purchasing a
futures contract, the Fund will maintain with its custodian (and mark-to-market
on a daily basis) cash, U.S. government securities, equity securities or other
liquid, unencumbered assets that, when added to the amounts deposited as margin
with a futures commission merchant or the custodian, are equal to the market
value of the futures contract. Alternatively, the Fund may "cover" its position
by purchasing a put option on the same futures contract with a strike price as
high or higher than the price of the contract held by the Fund.
When selling a futures contract, the Fund will maintain with its custodian
(and mark-to-market on a daily basis) liquid assets that, when added to the
amount deposited as margin with a futures commission merchant or the custodian,
are equal to the market value of the instruments underlying the contract.
Alternatively, the Fund may "cover" its position by owning the instruments
underlying the contract (or, in the case of an index futures contract, a
portfolio with a volatility substantially similar to that of the index on which
the futures contract is based), or by holding a call option permitting the Fund
to purchase the same futures contract at a price no higher than the price of the
contract written by the Fund (or at a higher price if the difference is
maintained in liquid assets with the Trust's custodian).
When selling a call option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets that, when
added to the amounts deposited as margin with a futures commission merchant or
the custodian, equal the total market value of the futures contract underlying
the call option. Alternatively, the Fund may cover its position by entering into
a long position in the same futures contract at a price no higher than the
strike price of the call option, by owning the instruments underlying the
futures contract, or by holding a separate call option permitting the Fund to
purchase the same futures contract at a price not higher than the strike price
of the call option sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets that equal
the purchase price of the futures contract, less any margin on deposit.
Alternatively, the Fund may cover the position either by entering into a short
position in the same futures contract, or by owning a separate put option
permitting it to sell the same futures contract so long as the strike price of
the purchased put option is the same or higher than the strike price of the put
option sold by the Fund.
In order to comply with current applicable regulations of the CFTC pursuant
to which the Trust avoids being deemed a "commodity pool operator," the Fund is
limited in its futures trading activities to positions which constitute "bona
fide hedging" positions within the meaning and intent of applicable CFTC rules,
or to non-hedging positions for which the aggregate initial margin and premiums
will not exceed 5% of the liquidation value of the Fund's assets.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not completely offset by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures
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<PAGE> 553
contracts. Conversely, the Fund may purchase or sell fewer futures contracts if
the volatility of the price of the hedged securities is historically less than
that of the futures contracts.
The particular securities comprising the index underlying the index
financial futures contract may vary from the securities held by the Fund. As a
result, the Fund's ability to hedge effectively all or a portion of the value of
its securities through the use of such financial futures contracts will depend
in part on the degree to which price movements in the index underlying the
financial futures contract correlate with the price movements of the securities
held by the Fund. The correlation may be affected by disparities in the Fund's
investments as compared to those comprising the index and general economic or
political factors. In addition, the correlation between movements in the value
of the index may be subject to change over time as additions to and deletions
from the index alter its structure. The correlation between futures contracts on
U.S. Government securities and the securities held by the Fund may be adversely
affected by similar factors and the risk of imperfect correlation between
movements in the prices of such futures contracts and the prices of securities
held by the Fund may be greater. The trading of futures contracts also is
subject to certain market risks, such as inadequate trading activity, which
could at times make it difficult or impossible to liquidate existing positions.
The Fund expects to liquidate a majority of the futures contracts it enters
into through offsetting transactions on the applicable contract market. There
can be no assurance, however, that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close out a futures position. In the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. In such situations, if the Fund has insufficient cash, it may be
required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability to
close out futures positions also could have an adverse impact on the Fund's
ability to hedge effectively its investments. 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. Prices have in the past moved beyond the daily limit on a number of
consecutive trading days. The Fund will enter into a futures position only if,
in the judgment of the Investment Adviser, there appears to be an actively
traded secondary market for such futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Investment Adviser to forecast correctly the
direction and extent of interest rate movements within a given time frame. To
the extent interest rates remain stable during the period in which a futures
contract or option is held by the Fund or such rates move in a direction
opposite to that anticipated, the Fund may realize a loss on a hedging
transaction which is not fully or partially offset by an increase in the value
of portfolio securities. As a result, the Fund's total return for such period
may be less than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made upon the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. There is also the risk of loss by the
Fund of margin deposits in the event of the bankruptcy of a broker with whom the
Fund has an open position in a financial futures contract.
The amount of risk the Fund assumes when it purchases an option on a
futures contract is the premium paid for the option plus related transaction
costs. In addition to the correlation risks discussed above, the purchase of an
option on a futures contract 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.
FOREIGN SECURITIES
The Fund may invest in American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") or other securities convertible into securities of
issuers based in foreign countries. These securities may not necessarily be
denominated in the same currency as the securities into which they may be
converted.
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ADRs are receipts, usually issued by a U.S. bank or trust company, evidencing
ownership of the underlying securities; EDRs are European receipts evidencing a
similar arrangement. Generally, ADRs are issued in registered form, denominated
in U.S. dollars, and are designed for use in the U.S. securities markets; EDRs
are issued in bearer form, denominated in other currencies, and are designed for
use in European securities markets.
The Fund may also invest in fixed-income securities of issuers located in
emerging foreign markets. Emerging markets generally include every country in
the world other than the United States, Canada, Japan, Australia, Malaysia, New
Zealand, Hong Kong, South Korea, Singapore and most Western European countries.
In determining what countries constitute emerging markets, the Investment
Adviser will consider, among other things, data, analysis and classification of
countries published or disseminated by the International Bank for Reconstruction
and Development (commonly known as the World Bank) and the International Finance
Corporation. Currently, investing in many emerging markets may not be desirable
or feasible, because of the lack of adequate custody arrangements for the Fund's
assets, overly burdensome repatriation and similar restrictions, the lack of
organized and liquid securities markets, unacceptable political risks or other
reasons. As opportunities to invest in securities in emerging markets develop,
the Fund expects to expand and further broaden the group of emerging markets in
which it invests.
From time to time, emerging markets have offered the opportunity for higher
returns in exchange for a higher level of risk. Accordingly, the Investment
Adviser believes that the Fund's ability to invest in emerging markets
throughout the world can assist in the overall diversification of the Fund's
portfolio.
The Fund may invest in the following types of emerging market fixed-income
securities: (1) fixed-income securities issued or guaranteed by governments,
their agencies, instrumentalities or political subdivisions, or by government
owned, controlled or sponsored entities, including central banks (collectively,
"Sovereign Debt"), including Brady Bonds (described below); (2) interests in
issuers organized and operated for the purpose of restructuring the investment
characteristics of Sovereign Debt; (3) fixed-income securities issued by banks
and other business entities; and (4) fixed-income securities denominated in or
indexed to the currencies of emerging markets. Fixed-income securities held by
the Fund may take the form of bonds, notes, bills, debentures, bank debt
obligations, short-term paper, loan participations, assignments and interests
issued by entities organized and operated for the purpose of restructuring the
investment characteristics of any of the foregoing. There is no requirement with
respect to the maturity of fixed-income securities in which the Fund may invest.
The Fund may invest in Brady Bonds and other Sovereign Debt of countries
that have restructured or are in the process of restructuring Sovereign Debt
pursuant to the Brady Plan. "Brady Bonds" are debt securities issued under the
framework of the Brady Plan, an initiative announced by former U.S. Treasury
Secretary Nicholas F. Brady in 1989 as a mechanism for debtor nations to
restructure their outstanding external commercial bank indebtedness. In
restructuring its external debt under the Brady Plan framework, a debtor nation
negotiates with its existing bank lenders as well as multilateral institutions
such as the World Bank and the International Monetary Fund ("IMF"). The Brady
Plan framework, as it has developed, contemplates the exchange of commercial
bank debt for newly issued Brady Bonds. Brady Bonds may also be issued in
respect of new money being advanced by existing lenders in connection with the
debt restructuring. The World Bank and/or the IMF support the restructuring by
providing funds pursuant to loan agreements or other arrangements which enable
the debtor nation to collateralize the new Brady Bonds or to repurchase
outstanding bank debt at a discount.
Emerging market fixed-income securities generally are considered to be of a
credit quality below investment grade, even though they often are not rated by
any nationally recognized statistical rating organizations. Investment in
emerging market fixed-income securities will be allocated among various
countries based upon the Investment Adviser's analysis of credit risk and its
consideration of a number of factors, including: (1) prospects for relative
economic growth among the different countries in which the Fund may invest; (2)
expected levels of inflation; (3) government policies influencing business
conditions; (4) the outlook for currency relationships; and (5) the range of the
individual investment opportunities available to international investors. The
Investment Adviser's emerging market sovereign credit analysis includes an
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<PAGE> 555
evaluation of the issuing country's total debt levels, currency reserve levels,
net exports/imports, overall economic growth, level of inflation, currency
fluctuation, political and social climate and payment history. Particular
fixed-income securities will be selected based upon a credit risk analysis of
potential issuers, the characteristics of the security, the interest rate
sensitivity of the various debt issues available with respect to a particular
issuer, an analysis of the anticipated volatility and liquidity of the
particular debt instruments, and the tax implications to the Fund. The emerging
market fixed-income securities in which the Fund may invest are not subject to
any minimum credit quality standards.
FOREIGN CURRENCY OPTIONS AND RELATED RISKS
The Fund may take positions in options on foreign currencies to hedge
against the risk that foreign exchange rate fluctuations will affect the value
of foreign securities the Fund holds in its portfolio or intends to purchase.
For example, if the Fund were to enter into a contract to purchase securities
denominated in a foreign currency, it could effectively fix the maximum U.S.
dollar cost of the securities by purchasing call options on that foreign
currency. Similarly, if the Fund held securities denominated in a foreign
currency and anticipated a decline in the value of that currency against the
U.S. dollar, it could hedge against such a decline by purchasing a put option on
the currency involved. The markets in foreign currency options are relatively
new, and the Fund's ability to establish and close out positions in such options
is subject to the maintenance of a liquid secondary market. There can be no
assurance that a liquid secondary market will exist for a particular option at
any specific time. In addition, options on foreign currencies are affected by
all of those factors that influence foreign exchange rates and investments
generally.
The quantities of currencies underlying option contracts represent odd lots
in a market dominated by transactions between banks, and as a result extra
transaction costs may be incurred upon exercise of an option.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations be firm or revised on a
timely basis. Quotation information is generally representative of very large
transactions in the interbank market and may not reflect smaller transactions
where rates may be less favorable. Option markets may be closed while
round-the-clock interbank currency markets are open, and this can create price
and rate discrepancies.
Risks of Options Trading. The Fund may effectively terminate its rights or
obligations under options by entering into closing transactions. Closing
transactions permit the Fund to realize profits or limit losses on its options
positions prior to the exercise or expiration of the option. The value of a
foreign currency option depends on the value of the underlying currency relative
to the U.S. dollar. Other factors affecting the value of an option are the time
remaining until expiration, the relationship of the exercise price to market
price, the historical price volatility of the underlying currency and general
market conditions. As a result, changes in the value of an option position may
have no relationship to the investment merit of a foreign security. Whether a
profit or loss is realized on a closing transaction depends on the price
movement of the underlying currency and the market value of the option.
Options normally have expiration dates of up to nine months. The exercise
price may be below, equal to or above the current market value of the underlying
currency. Options that expire unexercised have no value, and the Fund will
realize a loss of any premium paid and any transaction costs. Closing
transactions may be effected only by negotiating directly with the other party
to the option contract, unless a secondary market for the options develops.
Although the Fund intends to enter into foreign currency options only with
dealers which agree to enter into, and which are expected to be capable of
entering into, closing transactions with the Fund, there can be no assurance
that the Fund will be able to liquidate an option at a favorable price at any
time prior to expiration. In the event of insolvency of the counter-party, the
Fund may be unable to liquidate a foreign currency option. Accordingly, it may
not be possible to effect closing transactions with respect to certain options,
with the result that the Fund would have to exercise those options that it had
purchased in order to realize any profit.
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FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may use forward contracts to protect against uncertainty in the
level of future exchange rates. The Fund will not speculate with forward
contracts or foreign currency exchange rates.
The Fund may enter into forward contracts with respect to specific
transactions. For example, when the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, or when the Fund
anticipates the receipt in a foreign currency of dividend or interest payments
on a security that it holds, the Fund may desire to "lock in" the U.S. dollar
price of the security or the U.S. dollar equivalent of the payment, by entering
into a forward contract for the purchase or sale, for a fixed amount of U.S.
dollars or foreign currency, of the amount of foreign currency involved in the
underlying transaction. The Fund will thereby be able to protect itself against
a possible loss resulting from an adverse change in the relationship between the
currency exchange rates during the period between the date on which the security
is purchased or sold, or on which the payment is declared, and the date on which
such payments are made or received.
The Fund also may use forward contracts in connection with portfolio
positions to lock in the U.S. dollar value of those positions, to increase the
Fund's exposure to foreign currencies that the Investment Adviser believes may
rise in value relative to the U.S. dollar or to shift the Fund's exposure to
foreign currency fluctuations from one country to another. For example, when the
Investment Adviser believes that the currency of a particular foreign country
may suffer a substantial decline relative to the U.S. dollar or another
currency, it may enter into a forward contract to sell the amount of the former
foreign currency approximating the value of some or all of the Fund's portfolio
securities denominated in such foreign currency. This investment practice
generally is referred to as "cross-hedging" when another foreign currency is
used.
The precise matching of the forward contract amounts and the value of the
securities involved will not generally be possible because the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Accordingly, it may be necessary for
the Fund to purchase additional foreign currency on the spot (that is, cash)
market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Fund is obligated to
deliver and if a decision is made to sell the security and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio security if
its market value exceeds the amount of foreign currency the Fund is obligated to
deliver. The projection of short-term currency market movements is extremely
difficult, and the successful execution of a short-term hedging strategy is
highly uncertain. Forward contracts involve the risk that anticipated currency
movements will not be accurately predicted, causing the Fund to sustain losses
on these contracts and transaction costs. The Fund may enter into forward
contracts or maintain a net exposure to such contracts only if (1) the
consummation of the contracts would not obligate the Fund to deliver an amount
of foreign currency in excess of the value of the Fund's portfolio securities or
other assets denominated in that currency, or (2) the Fund marks as segregated
cash, U.S. government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily, in an amount not less than the
value of the Fund's total assets committed to the consummation of the contracts.
Under normal circumstances, consideration of the prospect for currency parities
will be incorporated into the longer term investment decisions made with regard
to overall diversification strategies. However, the Investment Adviser believes
it is important to have the flexibility to enter into such forward contracts
when it determines that the best interests of the Fund will be served.
At or before the maturity date of a forward contract that requires the Fund
to sell a currency, the Fund may either sell a portfolio security and use the
sale proceeds to 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 that it is obligated to deliver. Similarly, the Fund
may close out a forward contract requiring it to purchase a specified currency
by entering into a second contract entitling it to sell the same amount of the
same currency on the maturity date of the first contract. The Fund would realize
a gain or loss as a result of entering into such an offsetting forward contract
under either circumstance to the extent the exchange rate between the currencies
involved moved between the execution dates of the first and second contracts.
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The cost to the Fund of engaging in forward contracts varies with factors
such as the currencies involved, the length of the contract period and the
market conditions then prevailing. Because forward contracts are usually entered
into on a principal basis, no fees or commissions are involved. The use of
forward contracts does not eliminate fluctuations in the prices of the
underlying securities the Fund owns or intends to acquire, but it does fix a
rate of exchange in advance. In addition, although forward contracts limit the
risk of loss due to a decline in the value of the hedged currencies, at the same
time they limit any potential gain that might result should the value of the
currencies increase.
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend to convert holdings of foreign currencies into U.S. dollars on a
daily basis. The Fund may convert foreign currency from time to time, and
investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit
based on the difference between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to the
Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
Swap Agreements. The Fund may enter into interest rate, index and currency
exchange rate swap agreements for purposes of attempting to obtain a particular
desired return at a lower cost to the Fund than if the Fund had invested
directly in an instrument that yielded the desired return. Swap agreements are
two party contracts entered into primarily by institutional investors for
periods ranging from a few weeks to more than one year. In a standard "swap"
transaction, two parties agree to exchange the returns (or differentials in
rates of return) earned or realized on particular predetermined investments or
instruments. The gross returns to be exchanged or "swapped" between the parties
are calculated with respect to a "notional amount," i.e., the return on or
increase in value of a particular dollar amount invested at a particular
interest rate, in a particular foreign currency, or in a "basket" of securities
representing a particular index. The "notional amount" of the swap agreement is
only a fictive basis on which to calculate the obligations which the parties to
a swap agreement have agreed to exchange. The Fund's obligations (or rights)
under a swap agreement will generally be equal only to the net amount to be paid
or received under the agreement based on the relative values of the positions
held by each party to the agreement (the "net amount"). The Fund's obligations
under a swap agreement will be accrued daily (offset against any amounts owing
to the Fund) and any accrued but unpaid net amounts owed to a swap counter-party
will be covered by marking as segregated cash, U.S. government securities,
equity securities or other liquid, unencumbered assets, marked-to-market daily,
to avoid any potential leveraging of the Fund's portfolio. The Fund will not
enter into a swap agreement with any single party if the net amount owed or to
be received under existing contracts with that party would exceed 5% of the
Fund's assets.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Investment Adviser's
ability to correctly predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, the Fund bears the risk
of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counter-party.
Restrictions imposed by the Internal Revenue Code may limit the Fund's ability
to use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps market,
including potential government regulation, could adversely affect the Fund's
ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
FOREIGN INVESTMENT RISKS
Foreign Market Risk. The Fund may invest a portion of its assets in foreign
securities. Foreign security investment involves special risks not present in
U.S. investments that can increase the chances that the Fund will lose money.
Prices of foreign securities may fluctuate more than prices of securities traded
in the United States.
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of
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<PAGE> 558
capital, resources, and balance of payments position. Certain such economies may
rely heavily on particular industries or foreign capital and are more vulnerable
to diplomatic developments, the imposition of economic sanctions against a
particular country or countries, changes in international trading patterns,
trade barriers, and other protectionist or retaliatory measures. Investments in
foreign markets may also be adversely affected by governmental actions such as
the imposition of capital controls, nationalization of companies or industries,
expropriation of assets, or the imposition of punitive taxes. In addition, the
governments of certain countries may prohibit or impose substantial restrictions
on foreign investing in their capital markets or in certain industries. Any of
these actions could severely affect security prices, impair the Fund's ability
to purchase or sell foreign securities or transfer the Fund's assets or income
back into the United States, or otherwise adversely affect the Fund's
operations. Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government securities,
difficulties in enforcing favorable legal judgments in foreign courts, and
political and social instability. Legal remedies available to investors in
certain foreign countries may be less extensive than those available to
investors in the United States or other foreign countries.
Currency Risk and Exchange Risk. Securities in which the Fund invests may
be denominated or quoted in currencies other than the U.S. dollar. Changes in
foreign currency exchange rates will affect the value of the securities of the
Fund. Generally, when the U.S. dollar rises in value against a foreign currency,
your investment in a security denominated in that currency loses value because
the currency is worth fewer U.S. dollars. Similarly when the U.S. dollar
decreases in value against a foreign currency, your investment in a security
denominated in that currency gains value because the currency is worth more U.S.
dollars. This risk is generally known as "currency risk" which is the
possibility that a stronger U.S. dollar will reduce returns for U.S. investors
investing overseas and a weak U.S. dollar will increase returns for U.S.
investors investing overseas.
For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU established a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU participants by July 1, 2002. Upon implementation of EMU,
certain securities issued in participating EU countries (beginning with
government and corporate bonds) were redenominated in the euro, and are now
listed, traded, declaring dividends and making other payments only in euros.
No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on the Fund's investments
in Europe generally or in specific countries participating in EMU.
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some countries may not have laws
to protect investors the way that the United States securities laws do.
Accounting
20
<PAGE> 559
standards in other countries are not necessarily the same as in the United
States. If the accounting standards in another country do not require as much
disclosure or detail as U.S. accounting standards, it may be harder for the
Fund's portfolio managers to completely and accurately determine a company's
financial condition.
Certain Risks of Holding Fund Assets Outside the United States. The Fund
generally holds the foreign securities in which it invests outside the United
States in foreign banks and securities depositories. These foreign banks and
securities depositories may be recently organized or new to the foreign custody
business. They may also have operations subject to limited or no regulatory
oversight. Also, the laws of certain countries may put limits on the Fund's
ability to recover its assets if a foreign bank or depository or issuer of a
security or any of their agents goes bankrupt. In addition, it can be expected
that it will be more expensive for the Fund to buy, sell and hold securities in
certain foreign markets than it is in the U.S. market due to higher brokerage,
transaction, custody and/or other costs. The increased expense of investing in
foreign markets reduces the amount the Fund can earn on its investments.
Settlement and clearance procedures in certain foreign markets differ
significantly from those in the United States. Foreign settlement and clearance
procedures and trade regulations also may involve certain risks (such as delays
in payment for or delivery of securities) not typically involved with the
settlement of U.S. investments. Communications between the United States and
emerging market countries may be unreliable, increasing the risk of delayed
settlements or losses of security certificates. Settlements in certain foreign
countries at times have not kept pace with the number of securities
transactions. These problems may make it difficult for a Fund to carry out
transactions. If the Fund cannot settle or is delayed in settling a purchase of
securities, it may miss attractive investment opportunities and certain of its
assets may be uninvested with no return earned thereon for some period. If the
Fund cannot settle or is delayed in settling a sale of securities, it may lose
money if the value of the security then declines or, if it has contracted to
sell the security to another party, the Fund could be liable to that party for
any losses incurred.
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
RISK FACTORS RELATING TO INVESTING IN HIGH YIELD SECURITIES
A description of security ratings is attached as an Appendix. Lower-rated
or unrated (that is, high yield) securities are more likely to react to
developments affecting market risk (such as interest rate sensitivity, market
perception of the creditworthiness of the issuer and general market liquidity)
and credit risk (such as the issuer's inability to meet its obligations) than
are more highly rated securities, which react primarily to movements in the
general level of interest rates. The Investment Adviser considers both credit
risk and market risk in making investment decisions for the Fund.
The amount of high yield securities outstanding proliferated in the 1980's
in conjunction with the increase in merger and acquisition and leveraged buyout
activity. Under adverse economic conditions, there is a risk that highly
leveraged issuers may be unable to service their debt obligations upon maturity.
In addition, the secondary market for high yield securities, which is
concentrated in relatively few market makers, may not be as liquid as the
secondary market for more highly rated securities. Under adverse market or
economic conditions, the secondary market for high yield securities could
contract further, independent of any specific adverse changes in the condition
of a particular issuer. As a result, the Investment Adviser could find it more
difficult to sell these securities or may be able to sell the securities only at
prices lower than if such securities were widely traded. Prices realized upon
the sale of such lower-rated or unrated securities, under these circumstances,
may be less than the prices used in calculating the Fund's net asset value prior
to the sale.
Lower-rated or unrated debt obligations also present risks based on payment
expectations. If an issuer calls the obligation for redemption, the Fund may
have to replace the security with a lower yielding security, resulting in a
decreased return for investors. If the Fund experiences unexpected net
redemptions, it may be forced to sell its higher-rated securities, resulting in
a decline in the overall credit quality of the Fund's portfolio and increasing
the exposure of the Fund to the risks of high yield securities.
21
<PAGE> 560
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions of
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act, securities which are otherwise not readily
marketable and repurchase agreements that have a maturity of longer than seven
days. Securities which have not been registered under the Securities Act are
referred to as private placements or restricted securities and are purchased
directly from the issuer or in the secondary market. Limitations on resale may
have an adverse effect on the marketability of portfolio securities and a mutual
fund might be unable to dispose of restricted or other illiquid securities
promptly or at reasonable prices and might thereby experience difficulty
satisfying redemption within seven days. The absence of a trading market can
make it difficult to ascertain a market value for illiquid investments. Also
market quotations are less readily available. The judgment of the Investment
Adviser may at times play a greater role in valuing these securities than in the
case of unrestricted securities. A mutual fund might also have to register such
restricted securities in order to dispose of them resulting in additional
expense and delay. Adverse market conditions could impede such a public offering
of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Investment Adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least one nationally recognized statistical
rating organizations ("NRSRO"), or, if unrated, be of comparable quality in the
view of the Investment Adviser; and (2) it must not be in default as to
principal or interest. Investing in Rule 144A securities could have the effect
of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
REVERSE REPURCHASE AGREEMENTS
The Fund may enter into reverse repurchase agreements, whereby the Fund
sells securities concurrently with entering into an agreement to repurchase
those securities at a later date at a fixed price. During the reverse repurchase
agreement period, the Fund continues to receive principal and interest payments
on those
22
<PAGE> 561
securities. Reverse repurchase agreements are speculative techniques involving
leverage and are considered borrowings by the Fund for purposes of the limit
applicable to borrowings.
DOLLAR ROLLS
The Fund may use dollar rolls as part of its investment strategy. In a
dollar roll, the Fund sells securities for delivery in the current month and
simultaneously contracts to repurchase substantially similar securities (same
type and coupon) on a specified future date from the same party. During the roll
period, the Fund forgoes principal and interest paid on the securities. The Fund
is compensated by the difference between the current sales price and the forward
price for the future purchase (often referred to as the "drop") as well as by
the interest earned on the cash proceeds of the initial sale. A "covered roll"
is a specific type of dollar roll for which there is an offsetting cash position
or cash equivalent security position that matures on or before the forward
settlement date of the dollar roll transaction.
The Fund will mark as segregated cash, U.S. government securities, equity
securities or other liquid, unencumbered assets, marked-to-market daily, equal
in value to their obligations with respect to dollar rolls. Dollar rolls involve
the risk that the market value of the securities retained by the Fund may
decline below the price of the securities the Fund has sold but is obligated to
repurchase under the agreement. If the buyer of the securities under a dollar
roll files for bankruptcy or becomes insolvent, the Fund's use of the proceeds
of the agreement may be restricted pending a determination by the other party,
or its trustee or receiver, whether to enforce the Fund's obligation to
repurchase the securities. Dollar rolls are speculative techniques involving
leverage and are considered borrowings by the Fund for purposes of the limit
applicable to borrowings.
BORROWING
The Fund may borrow for temporary, emergency or investment purposes. This
borrowing may be unsecured. The 1940 Act requires the Fund to maintain
continuous asset coverage (that is, total assets including borrowings, less
liabilities exclusive of borrowings) of 300% of the amount borrowed. Borrowing
subjects the Fund to interest costs which may or may not be recovered by
appreciation of the securities purchased, and can exaggerate the effect on net
asset value of any increase or decrease in the market value of the Fund's
portfolio. This is the speculative factor known as leverage.
LOANS OF PORTFOLIO SECURITIES
For the purpose of achieving income, the Fund may lend its portfolio
securities, provided: (1) the loan is secured continuously by collateral
consisting of short-term, high quality debt securities, including U.S.
government securities, negotiable certificates of deposit, bankers' acceptances
or letters of credit, maintained on a daily marked-to-market basis in an amount
at least equal to the current market value of the securities loaned; (2) the
Fund may at any time call the loan and obtain the return of the securities
loaned; (3) the Fund will receive any interest or dividends paid on the loaned
securities; and (4) the aggregate market value of securities loaned will not at
any time exceed one-third of the total assets of the Fund.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value of the security each day in determining the Fund's net asset
value. The Fund will also mark as segregated with its custodian cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, equal in value to its obligations for when-issued
securities.
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<PAGE> 562
REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain Internal Revenue Code requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties, as well as
greater income potential than an investment in common stocks. Like any
investment in real estate, though, a REIT's performance depends on several
factors, such as its ability to find tenants for its properties, to renew leases
and to finance property purchases and renovations.
SHARES OF OTHER INVESTMENT COMPANIES
The Fund can invest in securities of other investment companies except to
the extent prohibited by law. Like all equity investments, these investments may
go up or down in value. They also may not perform in correlation with the Fund's
principal strategies. The Fund will pay additional fees through its investments
in other investment companies.
SHORT SALES AGAINST-THE-BOX
The Fund can borrow and sell "short" securities when it also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund's
total assets can be held as collateral for short sales at any one time.
CORPORATE LOANS
The Fund can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Fund may not
recover its investment, or there might be a delay in the Fund's recovery. By
investing in a corporate loan, the Fund becomes a member of the syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, the Fund may invest
all or part of its assets in short-term investment grade debt obligations of the
U.S. government, its agencies and instrumentalities, bank certificates of
deposit, bankers' acceptances, high quality commercial paper, demand notes and
repurchase agreements.
MANAGEMENT OF THE FUND
The Trustees oversee the actions of the Fund's Investment Adviser and other
service providers and decide upon matters of general policy. The Trustees also
review the actions of the Trust's officers, who conduct and supervise the daily
business operations of the Trust. The same individuals serve as Trustees of the
Master Trust. The Trustees (* denotes "interested" Trustee as defined in the
1940 Act, due to the relationship with the Investment Adviser) and officers of
the Trust are:
MICHAEL BAXTER* (37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since 1999);
Managing Director of the Investment Adviser (since 1996); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
24
<PAGE> 563
ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since 1994); Chairman, Gamma Services Corp.
(venture capital) (since 1968); Principal, Gavin, Dailey & Partners (consulting)
(since 1993); U.S. Ambassador to Mexico (1981 - 1986); Director, Apex Mortgage
Capital, Inc., Atlantic Richfield Co., International Wire Corp. and Krause's
Furniture.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (since 1986); Member of CIEBA's Executive Committee (since
1988) and its Chairman (from 1991 - 1992); Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds (1986 - 1993); Member of the Investment Advisory Committees of
the State of New York Common Retirement Fund and the Howard Hughes Medical
Institute (since 1997); Director, Duke Management Company (since 1992) and Vice
Chairman (since 1998); Director, Kimco Realty Corporation (since 1997);
Director, LaSalle Street Fund (since 1995); Member of the Investment Advisory
Committee of the Virginia Retirement System (since 1998); Director, Montpelier
Foundation (since 1998); Trustee or Director of 24 registered investment
companies (consisting of 56 portfolios) for which the Investment Adviser or an
advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since
1999); Managing Director of the Investment Adviser (since 1998); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (49) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 62 registered investment companies
(consisting of 86 portfolios) for which the Investment Adviser or an advisory
affiliate is the adviser.
NANCY D. CELICK (49) -- President -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Chief Administrative Officer of the Investment
Adviser (since 1998); Chief Financial Officer of the Investment Adviser
(1993 - 1998); Chief Financial Officer of Kennedy-Wilson, Inc. (auction
marketing services) (1992 - 1993); Chief Financial Officer of First National
Corporation (bank holding company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-9011. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services,
Inc. (since 1999); Vice President of FAM Distributors, Inc. (since 1999); First
Vice President of the Investment Adviser (1990 - 1997).
ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
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<PAGE> 564
GRACIE FERMELIA (38) -- Vice President and Assistant Secretary -- 725 South
Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Director of the
Investment Adviser (since 2000); Vice President of the Investment Adviser
(1994 - 2000); Senior Manager, Price Waterhouse (1985 - 1994).
The Trust does not pay salaries to any of its officers or fees to any of
its Trustees affiliated with the Investment Adviser. The following table sets
forth the aggregate compensation paid to the Trustees during the Trust's fiscal
year ended June 30, 2000 and the aggregate compensation paid to the Trustees for
service on the Trust's Board and that of any other fund for which the Investment
Adviser serves as investment adviser or which has an investment adviser that is
an affiliated person of the Investment Adviser ("Fund Complex") for the year
ended December 31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $ $ 34,000
John A. G. Gavin................................... $ $ 25,000
Joe Grills......................................... $ $232,333
Nigel Hurst-Brown.................................. $ -0- $ -0-
Robert B. Hutchinson**............................. $ $ 34,000
Madeleine A. Kleiner............................... $ $ 18,000
Merle T. Welshans**................................ $ $ 34,000
Richard R. West.................................... $ $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of the Mercury HW Variable Trust, the
Master Trust and Merrill Lynch Investment Managers Funds, Inc. Messrs. Grills
and West also serve on the boards of other investment companies advised by
the Investment Adviser and its advisory affiliates.
** Messrs. Hutchinson and Welshans retired on November 12, 1999.
The Trustees may be eligible for reduced sales charges on purchases of
Class I shares. See "Reduced Initial Sales Charges -- Purchase Privileges of
Certain Persons."
For information as to ownership of shares, see "General
Information -- Principal Holders."
MANAGEMENT AND ADVISORY ARRANGEMENTS
Investment Advisory Services and Fee. The Fund currently invests all of its
assets in shares of the Portfolio. Accordingly, the Fund does not invest
directly in portfolio securities and does not require investment advisory
services. All portfolio management occurs at the level of the Master Trust. The
Master Trust has entered into an investment advisory agreement for the Portfolio
with the Investment Adviser as investment adviser (the "Advisory Agreement").
Subject to the supervision of the Trustees, the Investment Adviser is
responsible for the actual management of the Portfolio and constantly reviews
the Portfolio's holdings in light of its own research analysis and that from
other relevant sources. The responsibility for making decisions to buy, sell or
hold a particular security rests with the Investment Adviser. The Investment
Adviser performs certain of the other administrative services and provides all
office space, facilities, equipment and necessary personnel for management of
the Master Trust. The Investment Adviser receives for its services to the
Portfolio a monthly fee at an annual rate of 0.21% of the Portfolio's average
daily net assets. For purposes of this calculation, average daily net assets is
determined at the end of each month on the basis of the average net assets of
the Portfolio for each day during the month.
Prior to October , 2000, the Fund did not invest its shares in the
Portfolio and was party to an investment advisory agreement under which it paid
Merrill Lynch Investment Managers, L.P., an affiliate of the Investment Adviser,
a fee at the annual rate of 0.46% of its average daily net assets. For the
fiscal years
26
<PAGE> 565
ended June 30, 2000, 1999 and 1998, the Fund paid Merrill Lynch Investment
Managers, L.P. $ , $1,469,150 and $773,803, respectively. As a result
of its agreement to limit Fund expenses, for these years Merrill Lynch
Investment Managers, L.P. waived a portion of its fee in the amount of $ ,
$230,145 and $144,309, respectively.
Securities held by the Portfolio may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients of the Investment Adviser or an affiliate when one or more clients of
the Investment Adviser or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Payment of Master Trust Expenses. The Advisory Agreement obligates the
Investment Adviser to provide investment advisory services and to pay, or cause
an affiliate to pay, for maintaining its staff and personnel and to provide
office space, facilities and necessary personnel for the Master Trust. The
Investment Adviser is also obligated to pay, or cause an affiliate to pay, the
fees of all officers and Trustees who are affiliated persons of the Investment
Adviser or any sub-adviser or of an affiliate of the Investment Adviser or any
sub-adviser. The Portfolio pays, or causes to be paid, all other expenses
incurred in the operation of the Portfolio (except to the extent paid by FAM
Distributors, Inc. (the "Distributor")), including, among other things, taxes,
expenses for legal and auditing services, costs of printing proxies, shareholder
reports, copies of the Registration Statement, charges of the custodian, any
sub-custodian and the transfer agent, expenses of portfolio transactions,
expenses of redemption of shares, Commission fees, expenses of registering the
shares under Federal, state or non-U.S. laws, fees and actual out-of-pocket
expenses of non-interested Trustees, accounting and pricing costs (including the
daily calculation of net asset value), insurance, interest, brokerage costs,
litigation and other extraordinary or non-recurring expenses, and other expenses
properly payable by the Portfolio. Accounting services are provided to the
Portfolio by the Investment Adviser or an affiliate of the Investment Adviser,
and the Portfolio reimburses the Investment Adviser or an affiliate of the
Investment Adviser for its costs in connection with such services.
Organization of the Investment Adviser. The Investment Adviser is a limited
partnership, the partners of which are Merrill Lynch & Co., Inc. ("ML & Co."), a
financial services holding company and the parent of Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch") and Princeton Services, Inc. ML &
Co. and Princeton Services, Inc. are "controlling persons" of the Investment
Adviser as defined under the 1940 Act because of their ownership of its voting
securities and their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Advisory Agreement will continue in effect for two years from its effective
date. Thereafter, it will remain in effect from year to year if approved
annually (a) by the Board of Trustees of the Master Trust or by a majority of
the outstanding shares of the Portfolio and (b) by a majority of the Trustees of
the Master Trust who are not parties to the Advisory Agreement or interested
persons (as defined in the 1940 Act) of any such party. The Advisory Agreement
is not assignable and will automatically terminate in the event of its
assignment. In addition, such contract may be terminated by the vote of a
majority of the outstanding voting securities of the Portfolio or by the
Investment Adviser without penalty on 60 days' written notice to the other
party.
ADMINISTRATION ARRANGEMENTS
The Fund has entered into an Administration Agreement (the "Administration
Agreement") with the Investment Adviser acting as Administrator (the
"Administrator"). The Administrator receives for its services to the Fund
monthly compensation at the annual rate of % of the average daily net assets
of the Fund.
27
<PAGE> 566
The Administration Agreement obligates the Administrator to provide certain
administrative services to the Fund and to pay, or cause its affiliates to pay,
for maintaining its staff and personnel and to provide office space, facilities
and necessary personnel for the Fund. The Administrator is also obligated to
pay, or cause its affiliates to pay, the fees of those officers and Trustees who
are affiliated persons of the Administrator or any of its affiliates. The Fund
pays, or causes to be paid, all other expenses incurred in the operation of the
Fund (except to the extent paid by the Distributor), including, among other
things, taxes, expenses for legal and auditing services, costs of printing
proxies, shareholder reports and prospectuses and statements of additional
information, charges of the custodian, any sub-custodian and Financial Data
Services, Inc. (the "Transfer Agent"), expenses of portfolio transactions,
expenses of redemption of shares, Commission fees, expenses of registering the
shares under Federal, state or non-U.S. laws, fees and actual out-of-pocket
expenses of Trustees who are not affiliated persons of the Administrator, or of
an affiliate of the Administrator, accounting and pricing costs (including the
daily calculation of the net asset value), insurance, interest, brokerage costs,
litigation and other extraordinary or non-recurring expenses, and other expenses
properly payable by the Fund. The Distributor will pay certain of the expenses
of the Fund incurred in connection with the continuous offering of its shares.
Certain expenses will be financed by the Fund pursuant to distribution plans in
compliance with Rule 12b-1 under the 1940 Act. See "Purchase of
Shares -- Distribution Plan." Accounting services are provided to the Fund by
the Investment Adviser, and the Fund reimburses the Investment Adviser for its
costs in connection with such services.
Duration and Termination. Unless earlier terminated as described below, the
Administration Agreement will remain in effect for two years from its effective
date. Thereafter it will remain in effect from year to year if approved annually
(a) by the Board of Trustees and (b) by a majority of the Trustees who are not
parties to such contract or interested persons (as defined in the 1940 Act) of
any such party. Such contract is not assignable and may be terminated without
penalty on 60 days' written notice at the option of either party thereto or by
the vote of the shareholders of the Fund.
Transfer Agency Services. The Transfer Agent, a subsidiary of ML & Co.,
acts as the Fund's Transfer Agent pursuant to a Transfer Agency, Dividend
Disbursing Agency and Shareholder Servicing Agency Agreement (the "Transfer
Agency Agreement"). Pursuant to the Transfer Agency Agreement, the Transfer
Agent is responsible for the issuance, transfer and redemption of shares and the
opening and maintenance of shareholder accounts. Pursuant to the Transfer Agency
Agreement, the Transfer Agent receives a fee ranging from $16.00 to $20.00 per
account (depending on the level of services required), and certain other fees
relating to special processing of sub-transfer agency relationships. The
Transfer Agent is entitled to reimbursement for certain transaction charges and
out-of-pocket expenses incurred by the Transfer Agent under the Transfer Agency
Agreement. For purposes of the Transfer Agency Agreement, the term "account"
includes a shareholder account maintained directly by the Transfer Agent and any
other account representing the beneficial interest of a person in the relevant
share class on a recordkeeping system.
Distribution Expenses. The Fund has entered into a distribution agreement
with the Distributor in connection with the continuous offering of shares of the
Fund (the "Distribution Agreement"). The Distribution Agreement obligates the
Distributor to pay certain expenses in connection with the offering of the
shares of the Fund. After the prospectuses, statements of additional information
and periodic reports have been prepared, set in type and mailed to shareholders,
the Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to dealers and investors. The Distributor also pays
for other supplementary sales literature and advertising costs. The Distribution
Agreement is subject to the same renewal requirements and termination provisions
as the Advisory Agreement described above.
CODE OF ETHICS
The Board of Trustees of the Master Trust and the Trust each have adopted a
Code of Ethics under Rule 17j-1 of the 1940 Act that covers the Master Trust,
the Fund, the Investment Adviser and the Distributor (the "Code of Ethics"). The
Code of Ethics significantly restricts the personal investing activities of all
employees of the Investment Adviser and the Distributor and, as described below,
imposes additional more onerous restrictions on fund investment personnel.
28
<PAGE> 567
The Code of Ethics requires that all employees of the Investment Adviser
and the Distributor pre-clear any personal securities investments (with limited
exceptions, such as mutual funds, high-quality short-term securities and direct
obligations of the U.S. government). The pre-clearance requirement and
associated procedures are designed to identify any substantive prohibition or
limitation applicable to the proposed investment. The substantive restrictions
applicable to all employees of the Investment Adviser and the Distributor
include a ban on acquiring any securities in a "hot" initial public offering. In
addition, investment personnel are prohibited from profiting on short-term
trading in securities. No employee may purchase or sell any security that at the
time is being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Investment Adviser. Furthermore, the Code of Ethics provides for trading
"blackout periods" which prohibit trading by investment personnel of the Fund
within seven calendar days, before or after, of trading by the Fund in the same
or equivalent security.
PURCHASE OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus for certain information as to the purchase of
Fund shares.
The Fund issues four classes of shares: shares of Class I and Class A are
sold to investors choosing the initial sales charge alternatives and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. Each Class I, Class A, Class B and Class C share of the Fund
represents an identical interest in the investment portfolio of the Fund, and
has the same rights, except that Class A, Class B and Class C shares bear the
expenses of the ongoing account maintenance fees (also known as service fees)
and Class B and Class C shares bear the expenses of the ongoing distribution
fees and the additional incremental transfer agency costs resulting from the
deferred sales charge arrangements. The contingent deferred sales charges
("CDSCs"), distribution fees and account maintenance fees that are imposed on
Class B and Class C shares, as well as the account maintenance fees that are
imposed on Class A shares, are imposed directly against those classes and not
against all assets of the Fund, and, accordingly, such charges do not affect the
net asset value of any other class or have any impact on investors choosing
another sales charge option. Dividends paid by the Fund for each class of shares
are calculated in the same manner at the same time and differ only to the extent
that account maintenance and distribution fees and any incremental transfer
agency costs in relation to a particular class are borne exclusively by that
class. Class A, Class B and Class C shares each have exclusive voting rights
with respect to the Rule 12b-1 distribution plan adopted with respect to such
class pursuant to which the account maintenance and/or distribution fees are
paid (except that Class B shareholders may vote upon any material changes to
expenses charged under the Distribution Plan for Class A shares). Each class has
different exchange privileges. See "Shareholder Services -- Exchange Privilege."
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class I and Class A shares are the same as
those of the CDSCs and distribution fees with respect to the Class B and Class C
shares in that the sales charges and distribution fees applicable to each class
provide for the financing of the distribution of the shares of the Fund. The
distribution-related revenues paid with respect to a class will not be used to
finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share plus any sales charge applicable to the
class of shares selected by the investor. The applicable offering price for
purchase orders is based upon the net asset value of the Fund next determined
after receipt of the purchase order by the Distributor. As to purchase orders
received by selected securities dealers or other financial intermediaries prior
to the close of regular trading on the New York Stock Exchange (the "NYSE")
(generally 4:00 p.m., Eastern time) which includes orders received after the
determination of net asset value on the previous day, the applicable offering
price will be based on the net asset value on the day the order is placed with
the Distributor, provided that the orders are received by the Distributor prior
to 30 minutes after the close of regular trading on the NYSE on that day. If the
purchase orders are not received prior to 30 minutes after the close of regular
trading on the NYSE on that day, such orders shall be deemed received
29
<PAGE> 568
on the next business day. Selected securities dealers or other financial
intermediaries have the responsibility of submitting purchase orders to the Fund
not later than 30 minutes after the close of regular trading on the NYSE in
order to purchase shares at that day's offering price.
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Any order may be rejected by the Fund or the Distributor. Neither
the Distributor nor the selected securities dealers or other financial
intermediaries are permitted to withhold placing orders to benefit themselves by
a price change. Certain selected securities dealers or other financial
intermediaries may charge a processing fee to confirm a sale of shares. For
example, the fee currently charged by Merrill Lynch is $5.35. Purchases made
directly through the Transfer Agent are not subject to the processing fee.
INITIAL SALES CHARGE ALTERNATIVES -- CLASS I AND CLASS A SHARES
Investors who prefer an initial sales charge alternative may elect to
purchase Class A shares or, if an eligible investor, Class I shares.
Investors choosing the initial sales charge alternative who are eligible to
purchase Class I shares should purchase Class I shares rather than Class A
shares, because there is an account maintenance fee imposed on Class A shares.
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class I and Class A
shares of the Fund, refers to a single purchase by an individual or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his or her spouse and their children under
the age of 21 years purchasing shares for his, her or their own account and to
single purchases by a trustee or other fiduciary purchasing shares for a single
trust estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company," as that
term is defined in the 1940 Act, but does not include purchases by any such
company that has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
Class I shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class I shares. Investors
who owned Investor Class shares or who currently own Class I shares of the Fund
in a shareholder account are entitled to purchase additional Class I shares of
the Fund in that account. Certain employer-sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class I shares at net asset
value provided such plans meet the required minimum number of eligible employees
or required amount of assets advised by the Investment Adviser or any of its
affiliates. Also eligible to purchase Class I shares at net asset value are
participants in certain investment programs including certain managed accounts
for which a trust institution, thrift or bank trust department provides
discretionary trustee services, certain collective investment trusts for which a
trust institution, thrift, or bank trust department serves as trustee, certain
purchases made in connection with certain fee-based programs and certain
purchases made through certain financial advisers that meet and adhere to
standards established by the Investment Adviser. Class I shares are available at
net asset value to corporate warranty insurance reserve fund programs and U.S.
branches of foreign banking institutions, provided that the participant has $3
million or more initially invested in affiliate-advised investment companies. In
addition, Class I shares are offered at net asset value to ML & Co. and its
subsidiaries and their directors and employees, to members of the Boards of
investment companies advised by the Investment Adviser or its affiliates,
including the Fund, and to employees of certain selected securities dealers or
other financial intermediaries. Class I shares may also be offered at net asset
value to certain accounts over which the Investment Adviser or an affiliate
exercises investment discretion. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative particularly
attractive, because similar sales charge reductions are not available with
respect to the deferred sales charges imposed in connection with purchases of
Class B or Class C shares.
30
<PAGE> 569
Investors not qualifying for reduced initial sales charges who expect to
maintain their investment for an extended period of time also may elect to
purchase Class I or Class A shares, because over time the accumulated ongoing
account maintenance and distribution fees on Class B or Class C shares may
exceed the initial sales charges, and, in the case of Class A shares, the
account maintenance fee. Although some investors who previously purchased Class
I shares may no longer be eligible to purchase Class I shares of other
affiliate-advised funds, those previously purchased Class I shares, together
with Class A, Class B and Class C share holdings, will count toward a right of
accumulation which may qualify the investor for a reduced initial sales charge
on new initial sales charge purchases. In addition, the ongoing Class B and
Class C account maintenance and distribution fees will cause Class B and Class C
shares to have higher expense ratios, pay lower dividends and have lower total
returns than the initial sales charge shares. The ongoing Class A account
maintenance fees will cause Class A shares to have a higher expense ratio, pay
lower dividends and have a lower total return than Class I shares.
The Distributor may reallow discounts to selected securities dealers or
other financial intermediaries and retain the balance over such discounts. At
times the Distributor may reallow the entire sales charge to such selected
securities dealers or other financial intermediaries. Since selected securities
dealers or other financial intermediaries selling Class I and Class A shares of
the Fund will receive a concession equal to most of the sales charge, they may
be deemed to be underwriters under the Securities Act.
REDUCED INITIAL SALES CHARGES
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
to obtain such investments.
Reinvested Dividends. No initial sales charges are imposed upon Class I and
Class A shares issued as a result of the automatic reinvestment of dividends.
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other Mercury mutual funds. For any such right of accumulation to be
made available, the Distributor must be provided at the time of purchase, by the
purchaser or the purchaser's selected securities dealer or other financial
intermediary, with sufficient information to permit confirmation of
qualification. Acceptance of the purchase order is subject to such confirmation.
The right of accumulation may be amended or terminated at any time. Shares held
in the name of a nominee or custodian under pension, profit-sharing, or other
employee benefit plans may not be combined with other shares to qualify for the
right of accumulation.
Letter of Intent. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class I or Class A shares of the Fund or any
other Mercury mutual funds made within a 13-month period starting with the first
purchase pursuant to the Letter of Intent. The Letter of Intent is available
only to investors whose accounts are established and maintained at the Fund's
Transfer Agent. The Letter of Intent is not available to employee benefit plans
for which affiliates of the Investment Adviser provide plan participant
record-keeping services. The Letter of Intent is not a binding obligation to
purchase any amount of Class I or Class A shares; however, its execution will
result in the purchaser paying a lower sales charge at the appropriate quantity
purchase level. A purchase not originally made pursuant to a Letter of Intent
may be included under a subsequent Letter of Intent executed within 90 days of
such purchase if the Distributor is informed in writing of this intent within
such 90-day period. The value of Class I and Class A shares of the Fund and of
other Mercury mutual funds presently held, at cost or maximum offering price
(whichever is higher), on the date of the first purchase under the Letter of
Intent, may be included as a credit toward the completion of such Letter, but
the reduced sales charge applicable to the amount covered by such Letter will be
applied only to new purchases. If the total amount of shares does not equal the
amount stated in the Letter of Intent (minimum of $25,000), the investor will be
notified and must pay, within 20 days of the execution of such Letter, the
difference between the sales charge on the Class I or Class A shares purchased
at the reduced
31
<PAGE> 570
rate and the sales charge applicable to the shares actually purchased through
the Letter. Class I or Class A shares equal to 5.0% of the intended amount will
be held in escrow during the 13-month period (while remaining registered in the
name of the purchaser) for this purpose. The first purchase under the Letter of
Intent must be at least 5.0% of the dollar amount of such Letter. If a purchase
during the term of such Letter would otherwise be subject to a further reduced
sales charge based on the right of accumulation, the purchaser will be entitled
on that purchase and subsequent purchases to that further reduced percentage
sales charge but there will be no retroactive reduction of the sales charges on
any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intent will be deducted from
the total purchases made under such Letter. An exchange from the Summit Cash
Reserves Fund ("Summit") into the Fund that creates a sales charge will count
toward completing a new or existing Letter of Intent from the Fund.
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and certain
other arrangements may purchase Class I or Class A shares at net asset value,
based on the number of employees or number of employees eligible to participate
in the plan and/or the aggregate amount invested by the plan in specified
investments. Certain other plans may purchase Class B shares with a waiver of
the CDSC upon redemption, based on similar criteria. Such Class B shares will
convert into Class A shares approximately ten years after the plan purchases the
first share of any Mercury mutual fund. Minimum purchase requirements may be
waived or varied for such plans. For additional information regarding purchases
by employer-sponsored retirement or savings plans and certain other
arrangements, call your plan administrator or your selected securities dealer or
other financial intermediary.
Managed Trusts. Class I shares are offered at net asset value to certain
trusts to which trust institutions, thrifts, and bank trust departments provide
discretionary trustee services.
Purchase Privileges of Certain Persons. Trustees of the Trust and Trustees
of the Master Trust and of other investment companies advised by the Investment
Adviser or its affiliates, directors and employees of ML & Co. and its
subsidiaries (the term "subsidiaries," when used herein with respect to ML &
Co., includes the Investment Adviser, Merrill Lynch Investment Managers, L.P.,
Merrill Lynch Investment Managers, International, Limited and certain other
entities directly or indirectly wholly owned and controlled by ML & Co.),
employees of certain selected securities dealers, and any trust, pension,
profit-sharing or other benefit plan for such persons, may purchase Class I
shares of the Fund at net asset value. The Fund realizes economies of scale and
reduction of sales-related expenses by virtue of the familiarity of these
persons with the Fund. Employees and Trustees wishing to purchase shares of the
Fund must satisfy the Fund's suitability standards.
Class I and Class A shares are also offered at net asset value to certain
accounts over which the Investment Adviser or an affiliate exercises investment
discretion.
Acquisition of Certain Investment Companies. Class A shares may be offered
at net asset value in connection with the acquisition of the assets of or merger
or consolidation with a personal holding company or a public or private
investment company.
Purchases Through Certain Financial Intermediaries. Reduced sales charges
may be applicable for purchases of Class I or Class A shares of the Fund through
certain financial advisers, selected securities dealers and other financial
intermediaries that meet and adhere to standards established by the Investment
Adviser from time to time.
A waived sales charge on a purchase of Class I shares will apply to current
beneficial shareholders who were also beneficial shareholders of the Fund as of
the opening of business of the Fund on October , 2000.
32
<PAGE> 571
DEFERRED SALES CHARGE ALTERNATIVES -- CLASS B AND CLASS C SHARES
Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in Mercury mutual funds.
Because no initial sales charges are deducted at the time of the purchase,
Class B and Class C shares provide the benefit of putting all of the investor's
dollars to work from the time the investment is made. The deferred sales charge
alternatives may be particularly appealing to investors that do not qualify for
the reduction in initial sales charges. Both Class B and Class C shares are
subject to ongoing account maintenance fees and distribution fees; however, the
ongoing account maintenance and distribution fees potentially may be offset to
the extent any return is realized on the additional funds initially invested in
Class B or Class C shares. In addition, Class B shares will be converted into
Class A shares of the Fund after a conversion period of approximately ten years,
and thereafter investors will be subject to lower ongoing fees.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net asset
value per share without the imposition of a sales charge at the time of
purchase. See "Pricing of Shares -- Determination of Net Asset Value" below.
Class B shares that are redeemed within four years of purchase may be
subject to a CDSC at the rates set forth below charged as a percentage of the
dollar amount subject thereto. In determining whether a CDSC is applicable to a
redemption, the calculation will be determined in the manner that results in the
lowest applicable rate being charged. The charge will be assessed on an amount
equal to the lesser of the proceeds of redemption or the cost of the shares
being redeemed. Accordingly, no CDSC will be imposed on increases in net asset
value above the initial purchase price. In addition, no CDSC will be assessed on
shares derived from reinvestment of dividends. It will be assumed that the
redemption is first of shares held for over six years or shares acquired
pursuant to reinvestment of dividends and then of shares held longest during the
six-year period. A transfer of shares from a shareholder's account to another
account will be assumed to be made in the same order as a redemption.
The following table sets forth the Class B CDSC:
<TABLE>
<CAPTION>
CDSC AS A PERCENTAGE
OF DOLLAR AMOUNT
YEAR SINCE PURCHASE PAYMENT MADE SUBJECT TO CHARGE
-------------------------------- --------------------
<S> <C>
0-1....................................... --%
1-2....................................... --%
2-3....................................... --%
3-4....................................... --%
4 and thereafter.......................... None
</TABLE>
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired 10
additional shares upon dividend reinvestment. If at such time the investor makes
his or her first redemption of 50 shares (proceeds of $600), 10 shares will not
be subject to a CDSC because of dividend reinvestment. With respect to the
remaining 40 shares, the charge is applied only to the original cost of $10 per
share and not to the increase in net asset value of $2 per share. Therefore,
$400 of the $600 redemption proceeds will be charged at a rate of % (the
applicable rate in the third year after purchase).
As discussed in the Prospectus under "Account Choices -- Pricing of
Shares -- Class B and C Shares -- Deferred Sales Charge Options," while Class B
shares redeemed within four years of purchase are subject to a CDSC under most
circumstances, the charge may be reduced or waived in certain instances. These
include certain post-retirement withdrawals from an individual retirement
account ("IRA") or other retirement plan or redemption of Class B shares in
certain circumstances following the death of a Class B shareholder. In the case
of such withdrawal, the reduction or waiver applies to: (a) any partial or
complete redemption in connection with a distribution following retirement under
a tax-deferred retirement plan on attaining age 59 1/2 in the case of an IRA or
other retirement plan, or part of a series of equal periodic payments (not less
33
<PAGE> 572
frequently than annually) made for life (or life expectancy) or any redemption
resulting from the tax-free return of an excess contribution to an IRA (certain
legal documentation may be required at the time of liquidation establishing
eligibility for qualified distribution); or (b) any partial or complete
redemption following the death or disability (as defined in the Internal Revenue
Code of 1986, as amended (the "Code")) of a Class B shareholder (including one
who owns the Class B shares as joint tenant with his or her spouse), provided
the redemption is requested within one year of the death or initial
determination of disability, or if later, reasonably promptly following
completion of probate or in connection with involuntary termination of an
account in which Fund shares are held (certain legal documentation may be
required at the time of liquidation establishing eligibility for qualified
distribution).
The charge may also be reduced or waived in other instances, such as: (a)
redemptions by certain eligible 401(a) and 401(k) plans and certain retirement
plan rollovers; (b) redemptions in connection with participation in certain
fee-based programs of the Investment Adviser or its affiliates; (c) redemptions
in connection with participation in certain fee-based programs of selected
securities dealers and other financial intermediaries that have agreements with
the Investment Adviser or Distributor; or (d) withdrawals through the Systematic
Withdrawal Plan of up to 10% per year of your account value at the time the plan
is established. See "Shareholder Services -- Fee-Based Programs" and
"-- Systematic Withdrawal Plan."
Conversion of Class B Shares to Class A Shares. After approximately ten
years (the "Conversion Period"), Class B shares of the Fund will be converted
automatically into Class A shares of the Fund. Class A shares are subject to an
ongoing account maintenance fee of % of the average daily net assets of the
Fund but are not subject to the distribution fee that is borne by Class B
shares. Automatic conversion of Class B shares into Class A shares will occur at
least once each month (on the "Conversion Date") on the basis of the relative
net asset value of the shares of the two classes on the Conversion Date, without
the imposition of any sales load, fee or other charge. Conversion of Class B
shares to Class A shares will not be deemed a purchase or sale of the shares for
Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class A shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at the Conversion Date the conversion of Class B shares to Class
A shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class A shares
of the Fund.
The Conversion Period may be modified for investors that participate in
certain fee-based programs. See "Shareholder Services -- Fee-Based Programs."
Class B shareholders of the Fund exercising the exchange privilege
described under "Shareholder Services -- Exchange Privilege" will continue to be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares acquired as a result of the exchange.
Class C shares that are redeemed within one year of purchase may be subject
to a % CDSC charged as a percentage of the dollar amount subject thereto. In
determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. The charge will be assessed on an amount equal to the lesser
of the proceeds of redemption or the cost of the shares being redeemed.
Accordingly, no Class C CDSC will be imposed on increases in net asset value
above the initial purchase price. In addition, no Class C CDSC will be assessed
on shares derived from reinvestment of dividends. It will be assumed that the
redemption is first of shares held for over one year or shares acquired pursuant
to reinvestment of dividends and then of shares held longest during the one-year
period. A transfer of shares from a shareholder's account to another account
will be assumed to be made in the same order as a redemption. The Class C CDSC
may be waived in connection with involuntary termination of an account in which
Fund shares are held and withdrawals through the Systematic Withdrawal Plans.
See "Shareholder Services -- Systematic Withdrawal Plan."
34
<PAGE> 573
Proceeds from the CDSC and the distribution fee are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers and other financial intermediaries (including Merrill Lynch) related to
providing distribution-related services to the Fund in connection with the sale
of the Class B and Class C shares, such as the payment of compensation to
financial consultants for selling Class B and Class C shares from the dealer's
own funds. The combination of the CDSC and the ongoing distribution fee
facilitates the ability of the Fund to sell the Class B and Class C shares
without a sales charge being deducted at the time of purchase. See "Distribution
Plans" below. Imposition of the CDSC and the distribution fee on Class B and
Class C shares is limited by the National Association of Securities Dealers,
Inc. (the "NASD") asset-based sales charge rule. See "Limitations on the Payment
of Deferred Sales Charges" below.
DISTRIBUTION PLANS
Reference is made to "Account Choices -- Pricing of Shares" in the
Prospectus for certain information with respect to separate distribution plans
for Class A, Class B, and Class C shares pursuant to Rule 12b-1 under the 1940
Act (each a "Distribution Plan") with respect to the account maintenance and/or
distribution fees paid by the Fund to the Distributor with respect to such
classes.
The Distribution Plans for each of the Class A, Class B and Class C shares
provide that the Fund pays the Distributor an account maintenance fee relating
to the shares of the relevant class, accrued daily and paid monthly, at the
annual rate of % of the average daily net assets of the Fund attributable to
shares of the relevant class in order to compensate the Distributor and selected
securities dealers or other financial intermediaries (pursuant to
sub-agreements) in connection with account maintenance activities with respect
to Class A, Class B and Class C shares. Each of those classes has exclusive
voting rights with respect to the Distribution Plan adopted with respect to such
class pursuant to which account maintenance and/or distribution fees are paid
(except that Class B shareholders may vote on any material changes to expenses
charged under the Class A Distribution Plan).
The Distribution Plans for each of the Class B and Class C shares provide
that the Fund also pays the Distributor a distribution fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual rate
of % of the average daily net assets of the Class B shares and % of the
average daily net assets of the Class C shares in order to compensate the
Distributor and selected securities dealers or other financial intermediaries
(pursuant to sub-agreements) for providing shareholder and distribution
services, and bearing certain distribution-related expenses of the Fund,
including payments to securities dealers and other financial intermediaries for
selling Class B and Class C shares of the Fund. The Distribution Plans relating
to Class B and Class C shares are designed to permit an investor to purchase
Class B and Class C shares through securities dealers and other financial
intermediaries without the assessment of an initial sales charge and at the same
time permit the Distributor to compensate securities dealers and other financial
intermediaries in connection with the sale of the Class B and Class C shares. In
this regard, the purpose and function of the ongoing distribution fees and the
CDSC are the same as those of the initial sales charge with respect to the Class
I and Class A shares of the Fund in that the ongoing distribution fees and
deferred sales charges provide for the financing of the distribution of the
Fund's Class B and Class C shares.
The Fund's Distribution Plans are subject to the provisions of Rule 12b-1
under the 1940 Act. In their consideration of each Distribution Plan, the
Trustees must consider all factors they deem relevant, including information as
to the benefits of each Distribution Plan to the Fund and the related class of
shareholders. Each Distribution Plan further provides that, so long as the
Distribution Plan remains in effect, the selection and nomination of
non-interested Trustees shall be committed to the discretion of the
non-interested Trustees then in office. In approving each Distribution Plan in
accordance with Rule 12b-1, the non-interested Trustees concluded that there is
a reasonable likelihood that such Distribution Plan will benefit the Fund and
its related class of shareholders. Each Distribution Plan can be terminated at
any time, without penalty, by the vote of a majority of the non-interested
Trustees or by the vote of the holders of a majority of the outstanding related
class of voting securities of the Fund. A Distribution Plan cannot be amended to
increase materially the amount to be spent by the Fund without the approval of
the related class of shareholders, and all material amendments are required to
be approved by the vote of Trustees, including a majority of the non-interested
Trustees who have no direct or indirect financial interest in such Distribution
Plan, cast in person at a meeting
35
<PAGE> 574
called for that purpose. Rule 12b-1 further requires that the Fund preserve
copies of its Distribution Plans and any report made pursuant to such plan for a
period of not less than six years from the date of such Distribution Plan or
such report, the first two years in an easily accessible place.
Among other things, each Distribution Plan provides that the Distributor
shall provide and the Trustees shall review quarterly reports of the
disbursement of the account maintenance and/or distribution fees paid to the
Distributor. Payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred and, accordingly, distribution-related revenues from each
Distribution Plan may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Trustees for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. This information will be presented annually as of December 31 of each
year on a "fully allocated accrual" basis and quarterly on a "direct expense and
revenue/cash" basis. On the fully allocated basis, revenues consist of the
account maintenance fees, the distribution fees, the CDSCs and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and marketing expenses, corporate
overhead and interest expense. On the direct expense and revenue/cash basis,
revenues consist of the account maintenance fees, the distribution fees and
CDSCs and the expenses consist of financial consultant compensation.
For the fiscal year ended June 30, 2000, the Fund made payments of $
to the Distributor under the Rule 12b-1 Plan for the Distributor Class shares
(which were redesignated as Class A shares).
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee and
the CDSC borne by the Class B and Class C shares, but not the account
maintenance fee. The maximum sales charge rule is applied separately to each
class. As applicable to the Fund, the maximum sales charge rule limits the
aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges), plus (2) interest on the unpaid balance for the respective
class, computed separately, at the prime rate plus 1% (the unpaid balance being
the maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC).
REDEMPTION OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Except for any CDSC that may be applicable, there will be no charge
for redemption if the redemption request is sent directly to the Transfer Agent.
Shareholders liquidating their holdings will receive upon redemption all
dividends reinvested through the date of redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists, as defined by the
Commission, as a result of which disposal of portfolio securities or
determination of the net asset value of the Fund is not reasonably practicable,
and for such other periods as the Commission may by order permit for the
protection of shareholders of the Fund.
The value of shares of the Fund at the time of redemption may be more or
less than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
36
<PAGE> 575
The Master Trust has entered into a joint committed line of credit with
other investment companies advised by the Investment Adviser and its affiliates
and a syndicate of banks that is intended to provide the Master Trust and the
Fund with a temporary source of cash to be used to meet redemption requests from
Fund shareholders in extraordinary or emergency circumstances.
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so by tendering the shares directly to the Fund's Transfer Agent, Financial Data
Services, Inc., P.O. Box 41621, Jacksonville, Florida 32232-1621. Redemption
requests delivered other than by mail should be delivered to Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting redemption. Redemption
requests should not be sent to the Fund. The redemption request in either event
requires the signature(s) of all persons in whose name(s) the shares are
registered, signed exactly as such name(s) appear(s) on the Transfer Agent's
register. The signature(s) on the redemption request may require a guarantee by
an "eligible guarantor institution" as defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications. In the
event a signature guarantee is required, notarized signatures are not
sufficient. In general, signature guarantees are waived on redemptions of less
than $50,000 as long as the following requirements are met: (i) all requests
require the signature(s) of all persons in whose name(s) shares are recorded on
the Transfer Agent's register; (ii) all checks must be mailed to the stencil
address of record on the Transfer Agent's register and (iii) the stencil address
must not have changed within 30 days. Certain rules may apply regarding certain
account types such as but not limited to UGMA/UTMA accounts, Joint Tenancies
with Rights of Survivorship, contra broker transactions and institutional
accounts. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority.
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the Transfer
Agent at 1-800-236-4479. The request must be made by the shareholder of record
and be for an amount less than $50,000. Before telephone requests will be
honored, signature approval from all shareholders of record on the account must
be obtained. The shares being redeemed must have been held for at least 15 days.
Telephone redemption requests will not be honored in the following situations:
the accountholder is deceased, the proceeds are to be sent to someone other than
the shareholder of record, funds are to be wired to the client's bank account, a
systematic withdrawal plan is in effect, the request is by an individual other
than the accountholder of record, the account is held by joint tenants who are
divorced, the address has changed within the last 30 days or share certificates
have been issued on the account.
Since this account feature involves a risk of loss from unauthorized or
fraudulent transactions, the Transfer Agent will take certain precautions to
protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address registered
on the account and the social security number registered on the account. The
Fund or the Transfer Agent may temporarily suspend telephone transactions at any
time.
For shareholders redeeming directly with the Transfer Agent, payments will
be mailed within seven days of receipt of a proper notice of redemption. At
various times the Fund may be requested to redeem shares for which it has not
yet received good payment (e.g., cash, Federal funds or certified check drawn on
a U.S. bank). The Fund may delay or cause to be delayed the mailing of a
redemption check until such time as good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank) has been collected for the purchase of
such Fund shares, which usually will not exceed 10 days. In the event that a
shareholder account held directly with the Transfer Agent contains a fractional
share balance, such fractional share balance will be automatically redeemed by
the Fund.
37
<PAGE> 576
REPURCHASE
The Fund also will repurchase its shares through a shareholder's listed
selected securities dealer or other financial intermediary. The Fund normally
will accept orders to repurchase shares by wire or telephone from dealers for
their customers at the net asset value next computed after the order is placed.
Shares will be priced at the net asset value calculated on the day the request
is received, provided that the request for repurchase is submitted to the
selected securities dealer or other financial intermediary prior to the close of
regular trading on the NYSE (generally, regular trading on the NYSE closes at
4:00 p.m., Eastern time) and such request is received by the Fund from such
selected securities dealer or other financial intermediary not later than 30
minutes after the close of regular trading on the NYSE on the same day.
Selected securities dealers and other financial intermediaries have the
responsibility of submitting such repurchase requests to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to obtain
that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any applicable
CDSC). Securities firms that do not have agreements with the Distributor,
however, may impose a transaction charge on the shareholder for transmitting the
notice of repurchase to the Fund. Certain selected securities dealers and other
financial intermediaries may charge a processing fee to confirm a repurchase of
shares. For example, the fee currently charged by Merrill Lynch is $5.35. Fees
charged by other selected securities dealers may be higher or lower. Repurchases
made through the Transfer Agent, on accounts held at the Transfer Agent, are not
subject to the processing fee. The Fund reserves the right to reject any order
for repurchase, which right of rejection might adversely affect shareholders
seeking redemption through the repurchase procedure. A shareholder whose order
for repurchase is rejected by the Fund, however, may redeem Fund shares as set
forth above.
REINSTATEMENT PRIVILEGE -- CLASS I AND CLASS A SHARES
Shareholders of the Fund who have redeemed their Class I and Class A shares
have a privilege to reinstate their accounts by purchasing Class I or Class A
shares of the Fund, as the case may be, at the net asset value without a sales
charge up to the dollar amount redeemed. The reinstatement privilege may be
exercised by sending a notice of exercise along with a check for the amount to
be reinstated to the Transfer Agent within 30 days after the date the request
for redemption was accepted by the Transfer Agent or the Distributor.
Alternatively, the reinstatement privilege may be exercised through the
investor's financial consultant within 30 days after the date the request for
redemption was accepted by the Transfer Agent or the Distributor. The
reinstatement will be made at the net asset value per share next determined
after the notice of reinstatement is received and cannot exceed the amount of
the redemption proceeds.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "Account Choices -- How Shares are Priced" in the
Prospectus.
The net asset value of the shares of all classes of the Fund is determined
once daily Monday through Friday as of the close of regular trading on the NYSE
on each day the NYSE is open for trading based on prices at the time of closing.
Regular trading on the NYSE generally closes at 4:00 p.m., Eastern time. Any
assets or liabilities initially expressed in terms of non-U.S. dollar currencies
are translated into U.S. dollars at the prevailing market rates as quoted by one
or more banks or dealers on the day of valuation. The NYSE is not open for
trading on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
Net asset value of the Fund is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Administrator and Distributor, are accrued daily.
38
<PAGE> 577
The principal assets of the Fund will normally be its interest in the
underlying Portfolio, which will be valued at its net asset value. Net asset
value of the Portfolio is computed by dividing the value of the securities held
by the Portfolio plus any cash or other assets (including interest and dividends
accrued but not yet received) minus all liabilities (including accrued expenses)
by the total number of shares outstanding at such time. Expenses, including the
investment advisory fees, are accrued daily.
The per share net asset value of Class A, Class B and Class C shares
generally will be lower than the per share net asset value of Class I shares,
reflecting the daily expense accruals of the account maintenance, distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares, and the daily expense accruals of the account maintenance fees
applicable with respect to Class A shares. Moreover, the per share net asset
value of the Class B and Class C shares of the Fund generally will be lower than
the per share net asset value of Class A shares of the Fund, reflecting the
daily expense accruals of the distribution fees and higher transfer agency fees
applicable with respect to Class B and Class C shares of the Fund. It is
expected, however, that the per share net asset value of the four classes of the
Fund will tend to converge (although not necessarily meet) immediately after the
payment of dividends which will differ by approximately the amount of the
expense accrual differentials between the classes.
Portfolio securities, including ADRs, EDRs or GDRs, that are traded on
stock exchanges are valued at the last sale price (regular way) on the exchange
on which such securities are traded, as of the close of regular trading on the
day the securities are being valued or, lacking any sales, at the last available
bid price for long positions, and at the last available ask price for short
positions. In cases where securities are traded on more than one exchange, the
securities are valued on the exchange designated by or under the authority of
the Board of Trustees as the primary market. Long positions in securities traded
in the OTC market are valued at the last available bid price in the OTC market
prior to the time of valuation. Short positions in securities traded in the OTC
market are valued at the last available ask price in the OTC market prior to the
time of valuation. Portfolio securities that are traded both in the OTC market
and on a stock exchange are valued according to the broadest and most
representative market. When the Portfolio writes an option, the amount of the
premium received is recorded on the books of the Master Trust as an asset and an
equivalent liability. The amount of the liability is subsequently valued to
reflect the current market value of the option written, based upon the last sale
price in the case of exchange-traded options or, in the case of options traded
in the OTC market, the last ask price. Options purchased by the Portfolio are
valued at their last sale price in the case of exchange-traded options or, in
the case of options traded in the OTC market, the last bid price. Other
investments, including financial futures contracts and related options, are
stated at market value. Securities and assets for which market quotations are
not readily available are valued at fair value as determined in good faith by or
under the direction of the Board of Trustees of the Master Trust. Such
valuations and procedures will be reviewed periodically by the Board of Trustees
of the Master Trust.
Generally, trading in non-U.S. securities, as well as U.S. Government
securities and money market instruments, is substantially completed each day at
various times prior to the close of regular trading on the NYSE. The values of
such securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of regular trading on the NYSE. Occasionally,
events affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of regular trading
on the NYSE that may not be reflected in the computation of the Fund's net asset
value.
Each investor in the Portfolio may add to or reduce its investment in the
Portfolio on each day the NYSE is open for trading. The value of each investor's
(including the Fund's) interest in the Portfolio will be determined as of the
close of regular trading on the NYSE by multiplying the net asset value of the
Portfolio by the percentage, effective for that day, that represents that
investor's share of the aggregate interests in the Portfolio. The close of
regular trading on the NYSE is generally 4:00 p.m., Eastern time. Any additions
or withdrawals to be effected on that day will then be effected. The investor's
percentage of the aggregate beneficial interests in the Portfolio will then be
recomputed as the percentage equal to the fraction (i) the numerator of which is
the value of such investor's investment in the Portfolio as of the time of
determination on such day plus or minus, as the case may be, the amount of any
additions to or withdrawals from the investor's investment in the Portfolio
effected on such day, and (ii) the denominator of which is the aggregate
39
<PAGE> 578
net asset value of the Portfolio as of such time on such day plus or minus, as
the case may be, the amount of the net additions to or withdrawals from the
aggregate investments in the Portfolio by all investors in the Portfolio. The
percentage so determined will then be applied to determine the value of the
investor's interest in the Portfolio after the close of regular trading on the
NYSE on the next determination of net asset value of the Portfolio.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class I, Class
A, Class B and Class C shares of the Fund based on the net asset value of the
Fund's shares on June 30, 2000 is as follows:
<TABLE>
<CAPTION>
CLASS I CLASS A CLASS B CLASS C
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net Assets................................................ $ $ $ $
------- ------- ------- -------
Number of Shares Outstanding..............................
------- ------- ------- -------
Net Asset Value Per Share (net assets divided by number of
shares outstanding)..................................... $ $ $ $
------- ------- ------- -------
Sales Charge (for Class I and Class A Shares; % of
Offering Price; ( % of net amount invested))*....... ** **
------- ------- ------- -------
Offering Price............................................ $ $ $ $
------- ------- ------- -------
</TABLE>
---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
** Class B and Class C shares are not subject to an initial sales charge but may
be subject to a CDSC on redemption. See "Purchase of Shares -- Deferred Sales
Charge Alternatives -- Class B and Class C Shares" herein. No Class B and
Class C shares were outstanding on June 30, 2000.
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Because the Fund will invest exclusively in shares of the Portfolio, it is
expected that all transactions in portfolio securities will be entered into by
the Master Trust. Subject to policies established by the Board of Trustees of
the Master Trust, the Investment Adviser is primarily responsible for the
execution of the Master Trust's portfolio transactions and the allocation of
brokerage. The Master Trust has no obligation to deal with any broker or group
of brokers in the execution of transactions in portfolio securities and does not
use any particular broker or dealer. In executing transactions with brokers and
dealers, the Investment Adviser seeks to obtain the best net results for the
Portfolio, taking into account such factors as price (including the applicable
brokerage commission or dealer spread), size of order, difficulty of execution
and operational facilities of the firm and the firm's risk in positioning a
block of securities. While the Investment Adviser generally seeks reasonably
competitive commission rates, the Portfolio does not necessarily pay the lowest
spread or commission available. In addition, consistent with the Conduct Rules
of the NASD and policies established by the Board of Trustees of the Master
Trust, the Investment Adviser may consider sales of Fund shares as a factor in
the selection of brokers or dealers to execute portfolio transactions for the
Portfolio; however, whether or not a particular broker or dealer sells shares of
the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Portfolio.
Subject to obtaining the best net results, brokers who provide supplemental
investment research to the Investment Adviser may receive orders for
transactions by the Portfolio. Such supplemental research services ordinarily
consist of assessments and analyses of the business or prospects of a company,
industry or economic sector. Information so received will be in addition to and
not in lieu of the services required to be performed by the Investment Adviser
under the Investment Advisory Agreement and the expenses of the Investment
Adviser will not necessarily be reduced as a result of the receipt of such
supplemental information. If in the judgment of the Investment Adviser the
Portfolio will benefit from supplemental research services, the Investment
Adviser is authorized to pay brokerage commissions to a broker furnishing such
services that are in excess of commissions that another broker may have charged
for effecting the same transactions. Certain
40
<PAGE> 579
supplemental research services may primarily benefit one or more other
investment companies or other accounts for which the Investment Adviser
exercises investment discretion. Conversely, the Portfolio may be the primary
beneficiary of the supplemental research services received as a result of
portfolio transactions effected for such other accounts or investment companies.
The Master Trust anticipates that its brokerage transactions involving
securities of issuers domiciled in countries other than the United States
generally will be conducted primarily on the principal stock exchanges of such
countries. Brokerage commissions and other transaction costs on foreign stock
exchange transactions generally are higher than in the United States, although
the Master Trust will endeavor to achieve the best net results in effecting its
portfolio transactions. There generally is less governmental supervision and
regulation of foreign stock exchanges and brokers than in the United States.
Foreign equity securities may be held by the Master Trust in the form of
ADRs, EDRs, GDRs or other securities convertible into foreign equity securities.
ADRs, EDRs and GDRs may be listed on stock exchanges, or traded in
over-the-counter markets in the United States or Europe, as the case may be.
ADRs, like other securities traded in the United States, will be subject to
negotiated commission rates. The Master Trust's ability and decisions to
purchase or sell portfolio securities of foreign issuers may be affected by laws
or regulations relating to the convertibility and repatriation of assets.
Because the shares of the Fund are redeemable on a daily basis in U.S. dollars,
the Master Trust intends to manage the Portfolio so as to give reasonable
assurance that it will be able to obtain U.S. dollars to the extent necessary to
meet anticipated redemptions. Under present conditions, it is not believed that
these considerations will have significant effect on the Master Trust's
portfolio strategies.
The Master Trust may invest in certain securities traded in the OTC market
and intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Master
Trust and persons who are affiliated with such affiliated persons are prohibited
from dealing with the Portfolio as principal in the purchase and sale of
securities unless a permissive order allowing such transactions is obtained from
the Commission. Since transactions in the OTC market usually involve
transactions with the dealers acting as principal for their own accounts, the
Portfolio will not deal with affiliated persons, including Merrill Lynch and its
affiliates, in connection with such transactions. However, an affiliated person
of the Portfolio may serve as its broker in OTC transactions conducted on an
agency basis provided that, among other things, the fee or commission received
by such affiliated broker is reasonable and fair compared to the fee or
commission received by non-affiliated brokers in connection with comparable
transactions. In addition, the Portfolio may not purchase securities during the
existence of any underwriting syndicate for such securities of which Merrill
Lynch or an affiliate is a member or in a private placement in which Merrill
Lynch or an affiliate serves as placement agent except pursuant to procedures
approved by the Board of Trustees of the Master Trust that either comply with
rules adopted by the Commission or with interpretations of the Commission staff.
See "Investment Objective and Policies -- Investment Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch or its affiliates acting as a
broker for the Master Trust in any of its portfolio transactions executed on any
such securities exchange of which it is a member, appropriate consents have been
obtained from the Master Trust and annual statements as to aggregate
compensation will be provided to the Master Trust. Securities may be held by, or
be appropriate investments for, the Master Trust as well as other funds or
investment advisory clients of the Investment Adviser or its affiliates.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or its affiliates
when one or more clients of the Investment Adviser or its affiliates are selling
the same security. If purchases or sales of securities arise for consideration
at or about the
41
<PAGE> 580
same time that would involve the Portfolio or other clients or funds for which
the Investment Adviser or an affiliate acts as investment adviser, transactions
in such securities will be made, insofar as feasible, for the respective funds
and clients in a manner deemed equitable to all. To the extent that transactions
on behalf of more than one client of the Investment Adviser or its affiliates
during the same period may increase the demand for securities being purchased or
the supply of securities being sold, there may be an adverse effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below that are
designed to facilitate investment in its shares. Full details as to each such
service and copies of the various plans or how to change options with respect
thereto, can be obtained from the Fund by calling the telephone number on the
cover page hereof, or from the Distributor or your selected securities dealer or
other financial intermediary. Certain of these services are available only to
U.S. investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of dividends. The statements
also will show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
dividends. A shareholder with an account held at the Transfer Agent may make
additions to his or her Investment Account at any time by mailing a check
directly to the Transfer Agent. The Fund does not issue share certificates.
Shareholders considering transferring their Class I or Class A shares from
a selected securities dealer to another brokerage firm or financial institution
should be aware that, if the firm to which the Class I or Class A shares are to
be transferred will not take delivery of shares of the Fund, a shareholder
either must redeem the Class I or Class A shares so that the cash proceeds can
be transferred to the account at the new firm or such shareholder must continue
to maintain an Investment Account at the Transfer Agent for those Class I or
Class A shares.
Shareholders interested in transferring their Class B or Class C shares
from a selected securities dealer or other financial intermediary and who do not
wish to have an Investment Account maintained for such shares at the Transfer
Agent may request their new brokerage firm to maintain such shares in an account
registered in the name of the brokerage firm for the benefit of the shareholder
at the Transfer Agent.
Certain shareholder services may not be available for the transferred
shares. After the transfer, the shareholder may purchase additional shares of
funds owned before the transfer, and all future trading of these assets must be
coordinated by the new firm.
Shareholders considering transferring a tax-deferred retirement account,
such as an individual retirement account, from a selected securities dealer or
other financial intermediary to another brokerage firm or financial institution
should be aware that, if the firm to which the retirement account is to be
transferred will not take delivery of shares of the Fund, a shareholder must
either redeem the shares (paying any applicable CDSC) so that the cash proceeds
can be transferred to the account at the new firm, or such shareholder must
continue to maintain a retirement account at a selected securities dealer or
other financial intermediary for those shares.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other Mercury mutual funds and Summit, a series of Financial
Institutions Series Trust, which is a Merrill Lynch-sponsored money market fund
specifically designated as available for exchange by holders of Class I, Class
A, Class B and Class C shares. Shares with a net asset value of at least $100
are required to qualify for the exchange privilege and any shares used in an
exchange must have been held by the shareholder for at least 15 days.
42
<PAGE> 581
Before effecting an exchange, shareholders should obtain a currently effective
prospectus of the fund into which the exchange is to be made. Exercise of the
exchange privilege is treated as a sale of the exchanged shares and a purchase
of the acquired shares for Federal income tax purposes.
Exchanges of Class I and Class A Shares. Under the Fund's pricing system,
Class I shareholders may exchange Class I shares of the Fund for Class I shares
of a second Mercury mutual fund. If the Class I shareholder wants to exchange
Class I shares for shares of a second Mercury mutual fund, but does not hold
Class I shares of the second fund in his or her account at the time of exchange
and is not otherwise eligible to acquire Class I shares of the second fund, the
shareholder will receive Class A shares of the second fund as a result of the
exchange. Class A shares also may be exchanged for Class I shares of a second
Mercury mutual fund at any time as long as, at the time of the exchange, the
shareholder is eligible to acquire Class I shares of any Mercury mutual fund.
Exchanges of Class I or Class A shares outstanding ("outstanding Class I or
Class A shares") for Class I or Class A shares of another Mercury mutual fund,
or for Class A shares of Summit ("new Class I or Class A shares") are transacted
on the basis of relative net asset value per Class I or Class A share,
respectively, plus an amount equal to the difference, if any, between the sales
charge previously paid on the outstanding Class I or Class A shares and the
sales charge payable at the time of the exchange on the new Class I or Class A
shares. With respect to outstanding Class I or Class A shares as to which
previous exchanges have taken place, the "sales charge previously paid" shall
include the aggregate of the sales charges paid with respect to such Class I or
Class A shares in the initial purchase and any subsequent exchange. Class I or
Class A shares issued pursuant to dividend reinvestment are sold on a no-load
basis. For purposes of the exchange privilege, Class I and Class A shares
acquired through dividend reinvestment shall be deemed to have been sold with a
sales charge equal to the sales charge previously paid on the Class I or Class A
shares on which the dividend was paid. Based on this formula, Class I and Class
A shares of the Fund generally may be exchanged into the Class I and Class A
shares, respectively, of the other funds with a reduced or without a sales
charge.
Exchanges of Class B and Class C Shares. In addition, the funds with Class
B or Class C shares outstanding ("outstanding Class B or Class C shares") offer
to exchange their Class B or Class C shares for Class B or Class C shares,
respectively, of another Mercury mutual fund or for Class B shares of Summit
("new Class B or Class C shares") on the basis of relative net asset value per
Class B or Class C share, without the payment of any CDSC that might otherwise
be due on redemption of the outstanding shares. Class B shareholders of the Fund
exercising the exchange privilege will continue to be subject to the Fund's CDSC
schedule if such schedule is higher than the CDSC schedule relating to the new
Class B shares acquired through use of the exchange privilege. In addition,
Class B shares of the Fund acquired through use of the exchange privilege will
be subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the fund from which the exchange was
made. For purposes of computing the CDSC that may be payable on a disposition of
the new Class B or Class C shares, the holding period for the outstanding Class
B shares is "tacked" to the holding period of the new Class B or Class C shares.
For example, an investor may exchange Class B shares of the Fund for those of
another Mercury fund ("new Mercury Fund") after having held the Fund's Class B
shares for two-and-a-half years. The % CDSC that generally would apply to a
redemption would not apply to the exchange. Four years later the investor may
decide to redeem the Class B shares of new Mercury Fund and receive cash. There
will be no CDSC due on this redemption since by "tacking" the
two-and-a-half-year holding period of the Fund's Class B shares to the four-year
holding period for the new Mercury Fund Class B shares, the investor will be
deemed to have held the new Mercury Fund Class B shares for more than six years.
Exchanges for Shares of a Money Market Fund. Class I and Class A shares are
exchangeable for Class A shares of Summit and Class B and Class C shares are
exchangeable for Class B shares of Summit. Class A shares of Summit have an
exchange privilege back into Class I or Class A shares of affiliate-advised
Funds; Class B shares of Summit have an exchange privilege back into Class B or
Class C shares of affiliate-advised Funds and, in the event of such an exchange,
the period of time that Class B shares of Summit are held will count toward
satisfaction of the holding period requirement for purposes of reducing any CDSC
and toward satisfaction of any Conversion Period with respect to Class B shares.
Class B shares of Summit will be subject to a distribution fee at an annual rate
of % of average daily net assets of such Class B shares. This
43
<PAGE> 582
exchange privilege does not apply with respect to certain fee-based programs for
which alternative exchange arrangements may exist. Please see your financial
consultant for further information.
Prior to October 12, 1998, exchanges from other affiliate-advised Funds
into a money market fund were directed to certain affiliate-advised money market
funds other than Summit. Shareholders who exchanged affiliate-advised Fund
shares for such other money market funds and subsequently wish to exchange those
money market fund shares for shares of the Fund will be subject to the CDSC
schedule applicable to such Fund shares, if any. The holding period for those
money market fund shares will not count toward satisfaction of the holding
period requirement for reduction of the CDSC imposed on such shares, if any,
and, with respect to Class B shares, toward satisfaction of the Conversion
Period. However, the holding period for Class B or Class C shares of the Fund
received in exchange for such money market fund shares will be aggregated with
the holding period for the fund shares originally exchanged for such money
market fund shares for purposes of reducing the CDSC or satisfying the
Conversion Period.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her financial consultant, who will advise the
relevant Fund of the exchange. Shareholders of the Fund and shareholders of the
other funds described above with shares for which certificates have not been
issued may exercise the exchange privilege by wire through their selected
securities dealers or other financial intermediaries. The Fund reserves the
right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated in accordance with the rules of the
Commission. The Fund reserves the right to limit the number of times an investor
may exercise the exchange privilege. Certain funds may suspend the continuous
offering of their shares to the general public at any time and may thereafter
resume such offering from time to time. The exchange privilege is available only
to U.S. shareholders in states where the exchange legally may be made. It is
contemplated that the exchange privilege may be applicable to other new mutual
funds whose shares may be distributed by the Distributor.
FEE-BASED PROGRAMS
Certain fee-based programs, including pricing alternatives for securities
transactions (each referred to in this paragraph as a "Program"), may permit the
purchase of Class I shares at net asset value. Under specified circumstances,
participants in certain Programs may deposit other classes of shares, which will
be exchanged for Class I shares. Initial or deferred sales charges otherwise due
in connection with such exchanges may be waived or modified, as may the
Conversion Period applicable to the deposited shares. Termination of
participation in certain Programs may result in the redemption of shares held
therein or the automatic exchange thereof to another class at net asset value.
In addition, upon termination of participation in a Program, shares that have
been held for less than specified periods within such Program may be subject to
a fee based on the current value of such shares. These Programs also generally
prohibit such shares from being transferred to another account, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and distribution and account maintenance fees)
in order for the investment not to be subject to Program fees. Additional
information regarding certain specific Programs offered through particular
selected securities dealers or other financial intermediaries (including charges
and limitations on transferability applicable to shares that may be held in such
Programs) is available in each such Program's client agreement and from the
Transfer Agent at 1-800-236-4479.
RETIREMENT PLANS
The minimum initial purchase to establish a retirement plan is $100.
Dividends received in retirement plans are exempt from Federal taxation until
distributed from the plans. Different tax rules apply to Roth IRA plans and
educational savings plans. Investors considering participation in any retirement
or education savings plan should review specific tax laws relating thereto and
should consult their attorneys or tax advisers with respect to the establishment
and maintenance of any such plan.
44
<PAGE> 583
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class I shares (if he or she is an eligible Class I investor) or
Class A, Class B or Class C shares at the applicable public offering price.
These purchases may be made either through the shareholder's securities dealer
or by mail directly to the Transfer Agent, acting as agent for such securities
dealer. You may also add to your account by automatically investing a specific
amount in the Fund on a periodic basis through your selected securities dealer
or other financial intermediary. The current minimum for such automatic
additional investments is $100. This minimum may be waived or revised under
certain circumstances.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Shareholders may, at any time, by written notification to their selected
securities dealer or other financial intermediary if their account is maintained
with a selected securities dealer or other financial intermediary, or by written
notification or by telephone (1-800-236-4479) to the Transfer Agent, if their
account is maintained with the Transfer Agent, elect to have subsequent
dividends of ordinary income and/or capital gains paid with respect to shares of
the Fund in cash, rather than reinvested in shares of the Fund (provided that,
in the event that a payment on an account maintained at the Transfer Agent would
amount to $10.00 or less, a shareholder will not receive such payment in cash
and such payment will automatically be reinvested in additional shares).
Commencing ten days after the receipt by the Transfer Agent of such notice,
those instructions will be effected. The Fund is not responsible for any failure
of delivery to the shareholder's address of record and no interest will accrue
on amounts represented by uncashed dividend checks. Cash payments can also be
directly deposited to the shareholder's bank account.
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals are available for shareholders with
shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed from
those on deposit in the shareholder's account to provide the withdrawal payment
specified by the shareholder. The shareholder may specify the dollar amount and
class of shares to be redeemed. Redemptions will be made at net asset value as
of the close of regular trading on the NYSE (generally, the NYSE closes at 4:00
p.m., Eastern time) on the 24th day of each month or the 24th day of the last
month of each quarter, whichever is applicable. If the NYSE is not open for
business on such date, the shares will be redeemed at the net asset value
determined after the close of regular trading on the NYSE on the following
business day. The check for the withdrawal payment will be mailed, or the direct
deposit for withdrawal payment will be made, on the next business day following
redemption. When a shareholder is making systematic withdrawals, dividends on
all shares in the Investment Account are reinvested automatically in Fund
shares. A shareholder's systematic withdrawal plan may be terminated at any
time, without a charge or penalty, by the shareholder, the Fund, the Transfer
Agent or the Distributor.
With respect to redemptions of Class B and Class C shares pursuant to a
systematic withdrawal plan, the maximum number of Class B or Class C shares that
can be redeemed from an account annually shall not exceed 10% of the value of
shares of such class in that account at the time the election to join the
systematic withdrawal plan was made. Any CDSC that otherwise might be due on
such redemption of Class B or Class C shares will be waived. Shares redeemed
pursuant to a systematic withdrawal plan will be redeemed in the same order as
Class B or Class C shares are otherwise redeemed. See "Purchase of
Shares -- Deferred Sales Charge Alternatives -- Class B and C Shares." Where the
systematic withdrawal plan is applied to Class B shares, upon conversion of the
last Class B shares in an account to Class A shares, a shareholder must make a
new election to join the systematic withdrawal program with respect to the Class
A shares. If an investor
45
<PAGE> 584
wishes to change the amount being withdrawn in a systematic withdrawal plan the
investor should contact his or her financial consultant.
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax liabilities.
The Fund will not knowingly accept purchase orders for shares of the Fund from
investors who maintain a systematic withdrawal plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
DIVIDENDS AND TAX STATUS
The Fund has qualified as a regulated investment company. Qualification as
a regulated investment company ("RIC") requires, among other things, that (1) at
least 90% of the Fund's annual gross income, without offset for losses from the
sale or other disposition of securities, be derived from payments with respect
to securities loans, interest, dividends and gains from the sale or other
disposition of stock, securities, or foreign currencies or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities, or currencies; and (2) the Fund diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of the Fund's assets is represented by cash, U.S. government securities,
securities of other regulated investment companies, and other securities limited
in respect of any one issuer to an amount not greater than 5% of the Fund's
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. government securities or the securities of other
regulated investment companies). In addition, in order not to be subject to
federal taxation, the Fund must distribute to its shareholders at least 90% of
its investment company taxable income earned in each year.
The Fund is required to pay an excise tax to the extent it does not
distribute to its shareholders during any calendar year at least 98% of its
ordinary income for that calendar year, 98% of the excess of its capital gains
over its capital losses for the one-year period ending October 31 in such
calendar year, and all undistributed ordinary income and capital gains for the
preceding respective one-year period. The Fund intends to meet these
distribution requirements to avoid excise tax liability. The Fund also intends
to continue distributing to shareholders all of the excess of net long-term
capital gain over net short-term capital loss on sales of securities. If the net
asset value of shares of the Fund should, by reason of a distribution of
realized capital gains, be reduced below a shareholder's cost, such distribution
would to that extent be a return of capital to that shareholder even though
taxable to the shareholder, and a sale of shares by a shareholder at net asset
value at that time would establish a capital loss for federal tax purposes.
In determining the extent to which the Fund's dividends may be eligible for
the 70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisors regarding other requirements applicable to the dividends received
deduction.
Special rules apply to the treatment of certain forward foreign currency
exchange contracts (Section 1256 contracts). At the end of each year, such
investments held by the Fund must be "marked to market" for federal income tax
purposes; that is, treated as having been sold at market value. Except to the
extent that such gains or losses are treated as "Section 988" gains or losses,
as described below, sixty percent of any gain or loss recognized on these
"deemed sales" and on actual dispositions may be treated as long-term capital
gain or loss, and the remainder will be treated as short-term capital gain or
loss.
Under the Internal Revenue Code, gains or losses attributable to
fluctuations in exchange rates which occur between the time the Fund accrues
interest or other receivables or accrues expenses or other liabilities
46
<PAGE> 585
denominated in a foreign currency and the time the Fund actually collects such
receivables or pays such liabilities are treated as ordinary income or loss.
Similarly, gains or losses on forward foreign currency exchange contracts or
dispositions of debt securities denominated in a foreign currency attributable
to fluctuations in the value of the foreign currency between the date of
acquisition of the security and the date of disposition are also treated as
ordinary gain or loss. These gains, referred to as "Section 988" gains or
losses, increase or decrease the amount of the Fund's investment company taxable
income available to be distributed to its shareholders as ordinary income,
rather than increasing or decreasing the Fund's net capital gain. If Section 988
losses exceed other investment company taxable income during a taxable year, the
Fund would not be able to make any ordinary dividend distributions, and any
ordinary dividend distributions made before the losses were realized would be
recharacterized as a return of capital to shareholders, rather than as an
ordinary dividend, reducing the basis of each shareholder's shares.
Any loss realized on a sale, redemption or exchange of shares of the Fund
by a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by the Fund constitute a
replacement of shares.
The per share dividends on Class B and Class C shares will be lower than
the per share dividends on Class I and Class A shares as a result of the account
maintenance, distribution and higher transfer agency fees applicable with
respect to the Class B and Class C shares; similarly, the per share dividends on
Class A shares will be lower than the per share dividends on Class I shares as a
result of the account maintenance fees applicable with respect to the Class A
shares. See "Pricing of Shares -- Determination of Net Asset Value."
Because the Portfolio will be classified as a partnership for tax purposes,
the Fund will be entitled to look to the underlying assets of the Portfolio in
which it has invested for purposes of satisfying various requirements of the
Code applicable to regulated investment companies. If any of the facts upon
which this classification is premised change in any material respect then the
Board of Trustees will determine, in its discretion, the appropriate course of
action for the Fund. One possible course of action would be to withdraw the
Fund's investment from the Portfolio and to retain an investment adviser to
manage the Fund's assets in accordance with the investment policies applicable
to the Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined separately for Class I, Class A, Class
B and Class C shares in accordance with a formula specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class I and Class A
shares and the CDSC that would be applicable to a complete redemption of the
investment at the end of the specified period as in the case of Class B and
Class C Shares. Dividends paid by the Fund with respect to all shares, to the
extent any dividends are paid, will be calculated in the same manner at the same
time on the same day and will be in the same amount, except that account
maintenance and the distribution charges and any incremental transfer agency
costs relating to each class of shares will be borne exclusively by that class.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for
47
<PAGE> 586
various periods other than those noted below. Such data will be computed as
described above, except that (1) as required by the periods of the quotations,
actual annual, annualized or aggregate data, rather than average annual data,
may be quoted and (2) the maximum applicable sales charges will not be included
with respect to annual or annualized rates of return calculations. Aside from
the impact on the performance data calculations of including or excluding the
maximum applicable sales charges, actual annual or annualized total return data
generally will be lower than average annual total return data since the average
rates of return reflect compounding of return; aggregate total return data
generally will be higher than average annual total return data since the
aggregate rates of return reflect compounding over a longer period of time. The
Fund's total return may be expressed either as a percentage or as a dollar
amount in order to illustrate such total return on a hypothetical $1,000
investment in the Fund at the beginning of each specified period.
Average annual total returns for the periods ended June 30, 2000 are as
follows:
<TABLE>
<CAPTION>
ONE FIVE SINCE
YEAR YEARS INCEPTION
----- ----- ---------
<S> <C> <C> <C> <C>
Investor Class........................ (Since 5/18/93)
Distributor Class..................... N/A (Since 9/24/99)
</TABLE>
In order to reflect the reduced sales charges in the case of Class I or
Class A shares or the waiver of the CDSC in the case of Class B or Class C
shares applicable to certain investors, as described under "Purchase of Shares"
and "Redemption of Shares," respectively, the total return data quoted by the
Fund in advertisements directed to such investors may take into account the
reduced, and not the maximum, sales charge or may take into account the CDSC and
therefore may reflect greater total return since, due to the reduced sales
charges or the waiver of sales charges, a lower amount of expenses is deducted.
Yield. Annualized yield quotations used in the Fund's advertising and
promotional materials are calculated by dividing the Fund's interest income for
a specified thirty-day period, net of expenses, by the average number of shares
outstanding during the period, and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the net asset value per share
at the end of the period. Yield quotations are calculated according to the
following formula:
YIELD = 2 [((a - b) + 1)(6) - 1]
-----
cd
where "a" equals dividends and interest earned during the period; "b" equals
expenses accrued for the period, net of reimbursements; "c" equals the average
daily number of shares outstanding during the period that are entitled to
receive dividends; and "d" equals the maximum offering price per share on the
last day of the period.
Except as noted below, in determining net investment income earned during
the period ("a" in the above formula), the Fund calculates interest earned on
each debt obligation held by it during the period by (1) computing the
obligation's yield to maturity, based on the market value of the obligation
(including actual accrued interest) on the last business day of the period or,
if the obligation was purchased during the period, the purchase price plus
accrued interest; (2) dividing the yield to maturity by 360 and multiplying the
resulting quotient by the market value of the obligation (including actual
accrued interest). Once interest earned is calculated in this fashion for each
debt obligation held by the Fund, net investment income is then determined by
totaling all such interest earned.
For purposes of these calculations, the maturity of an obligation with one
or more call provisions is assumed to be the next date on which the obligation
reasonably can be expected to be called or, if none, the maturity date.
48
<PAGE> 587
The 30-day yields for the Fund for the period ended June 30, 2000 were
% (Investor Class) and % (Distributor Class).
In advertising and sales literature, the Fund may compare its performance
to that of various broad market indexes, including without limitation the Lehman
Brothers Aggregate Bond Index, Standard & Poor's 500 Composite Stock Price Index
and other published indexes. When comparing its performance to a market index,
the Fund may refer to various statistical measures derived from the historic
performance of the Fund and the index, such as standard deviation and beta. In
addition, the Fund may refer in advertising or sales literature to (i) mutual
fund performance ratings, rankings and comparisons (including risk-adjusted
ratings, rankings and comparisons), (ii) other comparisons of mutual fund data
including assets, expenses, fees and other data, and (iii) other discussions
reported in or assigned by Barron's, Business Week, CDA Investment Technology,
Inc., Financial World, Forbes Magazine, Fortune Magazine, Lipper Inc., Money
Magazine, U.S. News & World Report, The Wall Street Journal and other industry
publications. The Fund may also make reference to awards that may be given to
the Investment Adviser. As with other performance data, performance comparisons
should not be considered indicative of the Fund's relative performance for any
future period.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Fund is a "feeder" fund that invests in the Portfolio. Investors in the
Fund will acquire an indirect interest in the Portfolio. The Portfolio accepts
investments from other feeder funds, and all of the feeders of the Portfolio
bear the Portfolio's expenses in proportion to their assets. This structure may
enable the Fund to reduce costs through economies of scale. A larger investment
portfolio also may reduce certain transaction costs to the extent that
contributions to and redemptions from the Master Trust from different feeders
may offset each other and produce a lower net cash flow. However, each feeder
can set its own transaction minimums, fund-specific expenses, and other
conditions. This means that one feeder could offer access to the same Portfolio
on more attractive terms, or could experience better performance, than another
feeder.
The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest and to divide or combine
the shares into a greater or lesser number of shares without thereby changing
the proportionate beneficial interest in the Fund. Each share represents an
interest in the Fund proportionately equal to the interest of each other share,
except that the Class B and C shares are subject to distribution fees payable
under the Plans of Distribution. Upon the Trust's liquidation, all shareholders
would share pro rata in the net assets of the Fund available for distribution to
shareholders. If they deem it advisable and in the best interest of
shareholders, the Board of Trustees may create additional classes of shares. The
Board of Trustees has created ten series of shares, and may create additional
series in the future, which have separate assets and liabilities.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a
Fund's shares may advise the Trustees in writing that they wish to communicate
with other shareholders for the purpose of requesting a meeting to remove a
Trustee. The Trustees will then, if requested by the applicants, mail at the
applicants' expense the applicants' communication to all other shareholders.
The Trust or any Fund may be terminated if approved by the vote of a
majority of the Trustees or by the approval of the holders of a majority of the
Trust's outstanding shares, as defined in the 1940 Act. If not so terminated,
the Trust will continue indefinitely.
49
<PAGE> 588
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Trust or its Trustees. The Declaration of Trust provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for its obligations. While Massachusetts
law permits a shareholder of a trust such as this to be held personally liable
as a partner under certain circumstances, the risk of a shareholder incurring
financial loss on account of shareholder liability is unlikely and is limited to
the relatively remote circumstances in which the Trust would be unable to meet
its obligations.
Common expenses incurred by the Trust are allocated among the portfolios
based upon: (1) relative net assets; (2) as incurred on a specific
identification basis; or (3) evenly among the portfolios, depending on the
nature of the expenditure.
Except for (1) changes which do not adversely affect the rights of Trust
shareholders; (2) a change in the name of the Trust, or a series or class
thereof; (3) authorization of a new series or class; (4) changes to supply any
omission or correct any ambiguous or defective provision; or (5) changes
required by any federal, state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust without the affirmative vote of the holders of at least 67%
of the Trust's outstanding shares at a meeting at which more than 50% of its
outstanding shares are present in person or represented by proxy. The holders of
shares have no preemptive or conversion rights. Shares when issued are fully
paid and non-assessable, except as set forth above.
Whenever the Master Trust holds a vote of its feeder funds, the Fund will
pass the vote through to its own shareholders. Smaller feeder funds may be
harmed by the actions of larger feeder funds. For example, a larger feeder fund
could have more voting power than the Fund over the operations of the Portfolio.
The Fund may withdraw from the Portfolio at any time and may invest all of its
assets in another pooled investment vehicle or retain an investment adviser to
manage the Fund's assets directly.
The Master Trust is organized as a Delaware business trust. Whenever the
Fund is requested to vote on any matter relating to the Master Trust, the Trust
will hold a meeting of the Fund's shareholders and will cast its vote as
instructed by the Fund's shareholders.
ISSUANCE OF FUND SHARES FOR SECURITIES
Investors may purchase Fund shares for consideration consisting of
securities rather than cash when, in the judgment of the Investment Adviser, the
securities: (a) meet the investment objective and policies of the Fund, (b) are
liquid and not subject to restrictions on resale, and (c) have a value that is
readily ascertainable via listing on or trading in a recognized United States or
international exchange or market.
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment wholly
in cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of the Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund
50
<PAGE> 589
during any 90 day period for any one shareholder. Should redemptions by any
shareholder exceed such limitation the Fund will have the option of redeeming
the excess in cash or in kind. If shares are redeemed in kind, the redeeming
shareholder would incur brokerage costs in converting the assets into cash.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202, has been selected as the independent auditors of the Fund and the Master
Trust. The independent auditors are responsible for auditing the annual
financial statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109-3661, acts as custodian of the Portfolio's assets and the Fund's assets
(the "Custodian"). Under its contract with the Trust and the Fund, the Custodian
is authorized to establish separate accounts in foreign currencies and to cause
foreign securities owned by the Trust and the Fund to be held in its offices
outside the United States and with certain foreign banks and securities
depositories. The Custodian is responsible for safeguarding and controlling the
Trust's and the Fund's cash and securities, handling the receipt and delivery of
securities and collecting interest and dividends on the Trust's and the Fund's
investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly-owned subsidiary of ML & Co., acts as the
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement (the "Transfer Agency Agreement").
The Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts.
LEGAL COUNSEL
Gardner, Carton & Douglas, 321 North Clark Street, Chicago, Illinois 60610,
is counsel for the Master Trust and the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio and
other information. An annual report containing financial statements audited by
independent auditors is sent to shareholders each year. After the end of each
year, shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
The Fund's financial statements are incorporated in this Statement of
Additional Information by reference to its annual report for the fiscal year
ended June 30, 2000. You may request copies of the annual report at no charge by
calling 1-800-236-4479 between 8:00 a.m. and 8:00 p.m. on any business day.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
51
<PAGE> 590
PRINCIPAL HOLDERS
[to come]
52
<PAGE> 591
APPENDIX -- DESCRIPTION OF RATINGS
MOODY'S INVESTORS SERVICE
BOND RATINGS:
"Aaa" -- Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
"Aa" -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
Moody's applies numerical modifiers "1," "2" and "3" in each generic rating
classification from Aa through B. The modifier "1" indicates that the obligation
ranks in the higher end of its generic rating category; the modifier "2"
indicates a mid-range ranking; and the modifier "3" indicates that the company
ranks in the lower end of that generic rating category.
"A" -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
"Baa" -- Bonds which are rated Baa are considered as medium-grade obligations
(that is, 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 which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
"B" -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
SHORT-TERM DEBT RATINGS:
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
"PRIME-1" -- Issuers rated "Prime-1" (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of these characteristics:
- Leading market positions in well-established industries.
- High rates of return on funds employed.
- Conservative capitalization structure with moderate reliance on debt and
ample asset protection.
- Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
- Well-established access to a range of financial markets and assured
sources of alternate liquidity.
"PRIME-2" -- Issuers rated "Prime-2" (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above,
A-1
<PAGE> 592
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. Adequate alternate
liquidity is maintained.
MUNICIPAL BOND RATINGS:
Moody's ratings for state and municipal short-term obligations are designated
Moody's Investment Grade or "MIG" with variable rate demand obligations being
designated as "VMIG." A VMIG rating may also be assigned to commercial paper
programs which are characterized as having variable short-term maturities, but
having neither a variable rate nor demand feature. Factors used in determining
ratings include liquidity of the borrower and short-term cyclical elements.
STANDARD & POOR'S RATING GROUP
BOND RATINGS:
"AAA" -- An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong.
"AA" -- An obligation rated AA differs from the highest rated obligations only
in small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
"A" -- An obligation rated A is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
"BBB" -- An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its commitment on the
obligation.
Obligations rated BB and B are regarded as having significant speculative
characteristics. While such obligations will likely have some quality and
protective characteristics, these may be outweighed by large uncertainties or
major exposures to adverse conditions.
COMMERCIAL PAPER RATINGS:
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market.
"A-1" -- This designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
"A-2" -- Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
MUNICIPAL BOND RATINGS:
S&P uses SP-1, SP-2 and SP-3 to rate short-term municipal obligations. A rating
of SP-1 denotes a strong capacity to pay principal and interest. An issue
determined to possess a very strong capacity to pay debt service is given a (+)
designation.
FITCH INVESTORS SERVICE, INC.
BOND RATINGS:
The following summarizes the ratings used by Fitch for corporate bonds:
"AAA" -- Highest credit quality. "AAA" ratings denote the lowest expectation of
credit risk. They 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.
A-2
<PAGE> 593
"AA" -- Very high credit quality. "AA" ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
"A" -- High credit quality. "A" ratings denote a low expectation of credit risk.
The capacity for timely payment of financial commitments is considered strong.
This capacity may, nevertheless, be more vulnerable to changes in circumstances
or in economic conditions than is the case for higher ratings.
"BBB" -- Good credit quality. "BBB" ratings indicate 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" -- Speculative. "BB" 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" -- Highly speculative. "B" 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.
PLUS (+) MINUS (--) -- Plus and minus signs may be appended to a rating to
denote relative status within major rating categories. Such suffixes are not
added to the "AAA" long-term rating category or to short-term ratings other than
"F1."
SHORT-TERM DEBT RATINGS:
"F1" -- Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
"F2" -- Good credit quality. 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.
"F3" -- Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
DUFF & PHELPS CREDIT RATING CO.
BOND RATINGS:
The following summarizes the ratings used by Duff & Phelps for long-term debt:
"AAA" -- Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
"AA+," "AA," "AA--" -- High credit quality. Protection factors are strong. Risk
is modest but may vary slightly from time to time because of economic
conditions.
"A+," "A," "A--" -- Protection factors are average but adequate. However, risk
factors are more variable and greater in periods of economic stress.
"BBB+," "BBB," "BBB--" -- Below-average protection factors but still considered
sufficient for prudent investment. Considerable variability in risk during
economic cycles.
"BB+," "BB," "BB--" -- Below investment grade but deemed likely to meet
obligations when due. Present or prospective financial protection factors
fluctuate according to industry conditions or company fortunes. Overall quality
may move up or down frequently within this category.
"B+," "B," "B--" -- Below investment grade and possessing risk that obligations
will not be met when due. Financial protection factors will fluctuate widely
according to economic cycles, industry conditions and/or
A-3
<PAGE> 594
company fortunes. Potential exists for frequent changes in the rating within
this category or into a higher or lower rating grade.
SHORT-TERM DEBT RATINGS:
"D-1+" -- Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of funds, is
outstanding and safety is just below risk-free U.S. Treasury short-term
obligations.
"D-1" -- Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are minor.
"D-1--" -- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
"D-2" -- Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small.
A-4
<PAGE> 595
STATEMENT OF ADDITIONAL INFORMATION
MERCURY SHORT-TERM INVESTMENT FUND
OF MERCURY HW FUNDS
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017
Phone No. (800) 236-4479
------------------------
Mercury Short-Term Investment Fund (the "Fund") is a fund of Mercury HW
Funds (the "Trust"). The Trust is a diversified, open-end management investment
company which is organized as a Massachusetts business trust. The investment
objective of the Fund is to seek to maximize long-term total return, consistent
with preservation of capital. The Fund seeks to achieve its investment objective
by investing primarily in a diversified portfolio of bonds of different
maturities. No assurance can be given that the investment objective of the Fund
will be realized. For more information on the Fund's investment objective and
policies, see "Investment Objective and Policies."
The Fund offers a single class (Class I) of shares. Only certain investors
are eligible to purchase Class I shares. See "Purchase of Shares."
------------------------
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the prospectus of the Fund, dated October , 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Fund at
1-800-236-4479 or your financial consultant or other financial intermediary, or
by writing to the Fund at Financial Data Services, Inc., P.O. Box 41621,
Jacksonville, Florida 32232-1621. The Prospectus is incorporated by reference
into this Statement of Additional Information, and this Statement of Additional
Information is incorporated by reference into the Prospectus. The Fund's
financial statements are incorporated by reference to its annual report for the
fiscal year ended June 30, 2000. You may request copies of the annual report at
no charge by calling 1-800-236-4479 between 8:00 a.m. and 8:00 p.m. on any
business day.
------------------------
MERCURY ADVISORS -- INVESTMENT ADVISER
FAM DISTRIBUTORS, INC. -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is October , 2000
<PAGE> 596
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Trust History............................................... 3
Investment Objective and Policies........................... 3
Investment Restrictions................................... 3
Repurchase Agreements..................................... 4
Bonds..................................................... 4
U.S. Government Securities................................ 4
Municipal Obligations..................................... 5
Corporate Debt Securities................................. 6
Convertible Securities.................................... 6
Mortgage-Related Securities............................... 7
Asset-Backed Securities................................... 10
Risk Factors Relating to Investing in Mortgage-Related and
Asset-Backed Securities................................. 10
Duration.................................................. 11
Derivative Instruments.................................... 11
Foreign Securities........................................ 15
Foreign Currency Options and Related Risks................ 16
Forward Foreign Currency Exchange Contracts............... 17
Foreign Investment Risks.................................. 18
Swap Agreements........................................... 20
Risk Factors Relating to Investing in High Yield
Securities.............................................. 21
Illiquid Securities....................................... 21
Reverse Repurchase Agreements............................. 22
Dollar Rolls.............................................. 22
Borrowing................................................. 23
Loans of Portfolio Securities............................. 23
When-Issued Securities.................................... 23
Real Estate Investment Trusts............................. 23
Shares of Other Investment Companies...................... 23
Short Sales Against-the-Box............................... 24
Corporate Loans........................................... 24
Temporary Defensive Position.............................. 24
Management of the Fund...................................... 24
Advisory Arrangements..................................... 26
Accounting and Administrative Services.................... 27
Code of Ethics............................................ 28
Purchase of Shares.......................................... 28
Class I Shares............................................ 29
Reduced Initial Sales Charges............................. 30
Redemption of Shares........................................ 31
Redemption................................................ 32
Repurchase................................................ 32
Reinstatement Privilege -- Class I Shares................. 33
Pricing of Shares........................................... 33
Determination of Net Asset Value.......................... 33
Computation of Offering Price Per Share................... 34
Portfolio Transactions and Brokerage........................ 35
Transactions in Portfolio Securities...................... 35
Shareholder Services........................................ 36
Investment Account........................................ 36
Exchange Privilege........................................ 37
Fee-Based Programs........................................ 38
Retirement Plans.......................................... 38
Automatic Investment Plans................................ 38
Automatic Dividend Reinvestment Plan...................... 38
Systematic Withdrawal Plans............................... 39
Dividends and Tax Status.................................... 39
Performance Data............................................ 40
General Information......................................... 42
Description of Shares..................................... 42
Issuance of Fund Shares for Securities.................... 43
Redemption in Kind........................................ 43
Independent Auditors...................................... 43
Custodian................................................. 43
Transfer Agent............................................ 43
Legal Counsel............................................. 44
Reports to Shareholders................................... 44
Shareholder Inquiries..................................... 44
Additional Information.................................... 44
Principal Holders......................................... 44
Appendix--Description of Ratings............................ A-1
</TABLE>
2
<PAGE> 597
TRUST HISTORY
The Trust was organized on August 22, 1984 as a Massachusetts business
trust. Before October 7, 1994, the Trust was called "Olympic Trust," and before
October , 2000, the Trust was called "Hotchkis and Wiley Funds." The Trust is
a diversified, open-end, management investment company currently consisting of
ten separate funds. Prior to October , 2000, the Fund was called the
Short-Term Investment Fund.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to maximize long-term total return,
consistent with preservation of capital. The investment objective of the Fund is
a fundamental policy of the Fund and may not be changed without the approval of
a majority of the Fund's outstanding voting securities as defined in the
Investment Company Act of 1940, as amended (the "1940 Act"). Reference is made
to the discussion under "How the Fund Invests" and "Investment Risks" in the
Prospectus for information with respect to the Fund's investment objective and
policies.
Mercury Advisors (the "Investment Adviser"), the Fund's investment adviser,
is responsible for the management of the Fund's portfolio.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of that Fund's outstanding
voting securities, as defined in the 1940 Act. Under the 1940 Act, the vote of
the holders of a "majority" of the Fund's outstanding voting securities means
the vote of the holders of the lesser of (1) 67% of the shares of the Fund
represented at a meeting at which the holders of more than 50% of its
outstanding shares are represented or (2) more than 50% of the outstanding
shares.
Except as noted, the Fund may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Fund's total assets (determined at the time of investment) would
then be invested in securities of a single issuer; or (ii) more than
25% of the Fund's total assets (determined at the time of investment)
would be invested in one or more issuers having their principal
business activities in a single industry.
2. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions),
provided that the deposit or payment by the Fund of initial or
maintenance margin in connection with futures or options is not
considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short (short sale
against-the-box), and unless not more than 25% of the Fund's net assets
(taken at current value) is held as collateral for such sales at any
one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Fund may borrow from a bank for temporary or emergency purposes in
amounts not exceeding 10% (taken at the lower of cost or current value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings. (The Fund may borrow from banks or
enter into reverse repurchase agreements and pledge assets in
connection therewith, but only if immediately after each borrowing
there is asset coverage of 300%.)
3
<PAGE> 598
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would
then hold more than 10% of the outstanding voting securities of an
issuer.
6. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws.
7. Make investments for the purpose of exercising control or management.
8. Participate on a joint or joint and several basis in any trading
account in securities.
Any percentage limitation on the Fund's investments is determined when the
investment is made, unless otherwise noted.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement where the seller agrees to
repurchase a security from the Fund at a mutually agreed-upon time and price.
The period of maturity is usually quite short, possibly overnight or a few days,
although it may extend over a number of months. The resale price is more than
the purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Fund's money is invested in the repurchase agreement. The
Fund's repurchase agreements will at all times be fully collateralized in an
amount at least equal to the resale price. The instruments held as collateral
are valued daily, and if the value of instruments declines, the Fund will
require additional collateral. In the event of a default, insolvency or
bankruptcy by a seller, the Fund will promptly seek to liquidate the collateral.
In such circumstances, the Fund could experience a delay or be prevented from
disposing of the collateral. To the extent that the proceeds from any sale of
such collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
BONDS
The term "bond" or "bonds" as used in the Prospectus is intended to include
all manner of fixed-income securities, debt securities and other debt
obligations unless specifically defined otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. The Fund will
invest in securities of such instrumentality only when the Investment Adviser is
satisfied that the credit risk with respect to any instrumentality is
acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely, either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (1) Treasury obligations from which the interest coupons
have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member bank representing ownership of Treasury obligation
components; or (4) receipts evidencing the component parts (corpus or coupons)
of Treasury obligations that have not actually been stripped. Such receipts
evidence ownership of component parts of Treasury obligations (corpus or
coupons) purchased by a third party
4
<PAGE> 599
(typically an investment banking firm) and held on behalf of the third party in
physical or book-entry form by a major commercial bank or trust company pursuant
to a custody agreement with the third party. These custodial receipts are known
by various names, including "Treasury Receipts," "Treasury Investment Growth
Receipts" ("TIGRs") and "Certificates of Accrual on Treasury Securities"
("CATS"), and are not issued by the U.S. Treasury; therefore they are not U.S.
Government securities, although the underlying bonds represented by these
receipts are debt obligations of the U.S. Treasury.
MUNICIPAL OBLIGATIONS
The Fund may invest in municipal obligations. The two principal
classifications of municipal bonds, notes and commercial paper are "general
obligation" and "revenue" bonds, notes or commercial paper. General obligation
bonds, notes or commercial paper are secured by the issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest.
Issuers of general obligation bonds, notes or commercial paper include states,
counties, cities, towns and other governmental units. Revenue bonds, notes and
commercial paper are payable from the revenues derived from a particular
facility or class of facilities or, in some cases, from specific revenue
sources. Revenue bonds, notes or commercial paper are issued for a wide variety
of purposes, including the financing of electric, gas, water and sewer systems
and other public utilities; industrial development and pollution control
facilities; single and multifamily housing units; public buildings and
facilities; air and marine ports; transportation facilities such as toll roads,
bridges and tunnels; and health and educational facilities such as hospitals and
dormitories. They rely primarily on user fees to pay debt service, although the
principal revenue source is often supplemented by additional security features
which are intended to enhance the creditworthiness of the issuer's obligations.
In some cases, particularly revenue bonds issued to finance housing and public
buildings, a direct or implied "moral obligation" of a governmental unit may be
pledged to the payment of debt service. In other cases, a special tax or other
charge may augment user fees.
Included within the revenue bonds category are participations in municipal
lease obligations or installment purchase contracts of municipalities
(collectively, "lease obligations"). State and local governments issue lease
obligations to acquire equipment leases and facilities. Lease obligations may
have risks not normally associated with general obligation or other revenue
bonds. Leases and installment purchase or conditional sale contracts (which may
provide for title to the leased asset to pass eventually to the issuer) have
developed as a means for governmental issuers to acquire property and equipment
without the necessity of complying with the constitutional and statutory
requirements generally applicable for the issuance of debt. Certain lease
obligations contain "non-appropriation" clauses that provide that the
governmental issuer has no obligation to make future payments under the lease or
contract unless money is appropriated for such purpose by the appropriate
legislative body on an annual or other periodic basis. Consequently, continued
lease payments on those lease obligations containing "non-appropriation" clauses
are dependent on future legislative actions. If such legislative actions do not
occur, the holders of the lease obligations may experience difficulty in
exercising their rights, including disposition of the property.
Private activity obligations are issued to finance, among other things,
privately operated housing facilities, pollution control facilities, convention
or trade show facilities, mass transit, airport, port or parking facilities and
certain facilities for water supply, gas, electricity, sewage or solid waste
disposal. Private activity obligations are also issued to privately held or
publicly owned corporations in the financing of commercial or industrial
facilities. The principal and interest on these obligations may be payable from
the general revenues of the users of such facilities. Shareholders, depending on
their individual tax status, may be subject to the federal alternative minimum
tax on the portion of a distribution attributable to these obligations. Interest
on private activity obligations will be considered exempt from federal income
taxes; however, shareholders should consult their own tax advisors to determine
whether they may be subject to the federal alternative minimum tax.
Resource recovery obligations are a type of municipal revenue obligation
issued to build facilities such as solid waste incinerators or waste-to-energy
plants. Usually, a private corporation will be involved and the revenue cash
flow will be supported by fees or units paid by municipalities for the use of
the facilities. The viability of a resource recovery project, environmental
protections regulations and project operator tax incentives may affect the value
and credit quality of these obligations.
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Tax, revenue or bond anticipation notes are issued by municipalities in
expectation of future tax or other revenues which are payable from these
specific taxes or revenues. Bond anticipation notes usually provide interim
financing in advance of an issue of bonds or notes, the proceeds of which are
used to repay the anticipation notes. Tax-exempt commercial paper is issued by
municipalities to help finance short-term capital or operating needs in
anticipation of future tax or other revenue.
A variable rate obligation is one whose terms provide for the adjustment of
its interest rate on set dates and which, upon such adjustment, can reasonably
be expected to have a market value that approximates its par value. A floating
rate obligation has terms which provide for the adjustment of its interest rate
whenever a specified interest rate changes and which, at any time, can
reasonably be expected to have a market value that approximates its par value.
Variable or floating rate obligations may be secured by bank letters of credit.
Variable rate auction and residual interest obligations are created when an
issuer or dealer separates the principal portion of a long-term, fixed-rate
municipal bond into two long-term, variable-rate instruments. The interest rate
on one portion reflects short-term interest rates, while the interest rate on
the other portion is typically higher than the rate available on the original
fixed-rate bond.
Yields on municipal securities are dependent on a variety of factors,
including the general conditions of the municipal bond and municipal note
markets, the size of a particular offering, the maturity of the obligation and
the rating of the issue. The achievement of the Fund's investment objective is
dependent in part on the continuing ability of the issuers of municipal
securities in which the Fund invests to meet their obligations for the payment
of principal and interest when due. Obligations of issuers of municipal
securities are subject to the provisions of bankruptcy, insolvency and other
laws affecting the rights and remedies of creditors, such as the Bankruptcy
Reform Act of 1978, as amended. Therefore, the possibility exists that, as a
result of litigation or other conditions, the ability of any issuer to pay, when
due, the principal of and interest on its municipal securities may be materially
affected.
CORPORATE DEBT SECURITIES
The Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, are in the Investment Adviser's opinion comparable
in quality to corporate debt securities in which the Fund may invest. The rate
of return or return of principal on some debt obligations may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying common stock.
The price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is
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without some risk, investments in convertible securities generally entail less
risk than investments in the common stock of the same issuer.
MORTGAGE-RELATED SECURITIES
The Fund may invest in residential or commercial mortgage-related
securities, including mortgage pass-through securities, collateralized mortgage
obligations ("CMOs"), adjustable rate mortgage securities, CMO residuals,
stripped mortgage-related securities, floating and inverse floating rate
securities and tiered index bonds.
Mortgage Pass-Through Securities. Mortgage pass-through securities
represent interests in pools of mortgages in which payments of both principal
and interest on the securities are generally made monthly, in effect "passing
through" monthly payments made by borrowers on the residential or commercial
mortgage loans which underlie the securities (net of any fees paid to the issuer
or guarantor of the securities). Mortgage pass-through securities differ from
other forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Early repayment of principal on mortgage pass-through securities (arising
from prepayments of principal due to the sale of underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose the Fund to a lower rate of return upon reinvestment of principal. Also,
if a security subject to repayment has been purchased at a premium, in the event
of prepayment, the value of the premium would be lost.
There are currently three types of mortgage pass-through securities: (1)
those issued by the U.S. Government or one of its agencies or instrumentalities,
such as the Government National Mortgage Association ("Ginnie Mae"), the Federal
National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage
Corporation ("Freddie Mac"); (2) those issued by private issuers that represent
an interest in or are collateralized by pass-through securities issued or
guaranteed by the U.S. Government or one of its agencies or instrumentalities;
and (3) those issued by private issuers that represent an interest in or are
collateralized by whole mortgage loans or pass-through securities without a
government guarantee but usually having some form of private credit enhancement.
Ginnie Mae is a wholly-owned United States Government corporation within
the Department of Housing and Urban Development. Ginnie Mae is authorized to
guarantee, with the full faith and credit of the United States Government, the
timely payment of principal and interest on securities issued by the
institutions approved by Ginnie Mae (such as savings and loan institutions,
commercial banks and mortgage banks), and backed by pools of FHA-insured or
VA-guaranteed mortgages.
Obligations of Fannie Mae and Freddie Mac are not backed by the full faith
and credit of the United States Government. In the case of obligations not
backed by the full faith and credit of the United States Government, the Fund
must look principally to the agency issuing or guaranteeing the obligation for
ultimate repayment. Fannie Mae and Freddie Mac may borrow from the U.S. Treasury
to meet their obligations, but the U.S. Treasury is under no obligation to lend
to Fannie Mae or Freddie Mac.
Private mortgage pass-through securities are structured similarly to Ginnie
Mae, Fannie Mae, and Freddie Mac mortgage pass-through securities and are issued
by originators of and investors in mortgage loans, including depository
institutions, mortgage banks, investment banks and special purpose subsidiaries
of the foregoing.
Pools created by private mortgage pass-through issuers generally offer a
higher rate of interest than government and government-related pools because
there are no direct or indirect government or agency guarantees of payments in
the private pools. However, timely payment of interest and principal of these
pools may be supported by various forms of insurance or guarantees, including
individual loan, title, pool and hazard insurance and letters of credit. The
insurance and guarantees are issued by governmental entities, private insurers
and the mortgage poolers. The insurance and guarantees and the creditworthiness
of the issuers thereof will be considered in determining whether a
mortgage-related security meets the Fund's investment quality standards. There
can be no assurance that the private insurers or guarantors can meet their
obligations under the insurance policies or guarantee arrangements. Private
mortgage pass-through securities may be bought without insurance or guarantees
if, through an examination of the loan experience and practices of the
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originator/servicers and poolers, the Investment Adviser determines that the
securities meet the Fund's quality standards.
Collateralized Mortgage Obligations. CMOs are debt obligations
collateralized by residential or commercial mortgage loans or residential or
commercial mortgage pass-through securities. Interest and prepaid principal are
generally paid monthly. CMOs may be collateralized by whole mortgage loans or
private mortgage pass-through securities but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by Ginnie Mae,
Freddie Mac, or Fannie Mae. The issuer of a series of CMOs may elect to be
treated as a Real Estate Mortgage Investment Conduit ("REMIC"). All future
references to CMOs also include REMICs.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral which is ordinarily unrelated to the stated
maturity date. CMOs often provide for a modified form of call protection through
a de facto breakdown of the underlying pool of mortgages according to how
quickly the loans are repaid. Monthly payment of principal received from the
pool of underlying mortgages, including prepayments, is first returned to
investors holding the shortest maturity class. Investors holding the longer
maturity classes usually receive principal only after the first class has been
retired. An investor may be partially protected against a sooner than desired
return of principal because of the sequential payments.
Certain issuers of CMOs are not considered investment companies pursuant to
a rule adopted by the Commission, and the Fund may invest in the securities of
such issuers without the limitations imposed by the 1940 Act on investments by
the Fund in other investment companies. In addition, in reliance on an earlier
Commission interpretation, the Fund's investments in certain other qualifying
CMOs, which cannot or do not rely on the rule, are also not subject to the
limitation of the 1940 Act on acquiring interests in other investment companies.
In order to be able to rely on the Commission's interpretation, these CMOs must
be unmanaged, fixed asset issuers, that: (1) invest primarily in mortgage-backed
securities; (2) do not issue redeemable securities; (3) operate under general
exemptive orders exempting them from all provisions of the 1940 Act; and (4) are
not registered or regulated under the 1940 Act as investment companies. To the
extent that the Fund selects CMOs that cannot rely on the rule or do not meet
the above requirements, the Fund may not invest more than 10% of its assets in
all such entities and may not acquire more than 3% of the voting securities of
any single such entity.
The Fund may also invest in, among other things, parallel pay CMOs, Planned
Amortization Class CMOs ("PAC bonds"), sequential pay CMOs, and floating rate
CMOs. Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. PAC bonds generally require payments of a
specified amount of principal on each payment date. Sequential pay CMOs
generally pay principal to only one class while paying interest to several
classes. Floating rate CMOs are securities whose coupon rate fluctuates
according to some formula related to an existing market index or rate. Typical
indexes would include the eleventh district cost-of-funds index ("COFI"), the
London Interbank Offered Rate ("LIBOR"), one-year Treasury yields, and ten-year
Treasury yields.
Adjustable Rate Mortgage Securities. Adjustable rate mortgage securities
("ARMs") are pass-through securities collateralized by mortgages with adjustable
rather than fixed rates. ARMs eligible for inclusion in a mortgage pool
generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, thirty-six, or sixty scheduled monthly
payments. Thereafter, the interest rates are subject to periodic adjustment
based on changes to a designated benchmark index.
The ARMs contain maximum and minimum rates beyond which the mortgage
interest rate may not vary over the lifetime of the security. In addition,
certain ARMs provide for additional limitations on the maximum amount by which
the mortgage interest rate may adjust for any single adjustment period. In the
event that market rates of interest rise more rapidly to levels above that of
the ARM's maximum rate, the ARM's coupon may represent a below market rate of
interest. In these circumstances, the market value of the ARM security will
likely have fallen.
Certain ARMs contain limitations on changes in the required monthly
payment. In the event that a monthly payment is not sufficient to pay the
interest accruing on an ARM, any such excess interest is added to
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<PAGE> 603
the principal balance of the mortgage loan, which is repaid through future
monthly payments. If the monthly payment for such an instrument exceeds the sum
of the interest accrued at the applicable mortgage interest rate and the
principal payment required at such point to amortize the outstanding principal
balance over the remaining term of the loan, the excess is then utilized to
reduce the outstanding principal balance of the ARM.
CMO Residuals. CMO residuals are derivative mortgage securities issued by
agencies or instrumentalities of the U.S. Government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks, and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
part, the yield to maturity on the CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-related securities. See
"Stripped Mortgage-Related Securities" below. In addition, if a series of a CMO
includes a class that bears interest at an adjustable rate, the yield to
maturity on the related CMO residual will also be extremely sensitive to changes
in the level of the index upon which interest rate adjustments are based. As
described below with respect to stripped mortgage-related securities, in certain
circumstances the Fund may fail to recoup fully its initial investment in a CMO
residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has recently developed and CMO residuals currently may not have
the liquidity of other more established securities trading in other markets.
Transactions in CMO residuals are generally completed only after careful review
of the characteristics of the securities in question. In addition, CMO residuals
may or, pursuant to an exemption therefrom, may not have been registered under
the Securities Act of 1933, as amended ("Securities Act"). CMO residuals,
whether or not registered under such Act, may be subject to certain restrictions
on transferability, and may be deemed "illiquid" and subject to the Fund's
limitations on investment in illiquid securities.
Stripped Mortgage-Related Securities. Stripped mortgage-related securities
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. Government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks, and special purpose entities
of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the IO class), while
the other class will receive all of the principal (the PO class). The yield to
maturity on an IO class is extremely sensitive to the rate of principal payments
(including prepayments) on the related underlying mortgage assets, and a rapid
rate of principal payments may have a material adverse effect on the Fund's
yield to maturity from these securities. If the underlying mortgage assets
experience greater than anticipated prepayments of principal, the Fund may fail
to fully recoup its initial investment in these securities even if the security
is in one of the highest rating categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently introduced. As a result, established trading markets have not
yet been fully developed and accordingly, these securities may be deemed
"illiquid" and subject to the Fund's limitations on investment in illiquid
securities.
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Inverse Floaters. An inverse floater is a debt instrument with a floating
or variable interest rate that moves in the opposite direction to the interest
rate on another security or index level. Changes in the interest rate on the
other security or index inversely affect the residual interest rate paid on the
inverse floater, with the result that the inverse floater's price will be
considerably more volatile than that of a fixed rate bond. Inverse floaters may
experience gains when interest rates fall and may suffer losses in periods of
rising interest rates. The market for inverse floaters is relatively new.
Tiered Index Bonds. Tiered index bonds are relatively new forms of
mortgage-related securities. The interest rate on a tiered index bond is tied to
a specified index or market rate. So long as this index or market rate is below
a predetermined "strike" rate, the interest rate on the tiered index bond
remains fixed. If, however, the specified index or market rate rises above the
"strike" rate, the interest rate of the tiered index bond will decrease. Thus,
under these circumstances, the interest rate on a tiered index bond, like an
inverse floater, will move in the opposite direction of prevailing interest
rates, with the result that the price of the tiered index bond may be
considerably more volatile than that of a fixed-rate bond.
ASSET-BACKED SECURITIES
The Fund may invest in various types of asset-backed securities. Through
the use of trusts and special purpose corporations, various types of assets,
primarily automobile and credit card receivables and home equity loans, are
being securitized in pass-through structures similar to the mortgage
pass-through or in a pay-through structure similar to the CMO structure.
Investments in these and other types of asset-backed securities must be
consistent with the investment objective and policies of the Fund.
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-RELATED AND ASSET-BACKED
SECURITIES
The yield characteristics of mortgage-related and asset-backed securities
differ from traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
or other assets generally may be prepaid at any time. As a result, if the Fund
purchases such a security at a premium, a prepayment rate that is faster than
expected will reduce yield to maturity, while a prepayment rate that is slower
than expected will have the opposite effect of increasing yield to maturity.
Alternatively, if the Fund purchases these securities at a discount, faster than
expected prepayments will increase, while slower than expected prepayments will
reduce, yield to maturity. The Fund may invest a portion of its assets in
derivative mortgage-related securities which are highly sensitive to changes in
prepayment and interest rates. The Investment Adviser will seek to manage these
risks (and potential benefits) by diversifying its investments in such
securities and through hedging techniques.
During periods of declining interest rates, prepayment of mortgages
underlying mortgage-related securities can be expected to accelerate.
Accordingly, the Fund's ability to maintain positions in high-yielding
mortgage-related securities will be affected by reductions in the principal
amount of such securities resulting from such prepayments, and its ability to
reinvest the returns of principal at comparable yields is subject to generally
prevailing interest rates at that time. Conversely, slower than expected
prepayments may effectively change a security that was considered short or
intermediate-term at the time of purchase into a long-term security. Long-term
securities tend to fluctuate more in response to interest rate changes, leading
to increased net asset value volatility. Prepayments may also result in the
realization of capital losses with respect to higher yielding securities that
had been bought at a premium or the loss of opportunity to realize capital gains
in the future from possible future appreciation.
Asset-backed securities involve certain risks that are not posed by
mortgage-related securities, resulting mainly from the fact that asset-backed
securities do not usually contain the complete benefit of a security interest in
the related collateral. For example, credit card receivables generally are
unsecured and the debtors are entitled to the protection of a number of state
and federal consumer credit laws, some of which may reduce the ability to obtain
full payment. In the case of automobile receivables, due to various legal and
economic factors, proceeds from repossessed collateral may not always be
sufficient to support payments on these securities.
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DURATION
In selecting securities for the Fund, the Investment Adviser makes use of
the concept of duration for fixed-income securities. Duration is a measure of
the expected life of a fixed-income security. Duration incorporates a bond's
yield, coupon interest payments, final maturity and call features into one
measure. Most debt obligations provide interest ("coupon") payments in addition
to a final ("par") payment at maturity. Some obligations also have call
provisions. Depending on the relative magnitude of these payments, the market
values of debt obligations may respond differently to changes in the level and
structure of interest rates.
Duration is a measure of the expected life of a fixed-income security on a
present value basis. Duration takes the length of the time intervals between the
present time and the time that the interest and principal payments are scheduled
or, in the case of a callable bond, expected to be received, and weights them by
the present values of the cash to be received at each future point in time. For
any fixed-income security with interest payments occurring prior to the payment
of principal, duration is always less than maturity. In general, all other
things being the same, the lower the stated or coupon rate of interest of a
fixed-income security, the longer the duration of the security; conversely, the
higher the stated or coupon rate of interest of a fixed-income security, the
shorter the duration of the security.
Futures, options and options on futures have durations which, in general,
are closely related to the duration of the securities which underlie them.
Holding long futures or call option positions (backed by a segregated account of
cash and cash equivalents) will lengthen the Fund's duration by approximately
the same amount that holding an equivalent amount of the underlying securities
would.
Short futures or put options positions have durations roughly equal to the
negative duration of the securities that underlie those positions, and have the
effect of reducing portfolio duration by approximately the same amount that
selling an equivalent amount of the underlying securities would.
There are some situations where even the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by duration is the case of mortgage pass-through securities. The stated
final maturity of such securities is generally 30 years, but current prepayment
rates are more critical in determining the securities' interest rate exposure.
In these and other similar situations, the Investment Adviser will use more
sophisticated analytical techniques that incorporate the economic life of a
security into the determination of its interest rate exposure.
DERIVATIVE INSTRUMENTS
As indicated in the prospectus, to the extent consistent with its
investment objective and policies and the investment restrictions listed in this
Statement of Additional Information, the Fund may purchase and write call and
put options on securities, securities indexes and foreign currencies and enter
into forward contracts, futures contracts and use options on futures contracts.
The Fund also may enter into swap agreements with respect to foreign currencies,
interest rates and securities indexes. The Fund may use these techniques to
hedge against changes in interest rates, foreign currency exchange rates, or
securities prices or as part of its overall investment strategies. The Fund may
also purchase and sell options relating to foreign currencies for the purpose of
increasing exposure to a foreign currency or to shift exposure to foreign
currency fluctuations from one country to another. The Fund will mark as
segregated cash, U.S. Government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily (or, as permitted by applicable
regulation, enter into certain offsetting positions), to cover its obligations
under forward contracts, futures contracts, swap agreements and options to avoid
leveraging of the Fund.
Options on Securities and on Securities Indexes. The Fund may purchase put
options on securities to protect holdings in an underlying or related security
against a substantial decline in market value. The Fund may purchase call
options on securities to protect against substantial increases in prices of
securities the Fund intends to purchase pending its ability to invest in such
securities in an orderly manner. The Fund may sell put or call options it has
previously purchased, which could result in a net gain or loss depending on
whether the amount realized on the sale is more or less than the premium and
other transaction costs paid on the put or
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call option which is sold. The Fund may write a call or put option only if the
option is "covered" by the Fund holding a position in the underlying securities
or by other means which would permit immediate satisfaction of the Fund's
obligation as writer of the option. Prior to exercise or expiration, an option
may be closed out by an offsetting purchase or sale of an option of the same
series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
Futures Contracts and Options on Futures Contracts. The Fund may use
interest rate, foreign currency or index futures contracts, as specified for the
Fund in its prospectus. An interest rate, foreign currency or index futures
contract provides for the future sale by one party and purchase by another party
of a specified quantity of a financial instrument, foreign currency or the cash
value of an index at a specified price and time. A futures contract on an index
is an agreement pursuant to which two parties agree to take or make delivery of
an amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. Although the value of an index might be a
function of the value of certain specified securities, no physical delivery of
these securities is made.
The Fund may purchase and write call and put options on futures. Options on
futures possess many of the same characteristics as options on securities and
indexes (discussed above). An option on a futures contract gives the holder the
right, in return for the premium paid, to assume a long position (call) or short
position (put) in a futures contract at a specified exercise price at any time
during the period of the option. Upon
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exercise of a call option, the holder acquires a long position in the futures
contract and the writer is assigned the opposite short position. In the case of
a put option, the opposite is true.
The Fund will use futures contracts and options on futures contracts in
accordance with the rules of the Commodity Futures Trading Commission ("CFTC").
For example, the Fund might use futures contracts to hedge against anticipated
changes in interest rates that might adversely affect either the value of the
Fund's securities or the price of the securities which the Fund intends to
purchase. The Fund's hedging activities may include sales of futures contracts
as an offset against the effect of expected increases in interest rates, and
purchases of futures contracts as an offset against the effect of expected
declines in interest rates. Although other techniques could be used to reduce
the Fund's exposure to interest rate fluctuations, the Fund may be able to hedge
its exposure more effectively and perhaps at a lower cost by using futures
contracts and options on futures contracts.
The Fund will only enter into futures contracts and options on futures
contracts which are standardized and traded on a U.S. or foreign exchange, board
of trade, or similar entity, or quoted on an automated quotation system.
When a purchase or sale of a futures contract is made by the Fund, the Fund
is required to deposit with its custodian or futures commission merchant, a
specified amount of cash or U.S. government securities ("initial margin"). The
margin required for a futures contract is set by the exchange on which the
contract is traded and may be modified during the term of the contract. The
initial margin is in the nature of a performance bond or good faith deposit on
the futures contract which is returned to the Fund upon termination of the
contract, assuming all contractual obligations have been satisfied. The Fund
expects to earn interest income on its initial margin deposits. A futures
contract held by the Fund is valued daily at the official settlement price of
the exchange on which it is traded. Each day the Fund pays or receives cash,
called "variation margin", equal to the daily change in value of the futures
contract. This process is known as "marking to market". Variation margin does
not represent a borrowing or loan by the Fund but is instead a settlement
between the Fund and the broker of the amount one would owe the other if the
futures contract expired. In computing daily net asset value, the Fund will mark
to market its open futures positions.
The Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying security or index and delivery month). If an offsetting
purchase price is less than the original sale price, the Fund realizes a capital
gain, or if it is more, the Fund realizes a capital loss. Conversely, if an
offsetting sale price is more than the original purchase price, the Fund
realizes a capital gain, or if it is less, the Fund realizes a capital loss. The
transaction costs must also be included in these calculations.
Limitations on Use of Futures and Options Thereon. When purchasing a
futures contract, the Fund will maintain with its custodian (and mark-to-market
on a daily basis) cash, U.S. government securities, equity securities or other
liquid, unencumbered assets that, when added to the amounts deposited as margin
with a futures commission merchant or the custodian, are equal to the market
value of the futures contract. Alternatively, the Fund may "cover" its position
by purchasing a put option on the same futures contract with a strike price as
high or higher than the price of the contract held by the Fund.
When selling a futures contract, the Fund will maintain with its custodian
(and mark-to-market on a daily basis) liquid assets that, when added to the
amount deposited as margin with a futures commission merchant or the custodian,
are equal to the market value of the instruments underlying the contract.
Alternatively, the Fund may "cover" its position by owning the instruments
underlying the contract (or, in the case of an index futures contract, a
portfolio with a volatility substantially similar to that of the index on which
the futures contract is based), or by holding a call option permitting the Fund
to purchase the same futures
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contract at a price no higher than the price of the contract written by the Fund
(or at a higher price if the difference is maintained in liquid assets with the
Trust's custodian).
When selling a call option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) cash, U.S. government
securities, equity securities or other liquid, unencumbered assets that, when
added to the amounts deposited as margin with a futures commission merchant or
the custodian, equal the total market value of the futures contract underlying
the call option. Alternatively, the Fund may cover its position by entering into
a long position in the same futures contract at a price no higher than the
strike price of the call option, by owning the instruments underlying the
futures contract, or by holding a separate call option permitting the Fund to
purchase the same futures contract at a price not higher than the strike price
of the call option sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) cash, U.S. government
securities, equity securities or other liquid, unencumbered assets that equal
the purchase price of the futures contract, less any margin on deposit.
Alternatively, the Fund may cover the position either by entering into a short
position in the same futures contract, or by owning a separate put option
permitting it to sell the same futures contract so long as the strike price of
the purchased put option is the same or higher than the strike price of the put
option sold by the Fund.
In order to comply with current applicable regulations of the CFTC pursuant
to which the Trust avoids being deemed a "commodity pool operator," the Fund is
limited in its futures trading activities to positions which constitute "bona
fide hedging" positions within the meaning and intent of applicable CFTC rules,
or to non-hedging positions for which the aggregate initial margin and premiums
will not exceed 5% of the liquidation value of the Fund's assets.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not completely offset by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, the Fund may purchase or sell fewer
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contracts.
The particular securities comprising the index underlying the index
financial futures contract may vary from the securities held by the Fund. As a
result, the Fund's ability to hedge effectively all or a portion of the value of
its securities through the use of such financial futures contracts will depend
in part on the degree to which price movements in the index underlying the
financial futures contract correlate with the price movements of the securities
held by the Fund. The correlation may be affected by disparities in the Fund's
investments as compared to those comprising the index and general economic or
political factors. In addition, the correlation between movements in the value
of the index may be subject to change over time as additions to and deletions
from the index alter its structure. The correlation between futures contracts on
U.S. Government securities and the securities held by the Fund may be adversely
affected by similar factors and the risk of imperfect correlation between
movements in the prices of such futures contracts and the prices of securities
held by the Fund may be greater. The trading of futures contracts also is
subject to certain market risks, such as inadequate trading activity, which
could at times make it difficult or impossible to liquidate existing positions.
The Fund expects to liquidate a majority of the futures contracts it enters
into through offsetting transactions on the applicable contract market. There
can be no assurance, however, that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close out a futures position. In the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. In such situations, if the Fund has insufficient cash, it may be
required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be
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<PAGE> 609
disadvantageous to do so. The inability to close out futures positions also
could have an adverse impact on the Fund's ability to hedge effectively its
investments. 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. Prices have in the past
moved beyond the daily limit on a number of consecutive trading days. The Fund
will enter into a futures position only if, in the judgment of the Investment
Adviser, there appears to be an actively traded secondary market for such
futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Investment Adviser to forecast correctly the
direction and extent of interest rate movements within a given time frame. To
the extent interest rates remain stable during the period in which a futures
contract or option is held by the Fund or such rates move in a direction
opposite to that anticipated, the Fund may realize a loss on a hedging
transaction which is not fully or partially offset by an increase in the value
of portfolio securities. As a result, the Fund's total return for such period
may be less than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made upon the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. There is also the risk of loss by the
Fund of margin deposits in the event of the bankruptcy of a broker with whom the
Fund has an open position in a financial futures contract.
The amount of risk the Fund assumes when it purchases an option on a
futures contract is the premium paid for the option plus related transaction
costs. In addition to the correlation risks discussed above, the purchase of an
option on a futures contract 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.
FOREIGN SECURITIES
The Fund may invest in American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") or other securities convertible into securities of
issuers based in foreign countries. These securities may not necessarily be
denominated in the same currency as the securities into which they may be
converted. ADRs are receipts, usually issued by a U.S. bank or trust company,
evidencing ownership of the underlying securities; EDRs are European receipts
evidencing a similar arrangement. Generally, ADRs are issued in registered form,
denominated in U.S. dollars, and are designed for use in the U.S. securities
markets; EDRs are issued in bearer form, denominated in other currencies, and
are designed for use in European securities markets.
The Fund may also invest in fixed-income securities of issuers located in
emerging foreign markets. Emerging markets generally include every country in
the world other than the United States, Canada, Japan, Australia, Malaysia, New
Zealand, Hong Kong, South Korea, Singapore and most Western European countries.
In determining what countries constitute emerging markets, the Investment
Adviser will consider, among other things, data, analysis and classification of
countries published or disseminated by the International Bank for Reconstruction
and Development (commonly known as the World Bank) and the International Finance
Corporation. Currently, investing in many emerging markets may not be desirable
or feasible, because of the lack of adequate custody arrangements for the Fund's
assets, overly burdensome repatriation and similar restrictions, the lack of
organized and liquid securities markets, unacceptable political risks or other
reasons. As opportunities to invest in securities in emerging markets develop,
the Fund expects to expand and further broaden the group of emerging markets in
which it invests.
From time to time, emerging markets have offered the opportunity for higher
returns in exchange for a higher level of risk. Accordingly, the Investment
Adviser believes that the Fund's ability to invest in emerging markets
throughout the world can assist in the overall diversification of the Fund's
portfolio.
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<PAGE> 610
The Fund may invest in the following types of emerging market fixed-income
securities: (1) fixed-income securities issued or guaranteed by governments,
their agencies, instrumentalities or political subdivisions, or by government
owned, controlled or sponsored entities, including central banks (collectively,
"Sovereign Debt"), including Brady Bonds (described below); (2) interests in
issuers organized and operated for the purpose of restructuring the investment
characteristics of Sovereign Debt; (3) fixed-income securities issued by banks
and other business entities; and (4) fixed-income securities denominated in or
indexed to the currencies of emerging markets. Fixed-income securities held by
the Fund may take the form of bonds, notes, bills, debentures, bank debt
obligations, short-term paper, loan participations, assignments and interests
issued by entities organized and operated for the purpose of restructuring the
investment characteristics of any of the foregoing. There is no requirement with
respect to the maturity of fixed-income securities in which the Fund may invest.
The Fund may invest in Brady Bonds and other Sovereign Debt of countries
that have restructured or are in the process of restructuring Sovereign Debt
pursuant to the Brady Plan. "Brady Bonds" are debt securities issued under the
framework of the Brady Plan, an initiative announced by former U.S. Treasury
Secretary Nicholas F. Brady in 1989 as a mechanism for debtor nations to
restructure their outstanding external commercial bank indebtedness. In
restructuring its external debt under the Brady Plan framework, a debtor nation
negotiates with its existing bank lenders as well as multilateral institutions
such as the World Bank and the International Monetary Fund ("IMF"). The Brady
Plan framework, as it has developed, contemplates the exchange of commercial
bank debt for newly issued Brady Bonds. Brady Bonds may also be issued in
respect of new money being advanced by existing lenders in connection with the
debt restructuring. The World Bank and/or the IMF support the restructuring by
providing funds pursuant to loan agreements or other arrangements which enable
the debtor nation to collateralize the new Brady Bonds or to repurchase
outstanding bank debt at a discount.
Emerging market fixed-income securities generally are considered to be of a
credit quality below investment grade, even though they often are not rated by
any nationally recognized statistical rating organizations. Investment in
emerging market fixed-income securities will be allocated among various
countries based upon the Investment Adviser's analysis of credit risk and its
consideration of a number of factors, including: (1) prospects for relative
economic growth among the different countries in which the Fund may invest; (2)
expected levels of inflation; (3) government policies influencing business
conditions; (4) the outlook for currency relationships; and (5) the range of the
individual investment opportunities available to international investors. The
Investment Adviser's emerging market sovereign credit analysis includes an
evaluation of the issuing country's total debt levels, currency reserve levels,
net exports/imports, overall economic growth, level of inflation, currency
fluctuation, political and social climate and payment history. Particular
fixed-income securities will be selected based upon a credit risk analysis of
potential issuers, the characteristics of the security, the interest rate
sensitivity of the various debt issues available with respect to a particular
issuer, an analysis of the anticipated volatility and liquidity of the
particular debt instruments, and the tax implications to the Fund. The emerging
market fixed-income securities in which the Fund may invest are not subject to
any minimum credit quality standards.
FOREIGN CURRENCY OPTIONS AND RELATED RISKS
The Fund may take positions in options on foreign currencies to hedge
against the risk that foreign exchange rate fluctuations will affect the value
of foreign securities the Fund holds in its portfolio or intends to purchase.
For example, if the Fund were to enter into a contract to purchase securities
denominated in a foreign currency, it could effectively fix the maximum U.S.
dollar cost of the securities by purchasing call options on that foreign
currency. Similarly, if the Fund held securities denominated in a foreign
currency and anticipated a decline in the value of that currency against the
U.S. dollar, it could hedge against such a decline by purchasing a put option on
the currency involved. The markets in foreign currency options are relatively
new, and the Fund's ability to establish and close out positions in such options
is subject to the maintenance of a liquid secondary market. There can be no
assurance that a liquid secondary market will exist for a particular option at
any specific time. In addition, options on foreign currencies are affected by
all of those factors that influence foreign exchange rates and investments
generally.
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<PAGE> 611
The quantities of currencies underlying option contracts represent odd lots
in a market dominated by transactions between banks, and as a result extra
transaction costs may be incurred upon exercise of an option.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations be firm or revised on a
timely basis. Quotation information is generally representative of very large
transactions in the interbank market and may not reflect smaller transactions
where rates may be less favorable. Option markets may be closed while
round-the-clock interbank currency markets are open, and this can create price
and rate discrepancies.
Risks of Options Trading. The Fund may effectively terminate its rights or
obligations under options by entering into closing transactions. Closing
transactions permit the Fund to realize profits or limit losses on its options
positions prior to the exercise or expiration of the option. The value of a
foreign currency option depends on the value of the underlying currency relative
to the U.S. dollar. Other factors affecting the value of an option are the time
remaining until expiration, the relationship of the exercise price to market
price, the historical price volatility of the underlying currency and general
market conditions. As a result, changes in the value of an option position may
have no relationship to the investment merit of a foreign security. Whether a
profit or loss is realized on a closing transaction depends on the price
movement of the underlying currency and the market value of the option.
Options normally have expiration dates of up to nine months. The exercise
price may be below, equal to or above the current market value of the underlying
currency. Options that expire unexercised have no value, and the Fund will
realize a loss of any premium paid and any transaction costs. Closing
transactions may be effected only by negotiating directly with the other party
to the option contract, unless a secondary market for the options develops.
Although the Fund intends to enter into foreign currency options only with
dealers which agree to enter into, and which are expected to be capable of
entering into, closing transactions with the Fund, there can be no assurance
that the Fund will be able to liquidate an option at a favorable price at any
time prior to expiration. In the event of insolvency of the counter-party, the
Fund may be unable to liquidate a foreign currency option. Accordingly, it may
not be possible to effect closing transactions with respect to certain options,
with the result that the Fund would have to exercise those options that it had
purchased in order to realize any profit.
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may use forward contracts to protect against uncertainty in the
level of future exchange rates. The Fund will not speculate with forward
contracts or foreign currency exchange rates.
The Fund may enter into forward contracts with respect to specific
transactions. For example, when the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, or when the Fund
anticipates the receipt in a foreign currency of dividend or interest payments
on a security that it holds, the Fund may desire to "lock in" the U.S. dollar
price of the security or the U.S. dollar equivalent of the payment, by entering
into a forward contract for the purchase or sale, for a fixed amount of U.S.
dollars or foreign currency, of the amount of foreign currency involved in the
underlying transaction. The Fund will thereby be able to protect itself against
a possible loss resulting from an adverse change in the relationship between the
currency exchange rates during the period between the date on which the security
is purchased or sold, or on which the payment is declared, and the date on which
such payments are made or received.
The Fund also may use forward contracts in connection with portfolio
positions to lock in the U.S. dollar value of those positions, to increase the
Fund's exposure to foreign currencies that the Investment Adviser believes may
rise in value relative to the U.S. dollar or to shift the Fund's exposure to
foreign currency fluctuations from one country to another. For example, when the
Investment Adviser believes that the currency of a particular foreign country
may suffer a substantial decline relative to the U.S. dollar or another
currency, it may enter into a forward contract to sell the amount of the former
foreign currency approximating the value of some or all of the Fund's portfolio
securities denominated in such foreign currency. This investment practice
generally is referred to as "cross-hedging" when another foreign currency is
used.
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<PAGE> 612
The precise matching of the forward contract amounts and the value of the
securities involved will not generally be possible because the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Accordingly, it may be necessary for
the Fund to purchase additional foreign currency on the spot (that is, cash)
market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Fund is obligated to
deliver and if a decision is made to sell the security and make delivery of the
foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio security if
its market value exceeds the amount of foreign currency the Fund is obligated to
deliver. The projection of short-term currency market movements is extremely
difficult, and the successful execution of a short-term hedging strategy is
highly uncertain. Forward contracts involve the risk that anticipated currency
movements will not be accurately predicted, causing the Fund to sustain losses
on these contracts and transaction costs. The Fund may enter into forward
contracts or maintain a net exposure to such contracts only if (1) the
consummation of the contracts would not obligate the Fund to deliver an amount
of foreign currency in excess of the value of the Fund's portfolio securities or
other assets denominated in that currency, or (2) the Fund marks as segregated
cash, U.S. government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily, in an amount not less than the
value of the Fund's total assets committed to the consummation of the contracts.
Under normal circumstances, consideration of the prospect for currency parities
will be incorporated into the longer term investment decisions made with regard
to overall diversification strategies. However, the Investment Adviser believes
it is important to have the flexibility to enter into such forward contracts
when it determines that the best interests of the Fund will be served.
At or before the maturity date of a forward contract that requires the Fund
to sell a currency, the Fund may either sell a portfolio security and use the
sale proceeds to 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 that it is obligated to deliver. Similarly, the Fund
may close out a forward contract requiring it to purchase a specified currency
by entering into a second contract entitling it to sell the same amount of the
same currency on the maturity date of the first contract. The Fund would realize
a gain or loss as a result of entering into such an offsetting forward contract
under either circumstance to the extent the exchange rate between the currencies
involved moved between the execution dates of the first and second contracts.
The cost to the Fund of engaging in forward contracts varies with factors
such as the currencies involved, the length of the contract period and the
market conditions then prevailing. Because forward contracts are usually entered
into on a principal basis, no fees or commissions are involved. The use of
forward contracts does not eliminate fluctuations in the prices of the
underlying securities the Fund owns or intends to acquire, but it does fix a
rate of exchange in advance. In addition, although forward contracts limit the
risk of loss due to a decline in the value of the hedged currencies, at the same
time they limit any potential gain that might result should the value of the
currencies increase.
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend to convert holdings of foreign currencies into U.S. dollars on a
daily basis. The Fund may convert foreign currency from time to time, and
investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit
based on the difference between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to the
Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
FOREIGN INVESTMENT RISKS
Foreign Market Risk. The Fund may invest a portion of its assets in foreign
securities. Foreign security investment involves special risks not present in
U.S. investments that can increase the chances that the Fund will lose money.
Prices of foreign securities may fluctuate more than prices of securities traded
in the United States.
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<PAGE> 613
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of capital, resources, and
balance of payments position. Certain such economies may rely heavily on
particular industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a particular country
or countries, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. Investments in foreign markets may
also be adversely affected by governmental actions such as the imposition of
capital controls, nationalization of companies or industries, expropriation of
assets, or the imposition of punitive taxes. In addition, the governments of
certain countries may prohibit or impose substantial restrictions on foreign
investing in their capital markets or in certain industries. Any of these
actions could severely affect security prices, impair the Fund's ability to
purchase or sell foreign securities or transfer the Fund's assets or income back
into the United States, or otherwise adversely affect the Fund's operations.
Other foreign market risks include foreign exchange controls, difficulties in
pricing securities, defaults on foreign government securities, difficulties in
enforcing favorable legal judgments in foreign courts, and political and social
instability. Legal remedies available to investors in certain foreign countries
may be less extensive than those available to investors in the United States or
other foreign countries.
Currency Risk and Exchange Risk. Securities in which the Fund invests may
be denominated or quoted in currencies other than the U.S. dollar. Changes in
foreign currency exchange rates will affect the value of the securities of the
Fund. Generally, when the U.S. dollar rises in value against a foreign currency,
your investment in a security denominated in that currency loses value because
the currency is worth fewer U.S. dollars. Similarly when the U.S. dollar
decreases in value against a foreign currency, your investment in a security
denominated in that currency gains value because the currency is worth more U.S.
dollars. This risk is generally known as "currency risk" which is the
possibility that a stronger U.S. dollar will reduce returns for U.S. investors
investing overseas and a weak U.S. dollar will increase returns for U.S.
investors investing overseas.
For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU established a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU participants by July 1, 2002. Upon implementation of EMU,
certain securities issued in participating EU countries (beginning with
government and corporate bonds) were redenominated in the euro, and are now
listed, traded, declaring dividends and making other payments only in euros.
No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on the Fund's investments
in Europe generally or in specific countries participating in EMU.
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<PAGE> 614
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some countries may not have laws
to protect investors the way that the United States securities laws do.
Accounting standards in other countries are not necessarily the same as in the
United States. If the accounting standards in another country do not require as
much disclosure or detail as U.S. accounting standards, it may be harder for the
Fund's portfolio managers to completely and accurately determine a company's
financial condition.
Certain Risks of Holding Fund Assets Outside the United States. The Fund
generally holds the foreign securities in which it invests outside the United
States in foreign banks and securities depositories. These foreign banks and
securities depositories may be recently organized or new to the foreign custody
business. They may also have operations subject to limited or no regulatory
oversight. Also, the laws of certain countries may put limits on the Fund's
ability to recover its assets if a foreign bank or depository or issuer of a
security or any of their agents goes bankrupt. In addition, it can be expected
that it will be more expensive for the Fund to buy, sell and hold securities in
certain foreign markets than it is in the U.S. market due to higher brokerage,
transaction, custody and/or other costs. The increased expense of investing in
foreign markets reduces the amount the Fund can earn on its investments.
Settlement and clearance procedures in certain foreign markets differ
significantly from those in the United States. Foreign settlement and clearance
procedures and trade regulations also may involve certain risks (such as delays
in payment for or delivery of securities) not typically involved with the
settlement of U.S. investments. Communications between the United States and
emerging market countries may be unreliable, increasing the risk of delayed
settlements or losses of security certificates. Settlements in certain foreign
countries at times have not kept pace with the number of securities
transactions. These problems may make it difficult for a Fund to carry out
transactions. If the Fund cannot settle or is delayed in settling a purchase of
securities, it may miss attractive investment opportunities and certain of its
assets may be uninvested with no return earned thereon for some period. If the
Fund cannot settle or is delayed in settling a sale of securities, it may lose
money if the value of the security then declines or, if it has contracted to
sell the security to another party, the Fund could be liable to that party for
any losses incurred.
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
SWAP AGREEMENTS
The Fund may enter into interest rate, index and currency exchange rate
swap agreements for purposes of attempting to obtain a particular desired return
at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded the desired return. Swap agreements are two party
contracts entered into primarily by institutional investors for periods ranging
from a few weeks to more than one year. In a standard "swap" transaction, two
parties agree to exchange the returns (or differentials in rates of return)
earned or realized on particular predetermined investments or instruments. The
gross returns to be exchanged or "swapped" between the parties are calculated
with respect to a "notional amount," i.e., the return on or increase in value of
a particular dollar amount invested at a particular interest rate, in a
particular foreign currency, or in a "basket" of securities representing a
particular index. The "notional amount" of the swap agreement is only a fictive
basis on which to calculate the obligations which the parties to a swap
agreement have agreed to exchange. The Fund's obligations (or rights) under a
swap agreement will generally be equal only to the net amount to be paid or
received under the agreement based on the relative values of the positions held
by each party to the agreement (the "net amount"). The Fund's obligations under
a swap agreement will be accrued daily (offset against any amounts owing to the
Fund) and any accrued but unpaid net amounts owed to a swap counter-party will
be covered by marking as segregated cash, U.S. government securities, equity
securities or other liquid, unencumbered assets, marked-to-market daily, to
avoid any potential leveraging of the Fund's portfolio. The Fund will not enter
into a swap agreement with any single party if the net amount owed or to be
received under existing contracts with that party would exceed 5% of the Fund's
assets.
20
<PAGE> 615
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Investment Adviser's
ability to correctly predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, the Fund bears the risk
of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counter-party.
Restrictions imposed by the Internal Revenue Code may limit the Fund's ability
to use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps market,
including potential government regulation, could adversely affect the Fund's
ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
RISK FACTORS RELATING TO INVESTING IN HIGH YIELD SECURITIES
A description of security ratings is attached as an Appendix. Lower-rated
or unrated (that is, high yield) securities are more likely to react to
developments affecting market risk (such as interest rate sensitivity, market
perception of the creditworthiness of the issuer and general market liquidity)
and credit risk (such as the issuer's inability to meet its obligations) than
are more highly rated securities, which react primarily to movements in the
general level of interest rates. The Investment Adviser considers both credit
risk and market risk in making investment decisions for the Fund.
The amount of high yield securities outstanding proliferated in the 1980's
in conjunction with the increase in merger and acquisition and leveraged buyout
activity. Under adverse economic conditions, there is a risk that highly
leveraged issuers may be unable to service their debt obligations upon maturity.
In addition, the secondary market for high yield securities, which is
concentrated in relatively few market makers, may not be as liquid as the
secondary market for more highly rated securities. Under adverse market or
economic conditions, the secondary market for high yield securities could
contract further, independent of any specific adverse changes in the condition
of a particular issuer. As a result, the Investment Adviser could find it more
difficult to sell these securities or may be able to sell the securities only at
prices lower than if such securities were widely traded. Prices realized upon
the sale of such lower-rated or unrated securities, under these circumstances,
may be less than the prices used in calculating the Fund's net asset value prior
to the sale.
Lower-rated or unrated debt obligations also present risks based on payment
expectations. If an issuer calls the obligation for redemption, the Fund may
have to replace the security with a lower yielding security, resulting in a
decreased return for investors. If the Fund experiences unexpected net
redemptions, it may be forced to sell its higher-rated securities, resulting in
a decline in the overall credit quality of the Fund's portfolio and increasing
the exposure of the Fund to the risks of high yield securities.
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions of
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act, securities which are otherwise not readily
marketable and repurchase agreements that have a maturity of longer than seven
days. Securities which have not been registered under the Securities Act are
referred to as private placements or restricted securities and are purchased
directly from the issuer or in the secondary market. Limitations on resale may
have an adverse effect on the marketability of portfolio securities and a mutual
fund might be unable to dispose of restricted or other illiquid securities
promptly or at reasonable prices and might thereby experience difficulty
satisfying redemption within seven days. The absence of a trading market can
make it difficult to ascertain a market value for illiquid investments. Also
market quotations are less readily available. The judgment of the Investment
Adviser may at times play a greater role in valuing these securities than in the
case of unrestricted securities. A mutual fund might also have to register such
restricted securities in order to dispose of them resulting in additional
expense and delay. Adverse market conditions could impede such a public offering
of securities.
21
<PAGE> 616
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Investment Adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least one nationally recognized statistical
rating organizations ("NRSRO"), or, if unrated, be of comparable quality in the
view of the Investment Adviser; and (2) it must not be in default as to
principal or interest. Investing in Rule 144A securities could have the effect
of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
REVERSE REPURCHASE AGREEMENTS
The Fund may enter into reverse repurchase agreements, whereby the Fund
sells securities concurrently with entering into an agreement to repurchase
those securities at a later date at a fixed price. During the reverse repurchase
agreement period, the Fund continues to receive principal and interest payments
on those securities. Reverse repurchase agreements are speculative techniques
involving leverage and are considered borrowings by the Fund for purposes of the
limit applicable to borrowings.
DOLLAR ROLLS
The Fund may use dollar rolls as part of its investment strategy. In a
dollar roll, the Fund sells securities for delivery in the current month and
simultaneously contracts to repurchase substantially similar securities (same
type and coupon) on a specified future date from the same party. During the roll
period, the Fund forgoes principal and interest paid on the securities. The Fund
is compensated by the difference between the current sales price and the forward
price for the future purchase (often referred to as the "drop") as well as by
the interest earned on the cash proceeds of the initial sale. A "covered roll"
is a specific type of dollar roll for which there is an offsetting cash position
or cash equivalent security position that matures on or before the forward
settlement date of the dollar roll transaction.
The Fund will mark as segregated cash, U.S. government securities, equity
securities or other liquid, unencumbered assets, marked-to-market daily, equal
in value to their obligations with respect to dollar rolls. Dollar rolls involve
the risk that the market value of the securities retained by the Fund may
decline below the price of the securities the Fund has sold but is obligated to
repurchase under the agreement. If the buyer of the securities under a dollar
roll files for bankruptcy or becomes insolvent, the Fund's use of the proceeds
of the
22
<PAGE> 617
agreement may be restricted pending a determination by the other party, or its
trustee or receiver, whether to enforce the Fund's obligation to repurchase the
securities. Dollar rolls are speculative techniques involving leverage and are
considered borrowings by the Fund for purposes of the limit applicable to
borrowings.
BORROWING
The Fund may borrow for temporary, emergency or investment purposes. This
borrowing may be unsecured. The 1940 Act requires the Fund to maintain
continuous asset coverage (that is, total assets including borrowings, less
liabilities exclusive of borrowings) of 300% of the amount borrowed. Borrowing
subjects the Fund to interest costs which may or may not be recovered by
appreciation of the securities purchased, and can exaggerate the effect on net
asset value of any increase or decrease in the market value of the Fund's
portfolio. This is the speculative factor known as leverage.
LOANS OF PORTFOLIO SECURITIES
For the purpose of achieving income, the Fund may lend its portfolio
securities, provided: (1) the loan is secured continuously by collateral
consisting of short-term, high quality debt securities, including U.S.
government securities, negotiable certificates of deposit, bankers' acceptances
or letters of credit, maintained on a daily marked-to-market basis in an amount
at least equal to the current market value of the securities loaned; (2) the
Fund may at any time call the loan and obtain the return of the securities
loaned; (3) the Fund will receive any interest or dividends paid on the loaned
securities; and (4) the aggregate market value of securities loaned will not at
any time exceed one-third of the total assets of the Fund.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value of the security each day in determining the Fund's net asset
value. The Fund will also mark as segregated with its custodian cash, U.S.
government securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily, equal in value to its obligations for when-issued
securities.
REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain Internal Revenue Code requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties, as well as
greater income potential than an investment in common stocks. Like any
investment in real estate, though, a REIT's performance depends on several
factors, such as its ability to find tenants for its properties, to renew leases
and to finance property purchases and renovations.
SHARES OF OTHER INVESTMENT COMPANIES
The Fund can invest in securities of other investment companies except to
the extent prohibited by law. Like all equity investments, these investments may
go up or down in value. They also may not perform in correlation with the Fund's
principal strategies. The Fund will pay additional fees through its investments
in other investment companies.
23
<PAGE> 618
SHORT SALES AGAINST-THE-BOX
The Fund can borrow and sell "short" securities when it also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund's
total assets can be held as collateral for short sales at any one time.
CORPORATE LOANS
The Fund can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Fund may not
recover its investment, or there might be a delay in the Fund's recovery. By
investing in a corporate loan, the Fund becomes a member of the syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, the Fund may invest
all or part of its assets in short-term investment grade debt obligations of the
U.S. government, its agencies and instrumentalities, bank certificates of
deposit, bankers' acceptances, high quality commercial paper, demand notes and
repurchase agreements.
MANAGEMENT OF THE FUND
The Trustees oversee the actions of the Fund's Investment Adviser and other
service providers and decide upon matters of general policy. The Trustees also
review the actions of the Trust's officers, who conduct and supervise the daily
business operations of the Trust. The Trustees (* denotes "interested" Trustee
as defined in the 1940 Act, due to the relationship with the Investment Adviser)
and officers of the Trust are:
MICHAEL BAXTER* (37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since 1999);
Managing Director of the Investment Adviser (since 1996); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since 1994); Chairman, Gamma Services Corp.
(venture capital) (since 1968); Principal, Gavin, Dailey & Partners (consulting)
(since 1993); U.S. Ambassador to Mexico (1981 - 1986); Director, Apex Mortgage
Capital, Inc., Atlantic Richfield Co., International Wire Corp. and Krause's
Furniture.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (since 1986); Member of CIEBA's Executive Committee (since
1988) and its Chairman (from 1991 - 1992); Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds (1986 - 1993); Member of the Investment Advisory Committees of
the State of New York Common Retirement Fund and the Howard Hughes Medical
Institute (since 1997); Director, Duke
24
<PAGE> 619
Management Company (since 1992) and Vice Chairman (since 1998); Director, Kimco
Realty Corporation (since 1997); Director, LaSalle Street Fund (since 1995);
Member of the Investment Advisory Committee of the Virginia Retirement System
(since 1998); Director, Montpelier Foundation (since 1998); Trustee or Director
of 31 registered investment companies (consisting of 47 portfolios) for which
the Investment Adviser or an advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since
1999); Managing Director of the Investment Adviser (since 1998); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (49) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 66 registered investment companies
(consisting of 70 portfolios) for which the Investment Adviser or an affiliate
is the adviser.
NANCY D. CELICK (49) -- President -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Chief Administrative Officer of the Investment
Adviser (since 1998); Chief Financial Officer of the Investment Adviser
(1993 - 1998); Chief Financial Officer of Kennedy-Wilson, Inc. (auction
marketing services) (1992 - 1993); Chief Financial Officer of First National
Corporation (bank holding company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-9011. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services,
Inc. (since 1999); Vice President of FAM Distributors, Inc. (since 1999); First
Vice President of the Investment Adviser (1990 - 1997).
ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
GRACIE FERMELIA (38) -- Vice President and Assistant Secretary -- 725 South
Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Director of the
Investment Adviser (since 2000); Vice President of the Investment Adviser
(1994 - 2000); Senior Manager, Price Waterhouse (1985 - 1994).
The Trust does not pay salaries to any of its officers or fees to any of
its Trustees affiliated with the Investment Adviser. The following table sets
forth the aggregate compensation paid to the Trustees during the Trust's fiscal
year ended June 30, 2000 and the aggregate compensation paid to the Trustees for
service on the Trust's Board and that of any other fund for which the Investment
Adviser serves as investment adviser or
25
<PAGE> 620
which has an investment adviser that is an affiliated person of the Investment
Adviser ("Fund Complex") for the year ended December 31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $ $ 39,007
John A. G. Gavin................................... $ $ 25,000
Joe Grills......................................... $ $232,333
Nigel Hurst-Brown.................................. $ -0- $ -0-
Robert B. Hutchinson**............................. $ $ 34,000
Madeleine A. Kleiner............................... $ $ 18,000
Merle T. Welshans**................................ $ $ 34,000
Richard R. West.................................... $ $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of Mercury HW Variable Trust, Fund
Asset Management Master Trust and Merrill Lynch Investment Managers Funds,
Inc. Messrs. Grills and West also serve on the boards of other investment
companies advised by the Investment Adviser and its advisory affiliates.
** Messrs. Hutchinson and Welshans retired on November 12, 1999.
The Trustees may be eligible for reduced sales charges on purchases of
Class I shares. See "Reduced Initial Sales Charges -- Purchase Privileges of
Certain Persons."
For information as to ownership of shares, see "General
Information -- Principal Holders."
ADVISORY ARRANGEMENTS
Investment Advisory Services and Fee. The Trust on behalf of the Fund has
entered into an investment advisory agreement (the "Advisory Agreement") with
the Investment Adviser acting as investment adviser. Subject to the supervision
of the Trustees, the Investment Adviser is responsible for the actual management
of the Fund and constantly reviews the Fund's holdings in light of its own
research analysis and that from other relevant sources. The responsibility for
making decisions to buy, sell or hold a particular security rests with the
Investment Adviser. The Investment Adviser performs certain of the other
administrative services and provides all office space, facilities, equipment and
necessary personnel for management of the Fund. The Investment Adviser receives
for its services to the Fund a monthly fee at an annual rate of 0.40% of the
Fund's average daily net assets up to $100 million, 0.35% of the Fund's average
daily net assets from $100 million through $249,999,999, 0.30% of the Fund's
average daily net assets from $250,000,000 through $499,999,999 and 0.25% of the
Fund's average daily net assets over $500 million. For purposes of this
calculation, average daily net assets is determined at the end of each month on
the basis of the average net assets of the Fund for each day during the month.
Prior to October , 2000, the Fund was party to an investment advisory
agreement under which it paid MLIM, an affiliate of the Investment Adviser, a
fee at the annual rate of 0.40% of the Fund's average daily net assets under
$100,000,000, 0.35% of the Fund's average daily net assets from $100,000,000
through $249,999,999, 0.30% of the Fund's average daily net assets from
$250,000,000 through $499,999,999, and 0.25% of the Fund's average daily net
assets over $500,000,000. For the fiscal years ended June 30, 2000, 1999 and
1998, the Fund paid Merrill Lynch Investment Managers, L.P. $ ,
$84,035 and $0, respectively. As a result of its agreement to limit Fund
expenses, for these years Merrill Lynch Investment Managers, L.P. waived a
portion of its fee in the amount of $ , $85,670 and $105,600. For the year
ended June 30, 1998, the Fund paid no advisory fees and was reimbursed $11,030
by Merrill Lynch Investment Managers, L.P.
26
<PAGE> 621
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients of the Investment Adviser or an affiliate when one or more clients of
the Investment Adviser or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Payment of Fund Expenses. The Advisory Agreement obligates the Investment
Adviser to provide investment advisory services and to pay, or cause an
affiliate to pay, for maintaining its staff and personnel and to provide office
space, facilities and necessary personnel for the Fund. The Investment Adviser
is also obligated to pay, or cause an affiliate to pay, the fees of all officers
and Trustees who are affiliated persons of the Investment Adviser or any
sub-adviser or of an affiliate of the Investment Adviser or any sub-adviser. The
Fund pays, or causes to be paid, all other expenses incurred in the operation of
the Fund (except to the extent paid by FAM Distributors, Inc. (the
"Distributor")), including, among other things, taxes, expenses for legal and
auditing services, costs of printing proxies, shareholder reports, copies of the
Registration Statement, charges of the custodian, any sub-custodian and the
transfer agent, expenses of portfolio transactions, expenses of redemption of
shares, commission fees, expenses of registering the shares under Federal, state
or non-U.S. laws, fees and actual out-of-pocket expenses of non-interested
Trustees, accounting and pricing costs (including the daily calculation of net
asset value), insurance, interest, brokerage costs, litigation and other
extraordinary or non-recurring expenses, and other expenses properly payable by
the Fund. Accounting services are provided to the Fund by the Investment Adviser
or an affiliate of the Investment Adviser, and the Fund reimburses the
Investment Adviser or an affiliate of the Investment Adviser for its costs in
connection with such services.
Organization of the Investment Adviser. The Investment Adviser is a limited
partnership, the partners of which are Merrill Lynch & CO. ("ML & Co."), a
financial services holding company and the parent of Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch") and Princeton Services, Inc. ML &
Co. and Princeton Services, Inc. are "controlling persons" of the Investment
Adviser as defined under the 1940 Act because of their ownership of its voting
securities and their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Advisory Agreement will remain in effect from year to year if approved annually
(a) by the Board of Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees of the Trust who are
not parties to the Advisory Agreement or interested persons (as defined in the
1940 Act) of any such party. The Advisory Agreement is not assignable and will
automatically terminate in the event of its assignment. In addition, such
contract may be terminated by the vote of a majority of the outstanding voting
securities of the Fund or by the Investment Adviser without penalty on 60 days'
written notice to the other party.
ACCOUNTING AND ADMINISTRATIVE SERVICES
The Trust has entered into a Fund Accounting and Administration Servicing
Agreement (the "Fund Accounting Agreement") with the Investment Adviser acting
as service provider. The Fund Accounting Agreement obligates the Investment
Adviser to provide certain accounting and administrative services to the Trust.
The Trust reimburses the Investment Adviser for its costs in connection with
such services.
Transfer Agency Services. The Transfer Agent, a subsidiary of ML & Co.,
acts as the Fund's Transfer Agent pursuant to a Transfer Agency, Dividend
Disbursing Agency and Shareholder Servicing Agency Agreement (the "Transfer
Agency Agreement"). Pursuant to the Transfer Agency Agreement, the Transfer
Agent is responsible for the issuance, transfer and redemption of shares and the
opening and maintenance of shareholder accounts. Pursuant to the Transfer Agency
Agreement, the Transfer Agent receives a fee ranging
27
<PAGE> 622
from $16.00 to $20.00 per account (depending on the level of services required)
and certain other fees relating to special processing of sub-transfer agency
relationships. The Transfer Agent is entitled to reimbursement for certain
transaction charges and out-of-pocket expenses incurred by the Transfer Agent
under the Transfer Agency Agreement. For purposes of the Transfer Agency
Agreement, the term "account" includes a shareholder account maintained directly
by the Transfer Agent and any other account representing the beneficial interest
of a person in the relevant share class on a recordkeeping system.
Distribution Expenses. The Fund has entered into a distribution agreement
with the Distributor in connection with the continuous offering of shares of the
Fund (the "Distribution Agreement"). The Distribution Agreement obligates the
Distributor to pay certain expenses in connection with the offering of the
shares of the Fund. After the prospectuses, statements of additional information
and periodic reports have been prepared, set in type and mailed to shareholders,
the Distributor pays for the printing and distribution of copies thereof used in
connection with the offering to dealers and investors. The Distributor also pays
for other supplementary sales literature and advertising costs. The Distribution
Agreement is subject to the same renewal requirements and termination provisions
as the Advisory Agreement described above.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act that covers the Trust, the Investment Adviser and the
Distributor (the "Code of Ethics"). The Code of Ethics significantly restricts
the personal investing activities of all employees of the Investment Adviser and
the Distributor and, as described below, imposes additional more onerous
restrictions on fund investment personnel.
The Code of Ethics requires that all employees of the Investment Adviser
and the Distributor pre-clear any personal securities investments (with limited
exceptions, such as mutual funds, high-quality short-term securities and direct
obligations of the U.S. government). The pre-clearance requirement and
associated procedures are designed to identify any substantive prohibition or
limitation applicable to the proposed investment. The substantive restrictions
applicable to all employees of the Investment Adviser and the Distributor
include a ban on acquiring any securities in a "hot" initial public offering. In
addition, investment personnel are prohibited from profiting on short-term
trading in securities. No employee may purchase or sell any security that at the
time is being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Investment Adviser. Furthermore, the Code of Ethics provides for trading
"blackout periods" which prohibit trading by investment personnel of the Fund
within seven calendar days, before or after, of trading by the Fund in the same
or equivalent security.
PURCHASE OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus for certain information as to the purchase of
Fund shares.
The Fund issues a single class of shares. Each share of the Fund represents
an identical interest in the investment portfolio of the Fund and has the same
rights.
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share plus any sales charge applicable to the
shares. The applicable offering price for purchase orders is based upon the net
asset value of the Fund next determined after receipt of the purchase order by
the Distributor. As to purchase orders received by selected securities dealers
or other financial intermediaries prior to the close of regular trading on the
New York Stock Exchange (the "NYSE") (generally 4:00 p.m., Eastern time) which
includes orders received after the determination of net asset value on the
previous day, the applicable offering price will be based on the net asset value
on the day the order is placed with the Distributor, provided that the orders
are received by the Distributor prior to 30 minutes after the close of regular
trading on the NYSE on that day. If the purchase orders are not received prior
to 30 minutes after the close of regular trading on the NYSE on that day, such
orders shall be deemed received on the next business day. Selected securities
dealers
28
<PAGE> 623
or other financial intermediaries have the responsibility of submitting purchase
orders to the Fund not later than 30 minutes after the close of regular trading
on the NYSE in order to purchase shares at that day's offering price.
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares at any time in response to conditions in the securities markets or
otherwise and may thereafter resume such offering from time to time. Any order
may be rejected by the Fund or the Distributor. Neither the Distributor nor the
selected securities dealers or other financial intermediaries are permitted to
withhold placing orders to benefit themselves by a price change. Certain
selected securities dealers or other financial intermediaries may charge a
processing fee to confirm a sale of shares. For example, the fee currently
charged by Merrill Lynch is $5.35. Purchases made directly through the Transfer
Agent are not subject to the processing fee.
CLASS I SHARES
Class I shares will be subject to an initial sales charge, unless you
qualify for a reduction or waiver of the sales charge. See "Reduced Initial
Sales Charges."
The term "purchase," as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class I shares of the
Fund, refers to a single purchase by an individual or to concurrent purchases,
which in the aggregate are at least equal to the prescribed amounts, by an
individual, his or her spouse and their children under the age of 21 years
purchasing shares for his, her or their own account and to single purchases by a
trustee or other fiduciary purchasing shares for a single trust estate or single
fiduciary account although more than one beneficiary is involved. The term
"purchase" also includes purchases by any "company," as that term is defined in
the 1940 Act, but does not include purchases by any such company that has not
been in existence for at least six months or which has no purpose other than the
purchase of shares of the Fund or shares of other registered investment
companies at a discount; provided, however, that it shall not include purchases
by any group of individuals whose sole organizational nexus is that the
participants therein are credit cardholders of a company, policyholders of an
insurance company, customers of either a bank or broker-dealer or clients of an
investment adviser.
Class I shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class I shares. Investors
who owned Investor Class shares or who currently own Class I shares of the Fund
in a shareholder account are entitled to purchase additional Class I shares of
the Fund in that account. Certain employer-sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class I shares at net asset
value provided such plans meet the required minimum number of eligible employees
or required amount of assets advised by the Investment Adviser or any of its
affiliates. Also eligible to purchase Class I shares at net asset value are
participants in certain investment programs including certain managed accounts
for which a trust institution, thrift or bank trust department provides
discretionary trustee services, certain collective investment trusts for which a
trust institution, thrift, or bank trust department serves as trustee, certain
purchases made in connection with certain fee-based programs and certain
purchases made through certain financial advisers that meet and adhere to
standards established by the Investment Adviser. Class I shares are available at
net asset value to corporate warranty insurance reserve fund programs and U.S.
branches of foreign banking institutions, provided that the participant has $3
million or more initially invested in Affiliate-Advised investment companies. In
addition, Class I shares are offered at net asset value to ML & Co. and its
subsidiaries and their directors and employees, to members of the Boards of
investment companies advised by the Investment Adviser or its affiliates,
including the Fund, and to employees of certain selected securities dealers or
other financial intermediaries. Class I shares may also be offered at net asset
value to certain accounts over which the Investment Adviser or an affiliate
exercises investment discretion. Although some investors who previously
purchased Class I shares may no longer be eligible to purchase Class I shares of
other affiliate-advised funds, those previously purchased Class I shares,
together with Class A, Class B and Class C share holdings of other Mercury
mutual funds, will count toward a right of accumulation which may qualify the
investor for a reduced initial sales charge on new initial sales charge
purchases.
29
<PAGE> 624
The Distributor may reallow discounts to selected securities dealers or
other financial intermediaries and retain the balance over such discounts. At
times the Distributor may reallow the entire sales charge to such selected
securities dealers or other financial intermediaries. Since selected securities
dealers or other financial intermediaries selling Class I shares of the Fund
will receive a concession equal to most of the sales charge, they may be deemed
to be underwriters under the Securities Act.
REDUCED INITIAL SALES CHARGES
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
to obtain such investments.
Reinvested Dividends. No initial sales charges are imposed upon shares
issued as a result of the automatic reinvestment of dividends.
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other Mercury mutual funds. For any such right of accumulation to be
made available, the Distributor must be provided at the time of purchase, by the
purchaser or the purchaser's selected securities dealer or other financial
intermediary, with sufficient information to permit confirmation of
qualification. Acceptance of the purchase order is subject to such confirmation.
The right of accumulation may be amended or terminated at any time. Shares held
in the name of a nominee or custodian under pension, profit-sharing, or other
employee benefit plans may not be combined with other shares to qualify for the
right of accumulation.
Letter of Intent. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class I shares of the Fund or any other Mercury
mutual funds made within a 13-month period starting with the first purchase
pursuant to the Letter of Intent. The Letter of Intent is available only to
investors whose accounts are established and maintained at the Fund's Transfer
Agent. The Letter of Intent is not available to employee benefit plans for which
affiliates of the Investment Adviser provide plan participant record-keeping
services. The Letter of Intent is not a binding obligation to purchase any
amount of Class I shares; however, its execution will result in the purchaser
paying a lower sales charge at the appropriate quantity purchase level. A
purchase not originally made pursuant to a Letter of Intent may be included
under a subsequent Letter of Intent executed within 90 days of such purchase if
the Distributor is informed in writing of this intent within such 90-day period.
The value of Class I shares of the Fund and of other Mercury mutual funds
presently held, at cost or maximum offering price (whichever is higher), on the
date of the first purchase under the Letter of Intent, may be included as a
credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied only to new
purchases. If the total amount of shares does not equal the amount stated in the
Letter of Intent (minimum of $25,000), the investor will be notified and must
pay, within 20 days of the execution of such Letter, the difference between the
sales charge on the Class I shares purchased at the reduced rate and the sales
charge applicable to the shares actually purchased through the Letter. Class I
shares equal to 5.0% of the intended amount will be held in escrow during the
13-month period (while remaining registered in the name of the purchaser) for
this purpose. The first purchase under the Letter of Intent must be at least
5.0% of the dollar amount of such Letter. If a purchase during the term of such
Letter would otherwise be subject to a further reduced sales charge based on the
right of accumulation, the purchaser will be entitled on that purchase and
subsequent purchases to that further reduced percentage sales charge but there
will be no retroactive reduction of the sales charges on any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intent will be deducted from
the total purchases made under such Letter. An exchange from the Summit Cash
Reserves Fund ("Summit") into the Fund that creates a sales charge will count
toward completing a new or existing Letter of Intent from the Fund.
30
<PAGE> 625
Employer-Sponsored Retirement or Savings Plans and Certain Other
Arrangements. Certain employer-sponsored retirement or savings plans and certain
other arrangements may purchase Class I shares at net asset value, based on the
number of employees or number of employees eligible to participate in the plan
and/or the aggregate amount invested by the plan in specified investments.
Minimum purchase requirements may be waived or varied for such plans. For
additional information regarding purchases by employer-sponsored retirement or
savings plans and certain other arrangements, call your plan administrator or
your selected securities dealer or other financial intermediary.
Managed Trusts. Class I shares are offered at net asset value to certain
trusts to which trust institutions, thrifts, and bank trust departments provide
discretionary trustee services.
Purchase Privileges of Certain Persons. Trustees of the Trust and of other
investment companies advised by the Investment Adviser or its affiliates,
directors and employees of ML & Co. and its subsidiaries (the term
"subsidiaries," when used herein with respect to ML & Co., includes the
Investment Adviser, Merrill Lynch Investment Managers, L.P., Merrill Lynch
Investment Managers International Limited and certain other entities directly or
indirectly wholly owned and controlled by ML & Co.), employees of certain
selected securities dealers, and any trust, pension, profit-sharing or other
benefit plan for such persons, may purchase Class I shares of the Fund at net
asset value. The Fund realizes economies of scale and reduction of sales-
related expenses by virtue of the familiarity of these persons with the Fund.
Employees and Trustees wishing to purchase shares of the Fund must satisfy the
Fund's suitability standards.
Class I shares are also offered at net asset value to certain accounts over
which the Investment Adviser or an affiliate exercises investment discretion.
Purchases Through Certain Financial Intermediaries. Reduced sales charges
may be applicable for purchases of Class I shares of the Fund through certain
financial advisers, selected securities dealers and other financial
intermediaries that meet and adhere to standards established by the Investment
Adviser from time to time.
A waived sales charge on a purchase of Class I shares will apply to current
beneficial shareholders who were also beneficial shareholders of the Fund as of
the opening of business of the Fund on October , 2000.
REDEMPTION OF SHARES
Reference is made to "Account Choices -- How to Buy, Sell, Transfer and
Exchange Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. There will be no charge for redemption if the redemption request is
sent directly to the Transfer Agent. Shareholders liquidating their holdings
will receive upon redemption all dividends reinvested through the date of
redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists, as defined by the
Commission, as a result of which disposal of portfolio securities or
determination of the net asset value of the Fund is not reasonably practicable,
and for such other periods as the Commission may by order permit for the
protection of shareholders of the Fund.
The value of shares of the Fund at the time of redemption may be more or
less than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
The Trust has entered into a joint committed line of credit with other
investment companies advised by the Investment Adviser and its affiliates and a
syndicate of banks that is intended to provide the Fund with a temporary source
of cash to be used to meet redemption requests from Fund shareholders in
extraordinary or emergency circumstances.
31
<PAGE> 626
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so by tendering the shares directly to the Fund's Transfer Agent, Financial Data
Services, Inc., P.O. Box 41621, Jacksonville, Florida 32232-1621. Redemption
requests delivered other than by mail should be delivered to Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting redemption. Redemption
requests should not be sent to the Fund. The redemption request in either event
requires the signature(s) of all persons in whose name(s) the shares are
registered, signed exactly as such name(s) appear(s) on the Transfer Agent's
register. The signature(s) on the redemption request may require a guarantee by
an "eligible guarantor institution" as defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications. In the
event a signature guarantee is required, notarized signatures are not
sufficient. In general, signature guarantees are waived on redemptions of less
than $50,000 as long as the following requirements are met: (i) all requests
require the signature(s) of all persons in whose name(s) shares are recorded on
the Transfer Agent's register; (ii) all checks must be mailed to the stencil
address of record on the Transfer Agent's register and (iii) the stencil address
must not have changed within 30 days. Certain rules may apply regarding certain
account types such as but not limited to UGMA/UTMA accounts, Joint Tenancies
with Rights of Survivorship, contra broker transactions and institutional
accounts. In certain instances, the Transfer Agent may require additional
documents such as, but not limited to, trust instruments, death certificates,
appointments as executor or administrator, or certificates of corporate
authority.
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the Transfer
Agent at 1-800-236-4479. The request must be made by the shareholder of record
and be for an amount less than $50,000. Before telephone requests will be
honored, signature approval from all shareholders of record on the account must
be obtained. The shares being redeemed must have been held for at least 15 days.
Telephone redemption requests will not be honored in the following situations:
the accountholder is deceased, the proceeds are to be sent to someone other than
the shareholder of record, funds are to be wired to the client's bank account, a
systematic withdrawal plan is in effect, the request is by an individual other
than the accountholder of record, the account is held by joint tenants who are
divorced, the address has changed within the last 30 days or share certificates
have been issued on the account.
Since this account feature involves a risk of loss from unauthorized or
fraudulent transactions, the Transfer Agent will take certain precautions to
protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address registered
on the account and the social security number registered on the account. The
Fund or the Transfer Agent may temporarily suspend telephone transactions at any
time.
For shareholders redeeming directly with the Transfer Agent, payments will
be mailed within seven days of receipt of a proper notice of redemption. At
various times the Fund may be requested to redeem shares for which it has not
yet received good payment (e.g., cash, Federal funds or certified check drawn on
a U.S. bank). The Fund may delay or cause to be delayed the mailing of a
redemption check until such time as good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank) has been collected for the purchase of
such Fund shares, which usually will not exceed 10 days. In the event that a
shareholder account held directly with the Transfer Agent contains a fractional
share balance, such fractional share balance will be automatically redeemed by
the Fund.
REPURCHASE
The Fund also will repurchase its shares through a shareholder's listed
selected securities dealer or other financial intermediary. The Fund normally
will accept orders to repurchase shares by wire or telephone from dealers for
their customers at the net asset value next computed after the order is placed.
Shares will be priced at the net asset value calculated on the day the request
is received, provided that the request for repurchase is submitted to the
selected securities dealer or other financial intermediary prior to the close of
regular trading
32
<PAGE> 627
on the NYSE (generally, regular trading on the NYSE closes at 4:00 p.m., Eastern
time) and such request is received by the Fund from such selected securities
dealer or other financial intermediary not later than 30 minutes after the close
of regular trading on the NYSE on the same day.
Selected securities dealers and other financial intermediaries have the
responsibility of submitting such repurchase requests to the Fund not later than
30 minutes after the close of regular trading on the NYSE in order to obtain
that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund. Securities firms that do
not have agreements with the Distributor, however, may impose a transaction
charge on the shareholder for transmitting the notice of repurchase to the Fund.
Certain selected securities dealers and other financial intermediaries may
charge a processing fee to confirm a repurchase of shares. For example, the fee
currently charged by Merrill Lynch is $5.35. Fees charged by other selected
securities dealers may be higher or lower. Repurchases made through the Transfer
Agent, on accounts held at the Transfer Agent, are not subject to the processing
fee. The Fund reserves the right to reject any order for repurchase, which right
of rejection might adversely affect shareholders seeking redemption through the
repurchase procedure. A shareholder whose order for repurchase is rejected by
the Fund, however, may redeem Fund shares as set forth above.
REINSTATEMENT PRIVILEGE -- CLASS I SHARES
Shareholders of the Fund who have redeemed their Class I shares have a
privilege to reinstate their accounts by purchasing Class I shares of the Fund
at the net asset value without a sales charge up to the dollar amount redeemed.
The reinstatement privilege may be exercised by sending a notice of exercise
along with a check for the amount to be reinstated to the Transfer Agent within
30 days after the date the request for redemption was accepted by the Transfer
Agent or the Distributor. Alternatively, the reinstatement privilege may be
exercised through the investor's financial consultant within 30 days after the
date the request for redemption was accepted by the Transfer Agent or the
Distributor. The reinstatement will be made at the net asset value per share
next determined after the notice of reinstatement is received and cannot exceed
the amount of the redemption proceeds.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "Account Choices -- How Shares are Priced" in the
Prospectus.
The net asset value of the shares of the Fund is determined once daily
Monday through Friday as of the close of regular trading on the NYSE on each day
the NYSE is open for trading based on prices at the time of closing. Regular
trading on the NYSE generally closes at 4:00 p.m., Eastern time. Any assets or
liabilities initially expressed in terms of non-U.S. dollar currencies are
translated into U.S. dollars at the prevailing market rates as quoted by one or
more banks or dealers on the day of valuation. The NYSE is not open for trading
on New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Net asset value of the Fund is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Investment Adviser, are accrued daily.
Portfolio securities, including ADRs, EDRs or GDRs, that are traded on
stock exchanges are valued at the last sale price (regular way) on the exchange
on which such securities are traded, as of the close of regular trading on the
day the securities are being valued or, lacking any sales, at the last available
bid price for long positions, and at the last available ask price for short
positions. In cases where securities are traded on more than one exchange, the
securities are valued on the exchange designated by or under the authority of
the Board of Trustees as the primary market. Long positions in securities traded
in the OTC market are valued at
33
<PAGE> 628
the last available bid price in the OTC market prior to the time of valuation.
Short positions in securities traded in the OTC market are valued at the last
available ask price in the OTC market prior to the time of valuation. Portfolio
securities that are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market. When the Fund
writes an option, the amount of the premium received is recorded on the books of
the Fund as an asset and an equivalent liability. The amount of the liability is
subsequently valued to reflect the current market value of the option written,
based upon the last sale price in the case of exchange-traded options or, in the
case of options traded in the OTC market, the last ask price. Options purchased
by the Fund are valued at their last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last bid price.
Other investments, including financial futures contracts and related options,
are stated at market value. Securities and assets for which market quotations
are not readily available are valued at fair value as determined in good faith
by or under the direction of the Board of Trustees. Such valuations and
procedures will be reviewed periodically by the Board of Trustees.
Generally, trading in non-U.S. securities, as well as U.S. Government
securities and money market instruments, is substantially completed each day at
various times prior to the close of regular trading on the NYSE. The values of
such securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of regular trading on the NYSE. Occasionally,
events affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of regular trading
on the NYSE that may not be reflected in the computation of the Fund's net asset
value.
Each investor in the Fund may add to or reduce its investment in the Fund
on each day the NYSE is open for trading. The value of each investor's interest
in the Fund will be determined as of the close of regular trading on the NYSE by
multiplying the net asset value of the Fund by the percentage, effective for
that day, that represents that investor's share of the aggregate interests in
the Fund. The close of regular trading on the NYSE is generally 4:00 p.m.,
Eastern time. Any additions or withdrawals to be effected on that day will then
be effected. The investor's percentage of the aggregate beneficial interests in
the Fund will then be recomputed as the percentage equal to the fraction (i) the
numerator of which is the value of such investor's investment in the Fund as of
the time of determination on such day plus or minus, as the case may be, the
amount of any additions to or withdrawals from the investor's investment in the
Fund effected on such day, and (ii) the denominator of which is the aggregate
net asset value of the Fund as of such time on such day plus or minus, as the
case may be, the amount of the net additions to or withdrawals from the
aggregate investments in the Fund by all investors in the Fund. The percentage
so determined will then be applied to determine the value of the investor's
interest in the Fund after the close of regular trading on the NYSE on the next
determination of net asset value of the Fund.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for shares of the
Fund based on the net asset value of the Fund's shares on June 30, 2000 is as
follows:
<TABLE>
<S> <C>
Net Assets.................................................. $
-------
Number of Shares Outstanding................................
-------
Net Asset Value Per Share (net assets divided by number of
shares outstanding)....................................... $
-------
Sales Charge (for Class I Shares; 2.00% of Offering Price;
( % of net amount invested))*.........................
-------
Offering Price.............................................. $
-------
</TABLE>
---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
34
<PAGE> 629
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Subject to policies established by the Board of Trustees, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Fund, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and operational facilities of the firm and the
firm's risk in positioning a block of securities. While the Investment Adviser
generally seeks reasonably competitive commission rates, the Fund does not
necessarily pay the lowest spread or commission available. In addition,
consistent with the Conduct Rules of the NASD and policies established by the
Board of Trustees, the Investment Adviser may consider sales of Fund shares as a
factor in the selection of brokers or dealers to execute portfolio transactions
for the Fund; however, whether or not a particular broker or dealer sells shares
of the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Fund.
Subject to obtaining the best net results, brokers who provide supplemental
investment research to the Investment Adviser may receive orders for
transactions by the Fund. Such supplemental research services ordinarily consist
of assessments and analyses of the business or prospects of a company, industry
or economic sector. Information so received will be in addition to and not in
lieu of the services required to be performed by the Investment Adviser under
the Investment Advisory Agreement and the expenses of the Investment Adviser
will not necessarily be reduced as a result of the receipt of such supplemental
information. If in the judgment of the Investment Adviser the Fund will benefit
from supplemental research services, the Investment Adviser is authorized to pay
brokerage commissions to a broker furnishing such services that are in excess of
commissions that another broker may have charged for effecting the same
transactions. Certain supplemental research services may primarily benefit one
or more other investment companies or other accounts for which the Investment
Adviser exercises investment discretion. Conversely, the Fund may be the primary
beneficiary of the supplemental research services received as a result of
portfolio transactions effected for such other accounts or investment companies.
The Fund anticipates that its brokerage transactions involving securities
of issuers domiciled in countries other than the United States generally will be
conducted primarily on the principal stock exchanges of such countries.
Brokerage commissions and other transaction costs on foreign stock exchange
transactions generally are higher than in the United States, although the Fund
will endeavor to achieve the best net results in effecting its portfolio
transactions. There generally is less governmental supervision and regulation of
foreign stock exchanges and brokers than in the United States.
The Fund may invest in certain securities traded in the OTC market and
intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Fund and
persons who are affiliated with such affiliated persons are prohibited from
dealing with the Fund as principal in the purchase and sale of securities unless
a permissive order allowing such transactions is obtained from the Commission.
Since transactions in the OTC market usually involve transactions with the
dealers acting as principal for their own accounts, the Fund will not deal with
affiliated persons, including Merrill Lynch and its affiliates, in connection
with such transactions. However, an affiliated person of the Fund may serve as
its broker in OTC transactions conducted on an agency basis provided that, among
other things, the fee or commission received by such affiliated broker is
reasonable and fair compared to the fee or commission received by non-affiliated
brokers in connection with comparable transactions. In addition, the Fund may
not purchase securities during the existence of any underwriting syndicate for
such securities of which Merrill Lynch or an affiliate is a member or in a
private placement in which Merrill Lynch or an affiliate serves as placement
agent except pursuant to procedures approved by the Board of Trustees that
either comply with rules adopted by the Commission or with interpretations of
the Commission staff. See "Investment Objective and Policies -- Investment
Restrictions."
35
<PAGE> 630
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch or its affiliates acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund. Securities may be held by, or be appropriate
investments for, the Fund as well as other funds or investment advisory clients
of the Investment Adviser or its affiliates.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or its affiliates
when one or more clients of the Investment Adviser or its affiliates are selling
the same security. If purchases or sales of securities arise for consideration
at or about the same time that would involve the Fund or other clients or funds
for which the Investment Adviser or an affiliate acts as investment adviser,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Investment Adviser or
its affiliates during the same period may increase the demand for securities
being purchased or the supply of securities being sold, there may be an adverse
effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below that are
designed to facilitate investment in its shares. Full details as to each such
service and copies of the various plans or how to change options with respect
thereto, can be obtained from the Fund by calling the telephone number on the
cover page hereof, or from the Distributor or your selected securities dealer or
other financial intermediary. Certain of these services are available only to
U.S. investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of dividends. The statements
also will show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
dividends. A shareholder with an account held at the Transfer Agent may make
additions to his or her Investment Account at any time by mailing a check
directly to the Transfer Agent. The Fund does not issue share certificates.
Shareholders considering transferring their Class I shares from a selected
securities dealer to another brokerage firm or financial institution should be
aware that, if the firm to which the Class I shares are to be transferred will
not take delivery of shares of the Fund, a shareholder either must redeem the
shares so that the cash proceeds can be transferred to the account at the new
firm or such shareholder must continue to maintain an Investment Account at the
Transfer Agent for those shares.
Certain shareholder services may not be available for the transferred
shares. After the transfer, the shareholder may purchase additional shares of
funds owned before the transfer, and all future trading of these assets must be
coordinated by the new firm.
Shareholders considering transferring a tax-deferred retirement account,
such as an individual retirement account, from a selected securities dealer or
other financial intermediary to another brokerage firm or financial institution
should be aware that, if the firm to which the retirement account is to be
transferred will not take delivery of shares of the Fund, a shareholder must
either redeem the shares so that the cash proceeds can be
36
<PAGE> 631
transferred to the account at the new firm, or such shareholder must continue to
maintain a retirement account at a selected securities dealer or other financial
intermediary for those shares.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other Mercury mutual funds and Summit, a series of Financial
Institutions Series Trust, which is a Merrill Lynch-sponsored money market fund
specifically designated as available for exchange by holders of Class I shares.
Shares with a net asset value of at least $100 are required to qualify for the
exchange privilege and any shares used in an exchange must have been held by the
shareholder for at least 15 days. Before effecting an exchange, shareholders
should obtain a currently effective prospectus of the fund into which the
exchange is to be made. Exercise of the exchange privilege is treated as a sale
of the exchanged shares and a purchase of the acquired shares for Federal income
tax purposes.
Exchanges of Class I Shares. Under the Fund's pricing system, Class I
shareholders may exchange Class I shares of the Fund for Class I shares of a
second Mercury mutual fund. If the Class I shareholder wants to exchange Class I
shares for shares of a second Mercury mutual fund, but does not hold Class I
shares of the second fund in his or her account at the time of exchange and is
not otherwise eligible to acquire Class I shares of the second fund, the
shareholder will receive Class A shares of the second fund as a result of the
exchange.
Exchanges of Class I shares outstanding ("outstanding Class I shares") for
Class I or Class A shares of another Mercury mutual fund, or for Class A shares
of Summit ("new Class I or Class A shares") are transacted on the basis of
relative net asset value per Class I or Class A share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously paid
on the outstanding Class I shares and the sales charge payable at the time of
the exchange on the new Class I or Class A shares. With respect to outstanding
Class I shares as to which previous exchanges have taken place, the "sales
charge previously paid" shall include the aggregate of the sales charges paid
with respect to such Class I shares in the initial purchase and any subsequent
exchange. Class I shares issued pursuant to dividend reinvestment are sold on a
no-load basis. For purposes of the exchange privilege, Class I shares acquired
through dividend reinvestment shall be deemed to have been sold with a sales
charge equal to the sales charge previously paid on the Class I shares on which
the dividend was paid. Based on this formula, Class I shares of the Fund
generally may be exchanged into the Class I and Class A shares, respectively, of
the other funds with a reduced or without a sales charge.
Exchanges for Shares of a Money Market Fund. Class I shares are
exchangeable for Class A shares of Summit. Class A shares of Summit have an
exchange privilege back into Class I or Class A shares of affiliate-advised
Funds. This exchange privilege does not apply with respect to certain fee-based
programs for which alternative exchange arrangements may exist. Please see your
financial consultant for further information.
Prior to October 12, 1998, exchanges from other affiliate-advised Funds
into a money market fund were directed to certain affiliate-advised money market
funds other than Summit. Shareholders who exchanged affiliate-advised Fund
shares for such other money market funds and subsequently wish to exchange those
money market fund shares for shares of the Fund will be subject to the CDSC
schedule applicable to such Fund shares, if any. The holding period for those
money market fund shares will not count toward satisfaction of the holding
period requirement for reduction of the CDSC imposed on such shares, if any,
and, with respect to Class B shares, toward satisfaction of the Conversion
Period. However, the holding period for Class B or Class C shares of the Fund
received in exchange for such money market fund shares will be aggregated with
the holding period for the fund shares originally exchanged for such money
market fund shares for purposes of reducing the CDSC or satisfying the
Conversion Period.
Exercise of the Exchange Privilege. To exercise the exchange privilege, a
shareholder should contact his or her financial consultant, who will advise the
relevant Fund of the exchange. Shareholders of the Fund and shareholders of the
other funds described above with shares for which certificates have not been
issued may exercise the exchange privilege by wire through their selected
securities dealers or other financial intermediaries. The Fund reserves the
right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated in accordance with the rules of the
Commission. The Fund
37
<PAGE> 632
reserves the right to limit the number of times an investor may exercise the
exchange privilege. Certain funds may suspend the continuous offering of their
shares to the general public at any time and may thereafter resume such offering
from time to time. The exchange privilege is available only to U.S. shareholders
in states where the exchange legally may be made. It is contemplated that the
exchange privilege may be applicable to other new mutual funds whose shares may
be distributed by the Distributor.
FEE-BASED PROGRAMS
Certain fee-based programs, including pricing alternatives for securities
transactions (each referred to in this paragraph as a "Program"), may permit the
purchase of Class I shares at net asset value. Under specified circumstances,
participants in certain Programs may deposit other classes of shares, which will
be exchanged for Class I shares. Initial or deferred sales charges otherwise due
in connection with such exchanges may be waived or modified. Termination of
participation in certain Programs may result in the redemption of shares held
therein. [In addition, upon termination of participation in a Program, shares
that have been held for less than specified periods within such Program may be
subject to a fee based on the current value of such shares.] These Programs also
generally prohibit such shares from being transferred to another account, to
another broker-dealer or to the Transfer Agent. Additional information regarding
certain specific Programs offered through particular selected securities dealers
or other financial intermediaries (including charges and limitations on
transferability applicable to shares that may be held in such Programs) is
available in each such Program's client agreement and from the Transfer Agent at
1-800-236-4479.
RETIREMENT PLANS
The minimum initial purchase to establish a retirement plan is $100.
Dividends received in retirement plans are exempt from Federal taxation until
distributed from the plans. Different tax rules apply to Roth IRA plans and
educational savings plans. Investors considering participation in any retirement
or education savings plan should review specific tax laws relating thereto and
should consult their attorneys or tax advisers with respect to the establishment
and maintenance of any such plan.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class I shares at the applicable public offering price. These
purchases may be made either through the shareholder's securities dealer or by
mail directly to the Transfer Agent, acting as agent for such securities dealer.
You may also add to your account by automatically investing a specific amount in
the Fund on a periodic basis through your selected securities dealer or other
financial intermediary. The current minimum for such automatic additional
investments is $100. This minimum may be waived or revised under certain
circumstances.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Shareholders may, at any time, by written notification to their selected
securities dealer or other financial intermediary if their account is maintained
with a selected securities dealer or other financial intermediary, or by written
notification or by telephone (1-800-236-4479) to the Transfer Agent, if their
account is maintained with the Transfer Agent, elect to have subsequent
dividends of ordinary income and/or capital gains paid with respect to shares of
the Fund in cash, rather than reinvested in shares of the Fund (provided that,
in the event that a payment on an account maintained at the Transfer Agent would
amount to $10.00 or less, a shareholder will not receive such payment in cash
and such payment will automatically be reinvested in additional shares).
Commencing ten days after the receipt by the Transfer Agent of such notice,
those instructions will be effected. The Fund is not responsible for any failure
of delivery to the shareholder's address of record and no interest will accrue
on amounts represented by uncashed dividend checks. Cash payments can also be
directly deposited to the shareholder's bank account.
38
<PAGE> 633
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
shares of the Fund having a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals are available for shareholders with
shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed from
those on deposit in the shareholder's account to provide the withdrawal payment
specified by the shareholder. The shareholder may specify the dollar amount to
be redeemed. Redemptions will be made at net asset value as of the close of
regular trading on the NYSE (generally, the NYSE closes at 4:00 p.m., Eastern
time) on the 24th day of each month or the 24th day of the last month of each
quarter, whichever is applicable. If the NYSE is not open for business on such
date, the shares will be redeemed at the net asset value determined after the
close of regular trading on the NYSE on the following business day. The check
for the withdrawal payment will be mailed, or the direct deposit for withdrawal
payment will be made, on the next business day following redemption. When a
shareholder is making systematic withdrawals, dividends on all shares in the
Investment Account are reinvested automatically in Fund shares. A shareholder's
systematic withdrawal plan may be terminated at any time, without a charge or
penalty, by the shareholder, the Fund, the Transfer Agent or the Distributor.
If an investor wishes to change the amount being withdrawn in a systematic
withdrawal plan the investor should contact his or her financial consultant.
Withdrawal payments should not be considered as dividends. Each withdrawal
is a taxable event. If periodic withdrawals continuously exceed reinvested
dividends, the shareholder's original investment may be reduced correspondingly.
Purchases of additional shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax liabilities.
The Fund will not knowingly accept purchase orders for shares of the Fund from
investors who maintain a systematic withdrawal plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
DIVIDENDS AND TAX STATUS
The Fund has qualified as a regulated investment company. Qualification as
a regulated investment company requires, among other things, that (1) at least
90% of the Fund's annual gross income, without offset for losses from the sale
or other disposition of securities, be derived from payments with respect to
securities loans, interest, dividends and gains from the sale or other
disposition of stock, securities, or foreign currencies or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities, or currencies; and (2) the Fund diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of the Fund's assets is represented by cash, U.S. government securities,
securities of other regulated investment companies, and other securities limited
in respect of any one issuer to an amount not greater than 5% of the Fund's
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. government securities or the securities of other
regulated investment companies). In addition, in order not to be subject to
federal taxation, the Fund must distribute to its shareholders at least 90% of
its investment company taxable income earned in each year.
The Fund is required to pay an excise tax to the extent it does not
distribute to its shareholders during any calendar year at least 98% of its
ordinary income for that calendar year, 98% of the excess of its capital gains
over its capital losses for the one-year period ending October 31 in such
calendar year, and all undistributed ordinary income and capital gains for the
preceding respective one-year period. The Fund intends to meet these
distribution requirements to avoid excise tax liability. The Fund also intends
to continue distributing to shareholders all of the excess of net long-term
capital gain over net short-term capital loss on sales of
39
<PAGE> 634
securities. If the net asset value of shares of the Fund should, by reason of a
distribution of realized capital gains, be reduced below a shareholder's cost,
such distribution would to that extent be a return of capital to that
shareholder even though taxable to the shareholder, and a sale of shares by a
shareholder at net asset value at that time would establish a capital loss for
federal tax purposes.
In determining the extent to which the Fund's dividends may be eligible for
the 70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisors regarding other requirements applicable to the dividends received
deduction.
Special rules apply to the treatment of certain forward foreign currency
exchange contracts (Section 1256 contracts). At the end of each year, such
investments held by the Fund must be "marked to market" for federal income tax
purposes; that is, treated as having been sold at market value. Except to the
extent that such gains or losses are treated as "Section 988" gains or losses,
as described below, sixty percent of any gain or loss recognized on these
"deemed sales" and on actual dispositions may be treated as long-term capital
gain or loss, and the remainder will be treated as short-term capital gain or
loss.
Under the Internal Revenue Code, gains or losses attributable to
fluctuations in exchange rates which occur between the time the Fund accrues
interest or other receivables or accrues expenses or other liabilities
denominated in a foreign currency and the time the Fund actually collects such
receivables or pays such liabilities are treated as ordinary income or loss.
Similarly, gains or losses on forward foreign currency exchange contracts or
dispositions of debt securities denominated in a foreign currency attributable
to fluctuations in the value of the foreign currency between the date of
acquisition of the security and the date of disposition are also treated as
ordinary gain or loss. These gains, referred to as "Section 988" gains or
losses, increase or decrease the amount of the Fund's investment company taxable
income available to be distributed to its shareholders as ordinary income,
rather than increasing or decreasing the Fund's net capital gain. If Section 988
losses exceed other investment company taxable income during a taxable year, the
Fund would not be able to make any ordinary dividend distributions, and any
ordinary dividend distributions made before the losses were realized would be
recharacterized as a return of capital to shareholders, rather than as an
ordinary dividend, reducing the basis of each shareholder's shares.
Any loss realized on a sale, redemption or exchange of shares of the Fund
by a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by the Fund constitute a
replacement of shares.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined in accordance with a formula specified
by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with
40
<PAGE> 635
respect to annual or annualized rates of return calculations. Aside from the
impact on the performance data calculations of including or excluding the
maximum applicable sales charges, actual annual or annualized total return data
generally will be lower than average annual total return data since the average
rates of return reflect compounding of return; aggregate total return data
generally will be higher than average annual total return data since the
aggregate rates of return reflect compounding over a longer period of time. The
Fund's total return may be expressed either as a percentage or as a dollar
amount in order to illustrate such total return on a hypothetical $1,000
investment in the Fund at the beginning of each specified period.
Average annual total returns for the periods ended June 30, 2000 are as
follows:
<TABLE>
<CAPTION>
ONE FIVE SINCE
YEAR YEARS INCEPTION
---- ----- ---------
<S> <C> <C> <C> <C>
Class I................................ 4.75% 5.76% 5.94% (Since 5/18/93)
</TABLE>
In order to reflect the reduced sales charges applicable to certain
investors, as described under "Purchase of Shares" and "Redemption of Shares,"
respectively, the total return data quoted by the Fund in advertisements
directed to such investors may take into account the reduced, and not the
maximum, sales charge and therefore may reflect greater total return since, due
to the reduced sales charges or the waiver of sales charges, a lower amount of
expenses is deducted.
Yield. Annualized yield quotations used in the Fund's advertising and
promotional materials are calculated by dividing the Fund's interest income for
a specified thirty-day period, net of expenses, by the average number of shares
outstanding during the period, and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the net asset value per share
at the end of the period. Yield quotations are calculated according to the
following formula:
YIELD = 2 [((a - b) + 1)(6) - 1]
-----
cd
where "a" equals dividends and interest earned during the period; "b" equals
expenses accrued for the period, net of reimbursements; "c" equals the average
daily number of shares outstanding during the period that are entitled to
receive dividends; and "d" equals the maximum offering price per share on the
last day of the period.
Except as noted below, in determining net investment income earned during
the period ("a" in the above formula), the Fund calculates interest earned on
each debt obligation held by it during the period by (1) computing the
obligation's yield to maturity, based on the market value of the obligation
(including actual accrued interest) on the last business day of the period or,
if the obligation was purchased during the period, the purchase price plus
accrued interest; (2) dividing the yield to maturity by 360 and multiplying the
resulting quotient by the market value of the obligation (including actual
accrued interest). Once interest earned is calculated in this fashion for each
debt obligation held by the Fund, net investment income is then determined by
totaling all such interest earned.
For purposes of these calculations, the maturity of an obligation with one
or more call provisions is assumed to be the next date on which the obligation
reasonably can be expected to be called or, if none, the maturity date.
The 30-day yield for the Fund for the period ended June 30, 2000 was %
(Class I).
In advertising and sales literature, the Fund may compare its performance
to that of various broad market indexes, including without limitation the Lehman
Brothers Aggregate Bond Index, Standard & Poor's 500 Composite Stock Price Index
and other published indexes. When comparing its performance to a market index,
the Fund may refer to various statistical measures derived from the historic
performance of the Fund
41
<PAGE> 636
and the index, such as standard deviation and beta. In addition, the Fund may
refer in advertising or sales literature to (i) mutual fund performance ratings,
rankings and comparisons (including risk-adjusted ratings, rankings and
comparisons), (ii) other comparisons of mutual fund data including assets,
expenses, fees and other data, and (iii) other discussions reported in or
assigned by Barron's, Business Week, CDA Investment Technology, Inc., Financial
World, Forbes Magazine, Fortune Magazine, Lipper Inc., Money Magazine, U.S. News
& World Report, The Wall Street Journal and other industry publications. The
Fund may also make reference to awards that may be given to the Investment
Adviser. As with other performance data, performance comparisons should not be
considered indicative of the Fund's relative performance for any future period.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest and to divide or combine
the shares into a greater or lesser number of shares without thereby changing
the proportionate beneficial interest in the Fund. Each share represents an
interest in a Fund proportionately equal to the interest of each other share.
Upon the Trust's liquidation, all shareholders would share pro rata in the net
assets of the Fund available for distribution to shareholders. If they deem it
advisable and in the best interest of shareholders, the Board of Trustees may
create additional classes of shares. The Board of Trustees has created ten
series of shares, and may create additional series in the future, which have
separate assets and liabilities.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a
Fund's shares may advise the Trustees in writing that they wish to communicate
with other shareholders for the purpose of requesting a meeting to remove a
Trustee. The Trustees will then, if requested by the applicants, mail at the
applicants' expense the applicants' communication to all other shareholders.
The Trust or the Fund may be terminated if approved by the vote of a
majority of the Trustees or by the approval of the holders of a majority of the
Trust's outstanding shares, as defined in the 1940 Act. If not so terminated,
the Trust will continue indefinitely.
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Trust or its Trustees. The Declaration of Trust provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for its obligations. While Massachusetts
law permits a shareholder of a trust such as this to be held personally liable
as a partner under certain circumstances, the risk of a shareholder incurring
financial loss on account of
42
<PAGE> 637
shareholder liability is unlikely and is limited to the relatively remote
circumstances in which the Trust would be unable to meet its obligations.
Common expenses incurred by the Trust are allocated among the portfolios
based upon: (1) relative net assets; (2) as incurred on a specific
identification basis; or (3) evenly among the portfolios, depending on the
nature of the expenditure.
Except for (1) changes which do not adversely affect the rights of Trust
shareholders; (2) a change in the name of the Trust, or a series or class
thereof; (3) authorization of a new series or class; (4) changes to supply any
omission or correct any ambiguous or defective provision; or (5) changes
required by any federal, state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust without the affirmative vote of the holders of at least 67%
of the Trust's outstanding shares at a meeting at which more than 50% of its
outstanding shares are present in person or represented by proxy. The holders of
shares have no preemptive or conversion rights. Shares when issued are fully
paid and non-assessable, except as set forth above.
ISSUANCE OF FUND SHARES FOR SECURITIES
Investors may purchase Fund shares for consideration consisting of
securities rather than cash when, in the judgment of the Investment Adviser, the
securities: (a) meet the investment objective and policies of the Fund, (b) are
liquid and not subject to restrictions on resale, and (c) have a value that is
readily ascertainable via listing on or trading in a recognized United States or
international exchange or market.
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment wholly
in cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of the Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund during
any 90 day period for any one shareholder. Should redemptions by any shareholder
exceed such limitation the Fund will have the option of redeeming the excess in
cash or in kind. If shares are redeemed in kind, the redeeming shareholder would
incur brokerage costs in converting the assets into cash.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202, has been selected as the independent auditors of the Fund. The
independent auditors are responsible for auditing the annual financial
statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109-3661, acts as custodian of the Fund's assets (the "Custodian"). Under its
contract with the Trust, the Custodian is authorized to establish separate
accounts in foreign currencies and to cause foreign securities owned by the
Trust to be held in its offices outside the United States and with certain
foreign banks and securities depositories. The Custodian is responsible for
safeguarding and controlling the Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and dividends on the
Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly owned subsidiary of ML & Co., acts as the
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement (the "Transfer Agency Agreement").
The Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts.
43
<PAGE> 638
LEGAL COUNSEL
Gardner, Carton & Douglas, 321 North Clark Street, Chicago, Illinois 60610,
is counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio and
other information. An annual report containing financial statements audited by
independent auditors is sent to shareholders each year. After the end of each
year, shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
PRINCIPAL HOLDERS
[to come]
44
<PAGE> 639
APPENDIX -- DESCRIPTION OF RATINGS
MOODY'S INVESTORS SERVICE
BOND RATINGS:
"Aaa" -- Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
"Aa" -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
Moody's applies numerical modifiers "1," "2" and "3" in each generic rating
classification from Aa through B. The modifier "1" indicates that the obligation
ranks in the higher end of its generic rating category; the modifier "2"
indicates a mid-range ranking; and the modifier "3" indicates that the company
ranks in the lower end of that generic rating category.
"A" -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
"Baa" -- Bonds which are rated Baa are considered as medium-grade obligations
(that is, 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 which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
"B" -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
SHORT-TERM DEBT RATINGS:
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
"PRIME-1" -- Issuers rated "Prime-1" (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of these characteristics:
- Leading market positions in well-established industries.
- High rates of return on funds employed.
- Conservative capitalization structure with moderate reliance on debt and
ample asset protection.
- Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
- Well-established access to a range of financial markets and assured
sources of alternate liquidity.
"PRIME-2" -- Issuers rated "Prime-2" (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above,
A-1
<PAGE> 640
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. Adequate alternate
liquidity is maintained.
MUNICIPAL BOND RATINGS:
Moody's ratings for state and municipal short-term obligations are designated
Moody's Investment Grade or "MIG" with variable rate demand obligations being
designated as "VMIG." A VMIG rating may also be assigned to commercial paper
programs which are characterized as having variable short-term maturities, but
having neither a variable rate nor demand feature. Factors used in determining
ratings include liquidity of the borrower and short-term cyclical elements.
STANDARD & POOR'S RATING GROUP
BOND RATINGS:
"AAA" -- An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong.
"AA" -- An obligation rated AA differs from the highest rated obligations only
in small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
"A" -- An obligation rated A is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
"BBB" -- An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its commitment on the
obligation.
Obligations rated BB and B are regarded as having significant speculative
characteristics. While such obligations will likely have some quality and
protective characteristics, these may be outweighed by large uncertainties or
major exposures to adverse conditions.
COMMERCIAL PAPER RATINGS:
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market.
"A-1" -- This designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
"A-2" -- Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
MUNICIPAL BOND RATINGS:
S&P uses SP-1, SP-2 and SP-3 to rate short-term municipal obligations. A rating
of SP-1 denotes a strong capacity to pay principal and interest. An issue
determined to possess a very strong capacity to pay debt service is given a (+)
designation.
FITCH INVESTORS SERVICE, INC.
BOND RATINGS:
The following summarizes the ratings used by Fitch for corporate bonds:
"AAA" -- Highest credit quality. "AAA" ratings denote the lowest expectation of
credit risk. They 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.
A-2
<PAGE> 641
"AA" -- Very high credit quality. "AA" ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
"A" -- High credit quality. "A" ratings denote a low expectation of credit risk.
The capacity for timely payment of financial commitments is considered strong.
This capacity may, nevertheless, be more vulnerable to changes in circumstances
or in economic conditions than is the case for higher ratings.
"BBB" -- Good credit quality. "BBB" ratings indicate 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" -- Speculative. "BB" 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" -- Highly speculative. "B" 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.
PLUS (+) MINUS (--) -- Plus and minus signs may be appended to a rating to
denote relative status within major rating categories. Such suffixes are not
added to the "AAA" long-term rating category or to short-term ratings other than
"F1."
SHORT-TERM DEBT RATINGS:
"F1" -- Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
"F2" -- Good credit quality. 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.
"F3" -- Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
DUFF & PHELPS CREDIT RATING CO.
BOND RATINGS:
The following summarizes the ratings used by Duff & Phelps for long-term debt:
"AAA" -- Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
"AA+," "AA," "AA--" -- High credit quality. Protection factors are strong. Risk
is modest but may vary slightly from time to time because of economic
conditions.
"A+," "A," "A--" -- Protection factors are average but adequate. However, risk
factors are more variable and greater in periods of economic stress.
"BBB+," "BBB," "BBB--" -- Below-average protection factors but still considered
sufficient for prudent investment. Considerable variability in risk during
economic cycles.
"BB+," "BB," "BB--" -- Below investment grade but deemed likely to meet
obligations when due. Present or prospective financial protection factors
fluctuate according to industry conditions or company fortunes. Overall quality
may move up or down frequently within this category.
"B+," "B," "B--" -- Below investment grade and possessing risk that obligations
will not be met when due. Financial protection factors will fluctuate widely
according to economic cycles, industry conditions and/or
A-3
<PAGE> 642
company fortunes. Potential exists for frequent changes in the rating within
this category or into a higher or lower rating grade.
SHORT-TERM DEBT RATINGS:
"D-1+" -- Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of funds, is
outstanding and safety is just below risk-free U.S. Treasury short-term
obligations.
"D-1" -- Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are minor.
"D-1--" -- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
"D-2" -- Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small.
A-4
<PAGE> 643
STATEMENT OF ADDITIONAL INFORMATION
MERCURY HW EQUITY FUND FOR INSURANCE COMPANIES
OF MERCURY HW FUNDS
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017 - Phone No.
(800) 236-4479
------------------------
Mercury HW Equity Fund for Insurance Companies (the "Fund") is a fund of
the Mercury HW Funds (the "Trust"). The Trust is a diversified, open-end,
management investment company which is organized as a Massachusetts business
trust. The investment objective of the Fund is to seek to provide current income
and long term growth of income, accompanied by growth of capital. The Fund seeks
to achieve its investment objective by investing primarily in the common stocks
of large U.S. companies. No assurance can be given that the investment objective
of the Fund will be realized. For more information on the Fund's investment
objective and policies, see "Investment Objective and Policies."
The Fund offers a single class (Investor Class) of shares. Shares of the
Fund are offered only to insurance companies.
------------------------
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the prospectus of the Fund, dated October , 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Fund at
1-800-236-4479 or by writing to the address listed above. The Prospectus is
incorporated by reference into this Statement of Additional Information, and
this Statement of Additional Information is incorporated by reference into the
Prospectus. The Fund's financial statements are incorporated by reference to its
annual report for the fiscal year ended June 30, 2000. You may request copies of
the annual report at no charge by calling 1-800-236-4479 between 8:00 a.m. and
8:00 p.m. on any business day.
------------------------
MERCURY ADVISORS -- INVESTMENT ADVISER
------------------------
The date of this Statement of Additional Information is October , 2000
<PAGE> 644
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Trust History............................................... 3
Investment Objective and Policies........................... 3
Investment Restrictions................................... 3
Repurchase Agreements..................................... 4
Bonds..................................................... 4
U.S. Government Securities................................ 4
Corporate Debt Securities................................. 5
Convertible Securities.................................... 5
Derivative Instruments.................................... 5
Foreign Securities........................................ 6
Currency Options and Related Risks........................
Foreign Currency Exchange Contracts.......................
Foreign Investment Risks.................................. 7
Swap Agreements........................................... 8
Illiquid Securities....................................... 8
Borrowing................................................. 9
When-Issued Securities.................................... 9
Real Estate Investment Trusts............................. 10
Shares of Other Investment Companies...................... 10
Limited Partnerships...................................... 10
Short Sales Against-the-Box............................... 10
Corporate Loans........................................... 10
Temporary Defensive Position.............................. 10
Management of the Fund...................................... 10
Accounting and Administrative Services.................... 13
Code of Ethics............................................ 14
Purchase of Shares.......................................... 14
Redemption of Shares........................................ 14
Redemption................................................ 15
Pricing of Shares........................................... 15
Determination of Net Asset Value.......................... 15
Portfolio Transactions and Brokerage........................ 17
Transactions in Portfolio Securities...................... 17
Shareholder Services........................................ 18
Investment Account........................................ 18
Automatic Dividend Reinvestment Plan...................... 18
Dividends and Tax Status.................................... 19
Performance Data............................................ 19
General Information......................................... 20
Description of Shares..................................... 20
Issuance of Fund Shares for Securities.................... 21
Redemption in Kind........................................ 21
Independent Auditors...................................... 22
Custodian................................................. 22
Transfer Agent............................................ 22
Legal Counsel............................................. 22
Reports to Shareholders................................... 22
Shareholder Inquiries..................................... 22
Additional Information.................................... 22
Principal Holders......................................... 22
</TABLE>
2
<PAGE> 645
TRUST HISTORY
The Trust was organized on August 22, 1984 as a Massachusetts business
trust. Before October 7, 1994, the Trust was called "Olympic Trust," and before
October , 2000, the Trust was called "Hotchkis and Wiley Funds." The Trust is
a diversified, open-end, management investment company currently consisting of
ten separate funds. Prior to October , 2000, the Fund was called the Equity
Fund for Insurance Companies.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide current income and
long-term growth of income, accompanied by growth of capital. Reference is made
to the discussion under "How the Fund Invests" and "Investment Risks" in the
Prospectus for information with respect to the Fund's investment objective and
policies.
Mercury Advisors (the "Investment Adviser"), the Fund's investment adviser,
is responsible for the management of the Fund's portfolio.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of the Fund's outstanding
voting securities, as defined in the Investment Company Act of 1940, as amended
(the "1940 Act"). Under the 1940 Act, the vote of the holders of a "majority" of
the Fund's outstanding voting securities means the vote of the holders of the
lesser of (1) 67% of the shares of the Fund represented at a meeting at which
the holders of more than 50% of its outstanding shares are represented or (2)
more than 50% of the outstanding shares.
Except as noted, the Fund may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Fund's total assets (determined at the time of investment) would
then be invested in securities of a single issuer; or (ii) more than
25% of the Fund's total assets (determined at the time of investment)
would be invested in one or more issuers having their principal
business activities in a single industry.
2. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions),
provided that the deposit or payment by the Fund of initial or
maintenance margin in connection with futures or options is not
considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it owns an equal amount of such
securities or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short (short sale
against-the-box), and unless not more than 25% of the Fund's net assets
(taken at current value) is held as collateral for such sales at any
one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Fund may borrow from a bank for temporary or emergency purposes in
amounts not exceeding 10% (taken at the lower of cost or current value)
of its total assets (not including the amount borrowed) and pledge its
assets to secure such borrowings; the Fund will not purchase any
additional portfolio securities while such borrowings are outstanding.
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Fund's total assets, the Fund would
then hold more than 10% of the outstanding voting securities of an
issuer.
3
<PAGE> 646
6. Buy or sell commodities or commodity contracts or real estate or
interests in real estate, although it may purchase and sell securities
which are secured by real estate and securities of companies which
invest or deal in real estate. (For the purposes of this restriction,
forward foreign currency exchange contracts are not deemed to be
commodities or commodity contracts.)
7. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws.
8. Make investments for the purpose of exercising control or management.
9. Participate on a joint or joint and several basis in any trading
account in securities.
10. Make loans, except through repurchase agreements.
11. Purchase or sell foreign currencies.
Any percentage limitation on the Fund's investments is determined when the
investment is made, unless otherwise noted.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement where the seller agrees to
repurchase a security from the Fund at a mutually agreed-upon time and price.
The period of maturity is usually quite short, possibly overnight or a few days,
although it may extend over a number of months. The resale price is more than
the purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Fund's money is invested in the repurchase agreement. The
Fund's repurchase agreements will at all times be fully collateralized in an
amount at least equal to the resale price. The instruments held as collateral
are valued daily, and if the value of instruments declines, the Fund will
require additional collateral. In the event of a default, insolvency or
bankruptcy by a seller, the Fund will promptly seek to liquidate the collateral.
In such circumstances, the Fund could experience a delay or be prevented from
disposing of the collateral. To the extent that the proceeds from any sale of
such collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
BONDS
The term "bond" or "bonds" as used in the Prospectus is intended to include
all manner of fixed-income securities, debt securities and other debt
obligations unless specifically defined otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. The Fund will
invest in securities of such instrumentality only when the Investment Adviser is
satisfied that the credit risk with respect to any instrumentality is
acceptable.
The Fund may invest in component parts of U.S. Treasury notes or bonds,
namely, either the corpus (principal) of such Treasury obligations or one of the
interest payments scheduled to be paid on such obligations. These obligations
may take the form of (1) Treasury obligations from which the interest coupons
4
<PAGE> 647
have been stripped; (2) the interest coupons that are stripped; (3) book-entries
at a Federal Reserve member bank representing ownership of Treasury obligation
components; or (4) receipts evidencing the component parts (corpus or coupons)
of Treasury obligations that have not actually been stripped. Such receipts
evidence ownership of component parts of Treasury obligations (corpus or
coupons) purchased by a third party (typically an investment banking firm) and
held on behalf of the third party in physical or book-entry form by a major
commercial bank or trust company pursuant to a custody agreement with the third
party. These custodial receipts are known by various names, including "Treasury
Receipts," "Treasury Investment Growth Receipts" ("TIGRs") and "Certificates of
Accrual on Treasury Securities" ("CATS"), and are not issued by the U.S.
Treasury; therefore they are not U.S. Government securities, although the
underlying bonds represented by these receipts are debt obligations of the U.S.
Treasury.
CORPORATE DEBT SECURITIES
The Fund's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Fund, or, if unrated, are in the Investment Adviser's opinion comparable
in quality to corporate debt securities in which the Fund may invest. The rate
of return or return of principal on some debt obligations may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying common stock.
The price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
DERIVATIVE INSTRUMENTS
As indicated in the prospectus, to the extent consistent with its
investment objective and policies and the investment restrictions listed in this
Statement of Additional Information, the Fund may purchase and write call and
put options on securities and securities indexes and enter into forward
contracts. The Fund also may enter into swap agreements with respect to interest
rates and securities indexes. The Fund may use these techniques to hedge against
changes in interest rates or securities prices or as part of its overall
investment strategies. The Fund will mark as segregated cash, U.S. government
securities, equity securities or other liquid, unencumbered assets,
marked-to-market daily (or, as permitted by applicable regulation, enter into
certain offsetting positions), to cover its obligations under forward contracts,
futures contracts, swap agreements and options to avoid leveraging of the Fund.
5
<PAGE> 648
Options on Securities and on Securities Indexes. The Fund may purchase put
options on securities to protect holdings in an underlying or related security
against a substantial decline in market value. The Fund may purchase call
options on securities to protect against substantial increases in prices of
securities the Fund intends to purchase pending its ability to invest in such
securities in an orderly manner. The Fund may sell put or call options it has
previously purchased, which could result in a net gain or loss depending on
whether the amount realized on the sale is more or less than the premium and
other transaction costs paid on the put or call option which is sold. The Fund
may write a call or put option only if the option is "covered" by the Fund
holding a position in the underlying securities or by other means which would
permit immediate satisfaction of the Fund's obligation as writer of the option.
Prior to exercise or expiration, an option may be closed out by an offsetting
purchase or sale of an option of the same series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security. There can be no assurance that a liquid market will exist when
the Fund seeks to close out an option position. Furthermore, if trading
restrictions or suspensions are imposed on the options markets, the Fund may be
unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it had purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
FOREIGN SECURITIES
The Fund may invest in American Depositary Receipts ("ADRs"), other
securities convertible into securities of issuers based in foreign countries or
other foreign securities that can be purchased and sold in U.S. dollars. These
securities may not necessarily be denominated in the same currency as the
securities into which they may be converted. ADRs are receipts, usually issued
by a U.S. bank or trust company, evidencing ownership of the underlying
securities; EDRs are European receipts evidencing a similar arrangement.
6
<PAGE> 649
Generally, ADRs are issued in registered form, denominated in U.S. dollars, and
are designed for use in the U.S. securities markets; EDRs are issued in bearer
form, denominated in other currencies, and are designed for use in European
securities markets.
FOREIGN INVESTMENT RISKS
Foreign Market Risk. The Fund may invest a portion of its assets in foreign
securities. Foreign security investment involves special risks not present in
U.S. investments that can increase the chances that the Fund will lose money.
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of capital, resources, and
balance of payments position. Certain such economies may rely heavily on
particular industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a particular country
or countries, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. Investments in foreign markets may
also be adversely affected by governmental actions such as the imposition of
capital controls, nationalization of companies or industries, expropriation of
assets, or the imposition of punitive taxes. In addition, the governments of
certain countries may prohibit or impose substantial restrictions on foreign
investing in their capital markets or in certain industries. Any of these
actions could severely affect security prices, impair the Fund's ability to
purchase or sell foreign securities or otherwise adversely affect the Fund's
operations. Other foreign market risks include difficulties in pricing
securities, defaults on foreign government securities, difficulties in enforcing
favorable legal judgments in foreign courts, and political and social
instability. Legal remedies available to investors in certain foreign countries
may be less extensive than those available to investors in the United States or
other foreign countries.
EMU. For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU establishes a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU participants by July 1, 2002. Upon implementation of EMU,
certain securities issued in participating EU countries (beginning with
government and corporate bonds) were redenominated in the euro, and are now
listed, traded, declaring dividends and making other payments only in euros.
No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on the Fund's investments
in Europe generally or in specific countries participating in EMU.
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some
7
<PAGE> 650
countries may not have laws to protect investors the way that the United States
securities laws do. Accounting standards in other countries are not necessarily
the same as in the United States. If the accounting standards in another country
do not require as much disclosure or detail as U.S. accounting standards, it may
be harder for the Fund's portfolio managers to completely and accurately
determine a company's financial condition.
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
SWAP AGREEMENTS
The Fund may enter into interest rate and index swap agreements for
purposes of attempting to obtain a particular desired return at a lower cost to
the Fund than if the Fund had invested directly in an instrument that yielded
the desired return. Swap agreements are two party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to
more than one year. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized on
particular predetermined investments or instruments. The gross returns to be
exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. The
"notional amount" of the swap agreement is only a fictive basis on which to
calculate the obligations which the parties to a swap agreement have agreed to
exchange. The Fund's obligations (or rights) under a swap agreement will
generally be equal only to the net amount to be paid or received under the
agreement based on the relative values of the positions held by each party to
the agreement (the "net amount"). The Fund's obligations under a swap agreement
will be accrued daily (offset against any amounts owing to the Fund) and any
accrued but unpaid net amounts owed to a swap counter-party will be covered by
marking as segregated cash, U.S. government securities, equity securities or
other liquid, unencumbered assets, marked-to-market daily, to avoid any
potential leveraging of the Fund's portfolio. The Fund will not enter into a
swap agreement with any single party if the net amount owed or to be received
under existing contracts with that party would exceed 5% of the Fund's assets.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Investment Adviser's
ability to correctly predict whether certain types of investments are likely to
produce greater returns than other investments. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid. Moreover, the Fund bears the risk
of loss of the amount expected to be received under a swap agreement in the
event of the default or bankruptcy of a swap agreement counter-party.
Restrictions imposed by the Internal Revenue Code may limit the Fund's ability
to use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that developments in the swaps market,
including potential government regulation, could adversely affect the Fund's
ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions of
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended ("Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
that have a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Limitations on resale may have an adverse effect on the
marketability of portfolio securities and a mutual fund might be unable to
dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemption within
seven days. The absence of a trading market can make it difficult to ascertain a
market value for illiquid investments. Also market quotations are less readily
available. The judgment of the
8
<PAGE> 651
Investment Adviser may at times play a greater role in valuing these securities
than in the case of unrestricted securities. A mutual fund might also have to
register such restricted securities in order to dispose of them resulting in
additional expense and delay. Adverse market conditions could impede such a
public offering of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Investment Adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least one nationally recognized statistical
rating organizations ("NRSRO"), or, if unrated, be of comparable quality in the
view of the Investment Adviser; and (2) it must not be in default as to
principal or interest. Investing in Rule 144A securities could have the effect
of increasing the level of Fund illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
BORROWING
The Fund may borrow for temporary or emergency purposes in amounts not
exceeding 10% of the Fund's total assets. This borrowing may be unsecured. The
1940 Act requires the Fund to maintain continuous asset coverage (that is, total
assets including borrowings, less liabilities exclusive of borrowings) of 300%
of the amount borrowed. Borrowing subjects the Fund to interest costs which may
or may not be recovered by appreciation of the securities purchased, and can
exaggerate the effect on net asset value of any increase or decrease in the
market value of the Fund's portfolio. This is the speculative factor known as
leverage.
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Fund is obligated to pay on the settlement
date may be different from the market value on that date. While securities may
be sold prior to the settlement date, the Fund intends to purchase such
securities with the purpose of actually acquiring them, unless a sale would be
desirable for investment reasons. At the time the Fund makes a commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value
9
<PAGE> 652
of the security each day in determining the Fund's net asset value. The Fund
will also mark as segregated with its custodian cash, U.S. government
securities, equity securities or other liquid, unencumbered assets, marked-
to-market daily, equal in value to its obligations for when-issued securities.
REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain Internal Revenue Code requirements. REITs offer investors greater
liquidity and diversification than direct ownership of properties, as well as
greater income potential than an investment in common stocks. Like any
investment in real estate, though, a REIT's performance depends on several
factors, such as its ability to find tenants for its properties, to renew leases
and to finance property purchases and renovations.
SHARES OF OTHER INVESTMENT COMPANIES
The Fund can invest in securities of other investment companies except to
the extent prohibited by law. Like all equity investments, these investments may
go up or down in value. They also may not perform in correlation with the Fund's
principal strategies. The Fund will pay additional fees through its investments
in other investment companies.
LIMITED PARTNERSHIPS
The Fund can invest in limited partnership interests.
SHORT SALES AGAINST-THE-BOX
The Fund can borrow and sell "short" securities when it also owns an equal
amount of those securities (or their equivalent). No more than 25% of the Fund's
total assets can be held as collateral for short sales at any one time.
CORPORATE LOANS
The Fund can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Fund may not
recover its investment, or there might be a delay in the Fund's recovery. By
investing in a corporate loan, the Fund becomes a member of the syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, the Fund may invest
all or part of its assets in short-term investment grade debt obligations of the
U.S. government, its agencies and instrumentalities, bank certificates of
deposit, bankers' acceptances, high quality commercial paper, demand notes and
repurchase agreements.
MANAGEMENT OF THE FUND
The Trustees oversee the actions of the Fund's Investment Adviser and other
service providers and decide upon matters of general policy. The Trustees also
review the actions of the Trust's officers, who conduct and
10
<PAGE> 653
supervise the daily business operations of the Trust. The Trustees (* denotes
"interested" Trustee as defined in the 1940 Act, due to the relationship with
the Investment Adviser) and officers of the Trust are:
MICHAEL BAXTER* (37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since 1999);
Managing Director of the Investment Adviser (since 1996); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since 1994); Chairman, Gamma Services Corp.
(venture capital) (since 1968); Principal, Gavin, Dailey & Partners (consulting)
(since 1993); U.S. Ambassador to Mexico (1981 - 1986); Director, Apex Mortgage
Capital, Inc., Atlantic Richfield Co., International Wire Corp. and Krause's
Furniture.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (since 1986); Member of CIEBA's Executive Committee (since
1988) and its Chairman (from 1991 - 1992); Assistant Treasurer of International
Business Machines Incorporated ("IBM") and Chief Investment Officer of IBM
Retirement Funds (1986 - 1993); Member of the Investment Advisory Committees of
the State of New York Common Retirement Fund and the Howard Hughes Medical
Institute (since 1997); Director, Duke Management Company (since 1992) and Vice
Chairman (since 1998); Director, Kimco Realty Corporation (since 1997);
Director, LaSalle Street Fund (since 1995); Member of the Investment Advisory
Committee of the Virginia Retirement System (since 1998); Director, Montpelier
Foundation (since 1998); Trustee or Director of 31 registered investment
companies (consisting of 47 portfolios) for which the Investment Adviser or an
advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Co-Head of the Investment Adviser (since
1999); Managing Director of the Investment Adviser (since 1998); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (49) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 66 registered investment companies
(consisting of 70 portfolios) for which the Investment Adviser or an advisory
affiliate is the adviser.
NANCY D. CELICK (49) -- President -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Chief Administrative Officer of the Investment
Adviser (since 1998); Chief Financial Officer of the Investment Adviser
(1993 - 1998); Chief Financial Officer of Kennedy-Wilson, Inc. (auction
marketing services) (1992 - 1993); Chief Financial Officer of First National
Corporation (bank holding company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-9011. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services,
Inc. (since 1999); Vice President of FAM Distributors, Inc. (since 1999); First
Vice President of the Investment Adviser (1990 - 1997).
11
<PAGE> 654
ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
GRACIE FERMELIA (38) -- Vice President and Assistant Secretary -- 725 South
Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400. Director of the
Investment Adviser (since 2000); Vice President of the Investment Adviser
(1994 - 2000); Senior Manager, Price Waterhouse (1985 - 1994).
The Trust does not pay salaries to any of its officers or fees to any of
its Trustees affiliated with the Investment Adviser. The following table sets
forth the aggregate compensation paid to the Trustees during the Trust's fiscal
year ended June 30, 2000 and the aggregate compensation paid to the Trustees for
service on the Trust's Board and that of any other fund for which the Investment
Adviser serves as investment adviser or which has an investment adviser that is
an affiliated person of the Investment Adviser ("Fund Complex") for the year
ended December 31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $ $ 34,000
John A. G. Gavin................................... $ $ 25,000
Joe Grills......................................... $ $232,333
Nigel Hurst-Brown.................................. $ -0- $ -0-
Robert B. Hutchinson**............................. $ $ 34,000
Madeleine A. Kleiner............................... $ $ 18,000
Merle T. Welshans**................................ $ $ 34,000
Richard R. West.................................... $ $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of Mercury HW Variable Trust, Fund
Asset Management Master Trust and Merrill Lynch Investment Managers Funds,
Inc. Messrs. Grills and West also serve on the boards of other investment
companies advised by the Investment Adviser and its advisory affiliates.
** Messrs. Hutchinson and Welshans retired on November 12, 1999.
For information as to ownership of shares, see "General
Information -- Principal Holders."
ADVISORY ARRANGEMENTS
Investment Advisory Services and Fee. The Trust on behalf of the Fund has
entered into an investment advisory agreement (the "Advisory Agreement") with
the Investment Adviser as investment adviser. Subject to the supervision of the
Trustees, the Investment Adviser is responsible for the actual management of the
Fund and constantly reviews the Fund's holdings in light of its own research
analysis and that from other relevant sources. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser. The Investment Adviser performs certain of the other administrative
services and provides all office space, facilities, equipment and necessary
personnel for management of the Fund. The Investment Adviser receives for its
services to the Fund a monthly fee at an annual rate of 0.60% on the first
$10,000,000 of the Fund's average daily net assets and 0.50% of average daily
net assets in excess of $10,000,000. For purposes of this calculation, average
daily net assets is determined at the end of each month on the basis of the
average net assets of the Fund for each day during the month.
12
<PAGE> 655
Prior to October , 2000, the Fund was party to an investment advisory
agreement under which it paid Merrill Lynch Investment Managers, L.P., an
affiliate of the Investment Adviser, a fee at the annual rate of 0.60% on the
first $10,000,000 of the Fund's average daily net assets and 0.50% of average
daily net assets in excess of $10,000,000. For the fiscal years ended June 30,
2000, 1999 and 1998, the Fund paid Merrill Lynch Investment Managers, L.P.
$ , $206,371 and $196,908, respectively.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for one or more
clients of the Investment Adviser or an affiliate when one or more clients of
the Investment Adviser or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Payment of Fund Expenses. The Advisory Agreement obligates the Investment
Adviser to provide investment advisory services and to pay, or cause an
affiliate to pay, for maintaining its staff and personnel and to provide office
space, facilities and necessary personnel for the Fund. The Investment Adviser
is also obligated to pay, or cause an affiliate to pay, the fees of all officers
and Trustees who are affiliated persons of the Investment Adviser and to pay all
other expenses incurred in the operation of the Fund, including, among other
things, taxes, expenses for legal and auditing services, costs of printing
proxies, shareholder reports, copies of the Registration Statement, charges of
the custodian, any sub-custodian and the transfer agent, expenses of portfolio
transactions, expenses of redemption of shares, commission fees, expenses of
registering the shares under Federal, state or non-U.S. laws, fees and actual
out-of-pocket expenses of non-interested Trustees, accounting and pricing costs
(including the daily calculation of net asset value), insurance, interest,
brokerage costs, litigation and other extraordinary or non-recurring expenses,
and other expenses properly payable by the Fund.
Organization of the Investment Adviser. The Investment Adviser is a limited
partnership, the partners of which are Merrill Lynch & Co., Inc. ("ML & Co."), a
financial services holding company and the parent of Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"), and Princeton Services, Inc. ML &
Co. and Princeton Services, Inc. are "controlling persons" of the Investment
Adviser as defined under the 1940 Act because of their ownership of its voting
securities and their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described below, the
Advisory Agreement will remain in effect from year to year if approved annually
(a) by the Board of Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees of the Trust who are
not parties to the Advisory Agreement or interested persons (as defined in the
1940 Act) of any such party. The Advisory Agreement is not assignable and will
automatically terminate in the event of its assignment. In addition, such
contract may be terminated by the vote of a majority of the outstanding voting
securities of the Fund or by the Investment Adviser without penalty on 60 days'
written notice to the other party.
ACCOUNTING AND ADMINISTRATIVE SERVICES
The Trust has entered into a Fund Accounting and Administration Servicing
Agreement (the "Fund Accounting Agreement") with the Investment Adviser acting
as service provider. The Fund Accounting Agreement obligates the Investment
Adviser to provide certain accounting and administrative services to the Trust.
Transfer Agency Services. Financial Data Services, Inc. (the "Transfer
Agent"), a subsidiary of ML & Co., acts as the Fund's Transfer Agent pursuant to
a Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing Agency
Agreement (the "Transfer Agency Agreement"). Pursuant to the Transfer Agency
Agreement, the Transfer Agent is responsible for the issuance, transfer and
redemption of shares and
13
<PAGE> 656
the opening and maintenance of shareholder accounts. Pursuant to the Transfer
Agency Agreement, the Transfer Agent receives a fee from the Investment Adviser
in the amount of $1,000 per year.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act that covers the Trust and the Investment Adviser (the
"Code of Ethics"). The Code of Ethics significantly restricts the personal
investing activities of all employees of the Investment Adviser and, as
described below, imposes additional more onerous restrictions on fund investment
personnel.
The Code of Ethics requires that all employees of the Investment Adviser
pre-clear any personal securities investments (with limited exceptions, such as
mutual funds, high-quality short-term securities and direct obligations of the
U.S. government). The pre-clearance requirement and associated procedures are
designed to identify any substantive prohibition or limitation applicable to the
proposed investment. The substantive restrictions applicable to all employees of
the Investment Adviser include a ban on acquiring any securities in a "hot"
initial public offering. In addition, investment personnel are prohibited from
profiting on short-term trading in securities. No employee may purchase or sell
any security that at the time is being purchased or sold (as the case may be),
or to the knowledge of the employee is being considered for purchase or sale, by
any fund advised by the Investment Adviser. Furthermore, the Code of Ethics
provides for trading "blackout periods" which prohibit trading by investment
personnel of the Fund within seven calendar days, before or after, of trading by
the Fund in the same or equivalent security.
PURCHASE OF SHARES
Shares of the Fund are offered only to insurance companies. The minimum
initial investment in the Fund is $1,000,000. There is no minimum subsequent
investment.
The Fund issues a single class (Class I) of shares. Each share of the Fund
represents an identical interest in the investment portfolio of the Fund, and
has the same rights.
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share. The applicable offering price for purchase
orders is based upon the net asset value of the Fund next determined after
receipt of the purchase order by the Transfer Agent.
The Fund may suspend the continuous offering of the Fund's shares at any
time in response to conditions in the securities markets or otherwise and may
thereafter resume such offering from time to time. Any order may be rejected by
the Fund.
Class I shares are offered only to insurance companies investing a minimum
of $1,000,000 and also will be issued upon reinvestment of dividends on
outstanding Class I shares. Investors who owned Investor Class shares or who
currently own Class I shares of the Fund are entitled to purchase additional
Class I shares of the Fund in that account.
REDEMPTION OF SHARES
Reference is made to "How to Redeem Shares" in the Prospectus.
The Fund is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset value
per share next determined after the initial receipt of proper notice of
redemption. Shareholders liquidating their holdings will receive upon redemption
all dividends reinvested through the date of redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period during
which trading on the NYSE is restricted as determined by the Commission or
during which the NYSE is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists, as defined by the
Commission, as a result of which disposal
14
<PAGE> 657
of portfolio securities or determination of the net asset value of the Fund is
not reasonably practicable, and for such other periods as the Commission may by
order permit for the protection of shareholders of the Fund.
The value of shares of the Fund at the time of redemption may be more or
less than the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
The Trust has entered into a joint committed line of credit with other
investment companies advised by the Investment Adviser and its affiliates and a
syndicate of banks that is intended to provide the Fund with a temporary source
of cash to be used to meet redemption requests from Fund shareholders in
extraordinary or emergency circumstances.
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so by tendering the shares directly to the Fund's Transfer Agent, Financial Data
Services, Inc., P.O. Box 41621, Jacksonville, Florida 32232-1621. Redemption
requests delivered other than by mail should be delivered to Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting redemption. Redemption
requests should not be sent to the Fund. The redemption request in either event
requires the signature(s) of all persons in whose name(s) the shares are
registered, signed exactly as such name(s) appear(s) on the Transfer Agent's
register. The signature(s) on the redemption request may require a guarantee by
an "eligible guarantor institution" as defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications. In the
event a signature guarantee is required, notarized signatures are not
sufficient. In general, signature guarantees are waived on redemptions of less
than $50,000 as long as the following requirements are met: (i) all requests
require the signature(s) of all persons in whose name(s) shares are recorded on
the Transfer Agent's register; (ii) all checks must be mailed to the stencil
address of record on the Transfer Agent's register and (iii) the stencil address
must not have changed within 30 days.
A shareholder may also redeem shares held with the Transfer Agent by
telephone request. To request a redemption from your account, call the Transfer
Agent at 1-800-236-4479. The request must be made by the shareholder of record
and be for an amount less than $50,000. Before telephone requests will be
honored, signature approval from all shareholders of record on the account must
be obtained. The shares being redeemed must have been held for at least 15 days.
Since this account feature involves a risk of loss from unauthorized or
fraudulent transactions, the Transfer Agent will take certain precautions to
protect your account from fraud. Telephone redemption may be refused if the
caller is unable to provide: the account number, the name and address registered
on the account and the social security number registered on the account. The
Fund or the Transfer Agent may temporarily suspend telephone transactions at any
time.
For shareholders redeeming directly with the Transfer Agent, payments will
be mailed within seven days of receipt of a proper notice of redemption. At
various times the Fund may be requested to redeem shares for which it has not
yet received good payment (e.g., cash, Federal funds or certified check drawn on
a U.S. bank). The Fund may delay or cause to be delayed the mailing of a
redemption check until such time as good payment (e.g., cash, Federal funds or
certified check drawn on a U.S. bank) has been collected for the purchase of
such Fund shares, which usually will not exceed 10 days. In the event that a
shareholder account held directly with the Transfer Agent contains a fractional
share balance, such fractional share balance will be automatically redeemed by
the Fund.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of the Fund is determined once daily
Monday through Friday as of the close of regular trading on the NYSE on each day
the NYSE is open for trading based on prices at the time of
15
<PAGE> 658
closing. Regular trading on the NYSE generally closes at 4:00 p.m., Eastern
time. Any assets or liabilities initially expressed in terms of non-U.S. dollar
currencies are translated into U.S. dollars at the prevailing market rates as
quoted by one or more banks or dealers on the day of valuation. The NYSE is not
open for trading on New Year's Day, Martin Luther King, Jr. Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day.
Net asset value of the Fund is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. The fees payable to the Investment Adviser, are
accrued daily.
Portfolio securities, including ADRs, EDRs or GDRs, that are traded on
stock exchanges are valued at the last sale price (regular way) on the exchange
on which such securities are traded, as of the close of regular trading on the
day the securities are being valued or, lacking any sales, at the last available
bid price for long positions, and at the last available ask price for short
positions. In cases where securities are traded on more than one exchange, the
securities are valued on the exchange designated by or under the authority of
the Board of Trustees as the primary market. Long positions in securities traded
in the OTC market are valued at the last available bid price in the OTC market
prior to the time of valuation. Short positions in securities traded in the OTC
market are valued at the last available ask price in the OTC market prior to the
time of valuation. Portfolio securities that are traded both in the OTC market
and on a stock exchange are valued according to the broadest and most
representative market. When the Fund writes an option, the amount of the premium
received is recorded on the books of the Fund as an asset and an equivalent
liability. The amount of the liability is subsequently valued to reflect the
current market value of the option written, based upon the last sale price in
the case of exchange-traded options or, in the case of options traded in the OTC
market, the last ask price. Options purchased by the Fund are valued at their
last sale price in the case of exchange-traded options or, in the case of
options traded in the OTC market, the last bid price. Other investments,
including financial futures contracts and related options, are stated at market
value. Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Trustees. Such valuations and procedures will be
reviewed periodically by the Board of Trustees.
Generally, trading in foreign securities, as well as U.S. Government
securities and money market instruments, is substantially completed each day at
various times prior to the close of regular trading on the NYSE. The values of
such securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of regular trading on the NYSE. Occasionally,
events affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of regular trading
on the NYSE that may not be reflected in the computation of the Fund's net asset
value.
Each investor in the Fund may add to or reduce its investment in the Fund
on each day the NYSE is open for trading. The value of each investor's interest
in the Fund will be determined as of the close of regular trading on the NYSE by
multiplying the net asset value of the Fund by the percentage, effective for
that day, that represents that investor's share of the aggregate interests in
the Fund. The close of regular trading on the NYSE is generally 4:00 p.m.,
Eastern time. Any additions or withdrawals to be effected on that day will then
be effected. The investor's percentage of the aggregate beneficial interests in
the Fund will then be recomputed as the percentage equal to the fraction (i) the
numerator of which is the value of such investor's investment in the Fund as of
the time of determination on such day plus or minus, as the case may be, the
amount of any additions to or withdrawals from the investor's investment in the
Fund effected on such day, and (ii) the denominator of which is the aggregate
net asset value of the Fund as of such time on such day plus or minus, as the
case may be, the amount of the net additions to or withdrawals from the
aggregate investments in the Fund by all investors in the Fund. The percentage
so determined will then be applied to determine the value of the investor's
interest in the Fund after the close of regular trading on the NYSE on the next
determination of net asset value of the Fund.
16
<PAGE> 659
PORTFOLIO TRANSACTIONS AND BROKERAGE
TRANSACTIONS IN PORTFOLIO SECURITIES
Subject to policies established by the Board of Trustees, the Investment
Adviser is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. The Fund has no obligation to deal
with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Fund, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and operational facilities of the firm and the
firm's risk in positioning a block of securities. While the Investment Adviser
generally seeks reasonably competitive commission rates, the Fund does not
necessarily pay the lowest spread or commission available. In addition,
consistent with the Conduct Rules of the NASD and policies established by the
Board of Trustees, the Investment Adviser may consider sales of Fund shares as a
factor in the selection of brokers or dealers to execute portfolio transactions
for the Fund; however, whether or not a particular broker or dealer sells shares
of the Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Fund.
Subject to obtaining the best net results, brokers who provide supplemental
investment research to the Investment Adviser may receive orders for
transactions by the Fund. Such supplemental research services ordinarily consist
of assessments and analyses of the business or prospects of a company, industry
or economic sector. Information so received will be in addition to and not in
lieu of the services required to be performed by the Investment Adviser under
the Investment Advisory Agreement and the expenses of the Investment Adviser
will not necessarily be reduced as a result of the receipt of such supplemental
information. If in the judgment of the Investment Adviser the Fund will benefit
from supplemental research services, the Investment Adviser is authorized to pay
brokerage commissions to a broker furnishing such services that are in excess of
commissions that another broker may have charged for effecting the same
transactions. Certain supplemental research services may primarily benefit one
or more other investment companies or other accounts for which the Investment
Adviser exercises investment discretion. Conversely, the Fund may be the primary
beneficiary of the supplemental research services received as a result of
portfolio transactions effected for such other accounts or investment companies.
Foreign equity securities may be held by the Fund in the form of ADRs,
EDRs, GDRs or other securities convertible into foreign equity securities. ADRs,
EDRs and GDRs may be listed on stock exchanges, or traded in over-the-counter
markets in the United States or Europe, as the case may be. ADRs, like other
securities traded in the United States, will be subject to negotiated commission
rates. The Fund's ability and decisions to purchase or sell portfolio securities
of foreign issuers may be affected by laws or regulations relating to the
convertibility and repatriation of assets. Because the shares of the Fund are
redeemable on a daily basis in U.S. dollars, the Fund intends to manage the
portfolio so as to give reasonable assurance that it will be able to obtain U.S.
dollars to the extent necessary to meet anticipated redemptions. Under present
conditions, it is not believed that these considerations will have significant
effect on the Fund's portfolio strategies.
The Fund may invest in certain securities traded in the OTC market and
intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Fund and
persons who are affiliated with such affiliated persons are prohibited from
dealing with the Fund as principal in the purchase and sale of securities unless
a permissive order allowing such transactions is obtained from the Commission.
Since transactions in the OTC market usually involve transactions with the
dealers acting as principal for their own accounts, the Fund will not deal with
affiliated persons, including Merrill Lynch and its affiliates, in connection
with such transactions. However, an affiliated person of the Fund may serve as
its broker in OTC transactions conducted on an agency basis provided that, among
other things, the fee or commission received by such affiliated broker is
reasonable and fair compared to the fee or commission received by non-affiliated
brokers in connection with comparable transactions. In addition, the Fund may
not purchase securities during the existence of any underwriting syndicate for
such securities of which Merrill Lynch or an affiliate is a member or in a
private placement in which Merrill Lynch or an affiliate serves as placement
agent except
17
<PAGE> 660
pursuant to procedures approved by the Board of Trustees that either comply with
rules adopted by the Commission or with interpretations of the Commission staff.
See "Investment Objective and Policies -- Investment Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with a statement
setting forth the aggregate compensation received by the member in effecting
such transactions, and (iii) complies with any rules the Commission has
prescribed with respect to the requirements of clauses (i) and (ii). To the
extent Section 11(a) would apply to Merrill Lynch or its affiliates acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund. Securities may be held by, or be appropriate
investments for, the Fund as well as other funds or investment advisory clients
of the Investment Adviser or its affiliates.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or its affiliates
when one or more clients of the Investment Adviser or its affiliates are selling
the same security. If purchases or sales of securities arise for consideration
at or about the same time that would involve the Fund or other clients or funds
for which the Investment Adviser or an affiliate acts as investment adviser,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Investment Adviser or
its affiliates during the same period may increase the demand for securities
being purchased or the supply of securities being sold, there may be an adverse
effect on price.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below that are
designed to facilitate investment in its shares. Full details as to each such
service and copies of the various plans or how to change options with respect
thereto, can be obtained from the Fund by calling the telephone number on the
cover page hereof. Certain of these services are available only to U.S.
investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of dividends. The statements
also will show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
dividends. A shareholder with an account held at the Transfer Agent may make
additions to his or her Investment Account at any time by mailing a check
directly to the Transfer Agent. The Fund does not issue share certificates.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Shareholders may, at any time, by written notification or by telephone
(1-800-236-4479) to the Transfer Agent, elect to have subsequent dividends of
ordinary income and/or capital gains paid with respect to shares of the Fund in
cash, rather than reinvested in shares of the Fund (provided that, in the event
that a payment on an account maintained at the Transfer Agent would amount to
$10.00 or less, a shareholder will not receive such payment in cash and such
payment will automatically be reinvested in additional shares). Commencing ten
days after the receipt by the Transfer Agent of such notice, those instructions
will be effected. The Fund is not responsible for any failure of delivery to the
shareholder's address of record and no interest will accrue on amounts
represented by uncashed dividend checks. Cash payments can also be directly
deposited to the shareholder's bank account.
18
<PAGE> 661
DIVIDENDS AND TAX STATUS
The Fund has qualified as a regulated investment company. Qualification as
a regulated investment company requires, among other things, that (1) at least
90% of the Fund's annual gross income, without offset for losses from the sale
or other disposition of securities, be derived from payments with respect to
securities loans, interest, dividends and gains from the sale or other
disposition of stock, securities, or foreign currencies or other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities, or currencies; and (2) the Fund diversify its holdings so that, at
the end of each quarter of the taxable year, (i) at least 50% of the market
value of the Fund's assets is represented by cash, U.S. government securities,
securities of other regulated investment companies, and other securities limited
in respect of any one issuer to an amount not greater than 5% of the Fund's
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. government securities or the securities of other
regulated investment companies). In addition, in order not to be subject to
federal taxation, the Fund must distribute to its shareholders at least 90% of
its investment company taxable income earned in each year.
The Fund is required to pay an excise tax to the extent it does not
distribute to its shareholders during any calendar year at least 98% of its
ordinary income for that calendar year, 98% of the excess of its capital gains
over its capital losses for the one-year period ending October 31 in such
calendar year, and all undistributed ordinary income and capital gains for the
preceding respective one-year period. The Fund intends to meet these
distribution requirements to avoid excise tax liability. The Fund also intends
to continue distributing to shareholders all of the excess of net long-term
capital gain over net short-term capital loss on sales of securities. If the net
asset value of shares of the Fund should, by reason of a distribution of
realized capital gains, be reduced below a shareholder's cost, such distribution
would to that extent be a return of capital to that shareholder even though
taxable to the shareholder, and a sale of shares by a shareholder at net asset
value at that time would establish a capital loss for federal tax purposes.
In determining the extent to which the Fund's dividends may be eligible for
the 70% dividends received deduction by corporate shareholders, interest income,
capital gain net income, gain or loss from Section 1256 contracts, dividend
income from foreign corporations and income from other sources will not
constitute qualified dividends. Corporate shareholders should consult their tax
advisers regarding other requirements applicable to the dividends received
deduction.
Any loss realized on a sale, redemption or exchange of shares of the Fund
by a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
received in connection with the payment of a dividend by the Fund constitute a
replacement of shares.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined in accordance with a formula specified
by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that
19
<PAGE> 662
(1) as required by the periods of the quotations, actual annual, annualized or
aggregate data, rather than average annual data, may be quoted and (2) the
maximum applicable sales charges will not be included with respect to annual or
annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time. The Fund's total return may be
expressed either as a percentage or as a dollar amount in order to illustrate
such total return on a hypothetical $1,000 investment in the Fund at the
beginning of each specified period.
Average annual total returns for the periods ended June 30, 2000 are as
follows:
<TABLE>
<CAPTION>
ONE FIVE SINCE
YEAR YEARS INCEPTION
------ ----- ---------
<S> <C> <C> <C> <C>
Investor Class.......................... -4.29% 16.62% 13.04% (Since 1/29/93)
</TABLE>
In advertising and sales literature, the Fund may compare its performance
to that of various broad market indexes, including without limitation the Lehman
Brothers Aggregate Bond Index, Standard & Poor's 500 Composite Stock Price Index
and other published indexes. When comparing its performance to a market index,
the Fund may refer to various statistical measures derived from the historic
performance of the Fund and the index, such as standard deviation and beta. In
addition, the Fund may refer in advertising or sales literature to (i) mutual
fund performance ratings, rankings and comparisons (including risk-adjusted
ratings, rankings and comparisons), (ii) other comparisons of mutual fund data
including assets, expenses, fees and other data, and (iii) other discussions
reported in or assigned by Barron's, Business Week, CDA Investment Technology,
Inc., Financial World, Forbes Magazine, Fortune Magazine, Lipper Inc., Money
Magazine, U.S. News & World Report, The Wall Street Journal and other industry
publications. The Fund may also make reference to awards that may be given to
the Investment Adviser. As with other performance data, performance comparisons
should not be considered indicative of the Fund's relative performance for any
future period.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest and to divide or combine
the shares into a greater or lesser number of shares without thereby changing
the proportionate beneficial interest in the Fund. Each share represents an
interest in a Fund proportionately equal to the interest of each other share.
Upon the Trust's liquidation, all shareholders would share pro rata in the net
assets of the Fund available for distribution to shareholders. If they deem it
advisable and in the best interest of shareholders, the Board of Trustees may
create additional classes of shares. The Board of Trustees has created ten
series of shares, and may create additional series in the future, which have
separate assets and liabilities.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office. The Declaration of Trust also provides that the Trust shall, upon
request, assume the defense of any claim made against any shareholder for any
act or obligation of the Trust and satisfy any judgment thereon.
Ten shareholders holding the lesser of $25,000 worth or one percent of a
Fund's shares may advise the Trustees in writing that they wish to communicate
with other shareholders for the purpose of requesting a meeting to remove a
Trustee. The Trustees will then, if requested by the applicants, mail at the
applicants' expense the applicants' communication to all other shareholders.
20
<PAGE> 663
The Trust or the Fund may be terminated if approved by the vote of a
majority of the Trustees or by the approval of the holders of a majority of the
Trust's outstanding shares, as defined in the 1940 Act. If not so terminated,
the Trust will continue indefinitely.
Rule 18f-2 under the 1940 Act provides that as to any investment company
which has two or more series outstanding and as to any matter required to be
submitted to shareholder vote, such matter is not deemed to have been
effectively acted upon unless approved by the holders of a "majority" (as
defined in the Rule) of the voting securities of each series affected by the
matter. Such separate voting requirements do not apply to the election of
Trustees or the ratification of the selection of accountants. The Rule contains
special provisions for cases in which an advisory contract is approved by one or
more, but not all, series. A change in investment policy may go into effect as
to one or more series whose holders so approve the change even though the
required vote is not obtained as to the holders of other affected series.
The Declaration of Trust contains an express disclaimer of shareholder
liability for the Trust's acts or obligations and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Trust or its Trustees. The Declaration of Trust provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for its obligations. While Massachusetts
law permits a shareholder of a trust such as this to be held personally liable
as a partner under certain circumstances, the risk of a shareholder incurring
financial loss on account of shareholder liability is highly unlikely and is
limited to the relatively remote circumstances in which the Trust would be
unable to meet its obligations.
Common expenses incurred by the Trust are allocated among the portfolios
based upon: (1) relative net assets; (2) as incurred on a specific
identification basis; or (3) evenly among the portfolios, depending on the
nature of the expenditure.
Except for (1) changes which do not adversely affect the rights of Trust
shareholders; (2) a change in the name of the Trust, or a series or class
thereof; (3) authorization of a new series or class; (4) changes to supply any
omission or correct any ambiguous or defective provision; or (5) changes
required by any federal, state or similar regulatory authority or required by
the Code to eliminate or reduce any federal, state or local taxes which may be
payable by a Fund or its shareholders, no amendment may be made to the
Declaration of Trust without the affirmative vote of the holders of at least 67%
of the Trust's outstanding shares at a meeting at which more than 50% of its
outstanding shares are present in person or represented by proxy. The holders of
shares have no preemptive or conversion rights. Shares when issued are fully
paid and non-assessable, except as set forth above.
ISSUANCE OF FUND SHARES FOR SECURITIES
Investors may purchase Fund shares for consideration consisting of
securities rather than cash when, in the judgment of the Investment Adviser, the
securities: (a) meet the investment objective and policies of the Fund, (b) are
liquid and not subject to restrictions on resale, and (c) have a value that is
readily ascertainable via listing on or trading in a recognized United States or
international exchange or market.
REDEMPTION IN KIND
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment wholly
in cash, the Fund may pay the redemption price in part by a distribution in kind
of readily marketable securities from the portfolio of the Fund, in lieu of
cash. The Trust has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or one percent of the net asset value of the Fund during
any 90 day period for any one shareholder. Should redemptions by any shareholder
exceed such limitation the Fund will have the option of redeeming the excess in
cash or in kind. If shares are redeemed in kind, the redeeming shareholder would
incur brokerage costs in converting the assets into cash.
21
<PAGE> 664
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202, has been selected as the independent auditors of the Fund. The
independent auditors are responsible for auditing the annual financial
statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109-3661, acts as custodian of the Fund's assets (the "Custodian"). The
Custodian is responsible for safeguarding and controlling the Fund's cash and
securities, handling the receipt and delivery of securities and collecting
interest and dividends on the Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly owned subsidiary of ML & Co., acts as the
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement (the "Transfer Agency Agreement").
The Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts.
LEGAL COUNSEL
Gardner, Carton & Douglas, 321 North Clark Street, Chicago, Illinois 60610,
is counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends to
its shareholders at least semi-annually reports showing the Fund's portfolio and
other information. An annual report containing financial statements audited by
independent auditors is sent to shareholders each year. After the end of each
year, shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
PRINCIPAL HOLDERS
[to come]
22
<PAGE> 665
How a $10,000 Investment Has Grown:
The following charts show the growth of a $10,000 investment for each of the
Hotchkis and Wiley Funds as compared to the performance of representative market
indices. The tables below the charts show the total returns of an investment
over various periods. Returns for periods greater than one year are average
annual total returns.
Mid-Cap Fund January 2, 1997 - June 30, 1999
[MID-CAP LINE GRAPH]
<TABLE>
<CAPTION>
MID-CAP FUND RUSSELL MIDCAP INDEX
------------ --------------------
<S> <C> <C>
12/96 10000.00 10000.00
10290.00 9918.00
6/97 11714.10 11262.90
13302.60 12758.60
12/97 13244.00 12900.20
14135.40 14294.70
6/98 13469.60 14078.90
11104.30 11992.40
12/98 11885.00 14203.80
11476.10 14137.00
6/99 14501.20 15672.30
</TABLE>
<TABLE>
<CAPTION>
ENDED 6/30/99
-------------------------------------------
FUND RUSSELL MIDCAP
-------------------------------------------
<S> <C> <C>
One Year 7.66% 11.31%
Since Inception (1/2/97) 16.03% 19.69%
</TABLE>
EQUITY INCOME FUND
JULY 1, 1989-JUNE 30, 1999
[EQUITY INCOME LINE GRAPH]
<TABLE>
<CAPTION>
EQUITY INCOME FUND S&P 500 INDEX
------------------ -------------
<S> <C> <C>
6/89 10000.00 10000.00
11081.00 11060.00
10545.80 11281.20
9958.39 10942.80
6/90 9959.38 11621.20
7973.48 10017.50
8641.66 10909.00
10171.20 12501.80
6/91 10651.30 12464.30
11289.30 13124.90
11633.70 14227.40
12270.00 13871.70
6/92 12705.60 14135.20
12548.10 14573.40
13257.00 15302.10
14007.40 15975.40
6/93 14189.50 16039.30
14610.90 16456.30
15347.30 16834.00
14626.00 16195.10
6/94 14672.80 16259.90
15365.30 17059.80
14804.50 17061.60
16314.50 18716.50
6/95 17685.00 20494.60
19101.50 22132.10
19905.70 23446.80
21062.20 24724.60
6/96 21230.70 25847.10
21570.40 26648.40
23362.90 28902.80
23708.70 29660.10
6/97 26776.60 34850.60
29679.20 37502.70
30643.70 38552.80
33803.10 43950.20
6/98 32832.90 45409.30
29273.90 40932.00
31972.90 49654.60
31103.20 52117.40
6/99 35236.90 55724.00
</TABLE>
<TABLE>
<CAPTION>
ENDED 6/30/99
--------------------------------------------------
FUND S&P 500
--------------------------------------------------
<S> <C> <C>
One Year 7.32% 22.71%
Five Years 19.15% 27.93%
Ten Years 13.42% 18.78%
Since Inception (6/24/87) 12.63% 16.32%
</TABLE>
SMALL CAP FUND
JULY 1, 1989-JUNE 30, 1999
[SMALL CAP LINE GRAPH]
<TABLE>
<CAPTION>
SMALL CAP FUND RUSSELL 2000 INDEX
-------------- ------------------
<S> <C> <C>
6/89 10000.00 10000.00
11348.00 10675.00
11185.70 10146.60
11250.60 9922.35
6/90 12055.00 10305.40
8738.68 7776.42
10177.90 8167.57
12510.70 10596.60
6/91 12730.90 10432.40
13620.80 11282.60
15087.80 11929.10
16092.60 12823.80
6/92 15154.40 11949.20
15213.50 12292.10
17159.30 14126.10
17469.90 14729.30
6/93 18154.70 15050.40
19013.50 16365.80
19319.60 16791.30
19447.10 16338.00
6/94 18848.10 15700.80
19349.50 16784.10
19535.20 16470.30
20449.50 17229.50
6/95 21633.50 18831.90
23130.50 20692.50
23135.20 21141.50
22684.00 22226.10
6/96 24712.00 23337.40
25601.60 23430.70
26433.70 24649.10
27792.30 23374.80
6/97 32055.70 27184.80
38434.80 31235.40
36858.90 30173.40
42056.10 33220.90
6/98 39175.20 31656.20
28613.60 25277.50
31131.60 29400.20
26710.90 27812.60
6/99 33580.90 32137.50
</TABLE>
<TABLE>
<CAPTION>
ENDED 6/30/99
---------------------------------------------
FUND RUSSELL 2000
---------------------------------------------
<S> <C> <C>
One Year -14.26% 1.50%
Five Years 12.26% 15.40%
Ten Years 12.88% 12.39%
Since Inception (9/20/85) 12.14% 11.95%
</TABLE>
Past performance is no guarantee of future performance.
Please see page 13 for important performance and risk disclosures.
10
<PAGE> 666
Short-Term Investment Fund
May 18, 1993 - June 30, 1999
[SHORT-TERM INVESTMENT LINE GRAPH]
<TABLE>
<CAPTION>
SHORT-TERM INVESTMENT FUND MERRILL LYNCH 6-MTH TREAS. INDEX
-------------------------- --------------------------------
<S> <C> <C>
6/93 10028.00 10033.00
10272.70 10121.30
10505.90 10203.30
10650.90 10271.60
6/94 10778.70 10362.00
10870.30 10476.00
10971.40 10599.60
11216.00 10786.20
6/95 11401.10 10966.30
11591.50 11122.00
11830.30 11293.30
12048.00 11428.80
6/96 12225.10 11571.70
12354.70 11734.80
12559.70 11893.30
12711.70 12046.70
6/97 12929.10 12228.60
13146.30 12398.60
13335.60 12557.30
13549.00 12730.60
6/98 13754.90 12905.00
14005.30 13111.50
14104.70 13258.30
14252.80 13405.50
6/99 14401.00 13546.20
</TABLE>
<TABLE>
<CAPTION>
ENDED 6/30/99
------------------------------------------
FUND ML 6-MO.
---- --------
<S> <C> <C>
One Year 4.70% 4.96%
Five Years 5.97% 5.50%
Since Inception (5/18/93) 6.14% 5.19%
</TABLE>
Total Return Bond Fund - Investor Class December 6, 19994 - June 30, 1999
[TOTAL RETURN BOND LINE GRAPH]
<TABLE>
<CAPTION>
TOTAL RETURN BOND FUND LEHMAN AGGREGATE INDEX
---------------------- ----------------------
<S> <C> <C>
10033.00 10006.00
10497.50 10510.30
6/95 11187.20 11150.40
11555.30 11368.90
12172.30 11853.20
11882.60 11643.40
6/96 11971.70 11709.80
12311.70 11926.40
12700.80 12284.20
12754.10 12215.40
6/97 13224.80 12663.70
13608.30 13084.20
14066.90 13468.90
14331.30 13679.00
6/98 14686.80 13999.10
15305.10 14591.20
15303.50 14640.80
15175.00 14567.60
6/99 15026.30 14439.40
</TABLE>
<TABLE>
<CAPTION>
ENDED 6/30/99
--------------------------------------------
INVESTOR CLASS FUND LEHMAN AGG
-------------- ---- ----------
<S> <C> <C>
One Year 2.30% 3.15%
Three Years 7.86% 7.23%
Since Inception (12/6/94) 9.32% 8.12%
DISTRIBUTOR CLASS
------------------
<S> <C> <C>
Since Inception (6/2/99) 0.23% 0.32%
</TABLE>
Low Duration Fund May 18, 1993 - June 30, 1999
[LOW DURATION LINE GRAPH]
<TABLE>
<CAPTION>
LOW DURATION FUND MERRILL LYNCH 1-3 YR TREAS. INDEX
----------------- ---------------------------------
<S> <C> <C>
6/93 10053.00 10058.00
10579.80 10201.80
10713.10 10262.00
10872.70 10210.70
6/94 10961.90 10218.90
11149.30 10320.00
11274.20 10320.50
11616.90 10667.20
6/95 12083.90 11009.60
12330.40 11174.80
12711.40 11456.40
12818.20 11494.20
6/96 12988.70 11610.30
13239.40 11801.90
13502.80 12026.10
13627.10 12105.50
6/97 14000.50 12371.80
14272.10 12614.30
14527.50 12826.20
14736.70 13014.70
6/98 15003.50 13213.90
15362.00 13620.90
15348.20 13724.40
15420.40 13806.70
6/99 15479.00 13885.40
</TABLE>
<TABLE>
<CAPTION>
ENDED 6/30/99
----------------------------------------
FUND ML 1-3
---- ------
<S> <C> <C>
One Year 3.15% 5.08%
Three Years 7.15% 6.32%
Since Inception (5/18/93) 7.40% 5.49%
</TABLE>
Balanced Fund July 1, 1989 - June 30, 1999
[BALANCED FUND LINE GRAPH]
<TABLE>
<CAPTION>
LB GOVT/CORP INT.
CPI+4% INDEX BALANCED FUND S&P 500 INDEX
------ ----------------- ------------- -------------
<S> <C> <C> <C> <C>
6/89 10000.00 10000.00 10000.00 10000.00
10173.00 10121.00 10527.00 11060.00
10364.30 10462.10 10524.90 11281.20
10682.40 10446.40 10380.70 10942.80
6/90 10890.70 10781.70 10630.90 11621.20
11234.90 10970.40 9746.39 10017.50
11441.60 11420.20 10477.40 10909.00
11659.00 11706.80 11554.40 12501.80
6/91 11863.00 11915.20 11630.70 12464.30
12087.20 12489.50 12204.10 13124.90
12271.00 13089.00 12628.80 14227.40
12520.10 12969.90 12954.60 13871.70
6/92 12727.90 13483.50 13392.50 14135.20
12957.00 14078.10 13515.70 14573.40
13142.30 14027.50 13817.10 15302.10
13432.70 14582.90 14498.30 15975.00
6/93 13642.30 14897.90 14743.30 16055.30
13845.60 15234.60 15380.20 16472.70
14051.90 15260.50 15549.40 16851.60
14328.70 14950.70 15188.60 16211.20
6/94 14550.80 14861.00 15282.80 16276.10
14834.50 14982.90 15866.60 17073.60
15012.50 14966.40 15669.90 17075.30
15333.80 15263.40 16688.40 18731.60
6/95 15599.10 16403.10 17706.40 20511.10
15826.80 16675.30 18765.30 22149.90
16016.70 17262.30 19480.20 23465.60
16409.10 17119.00 20091.90 24744.50
6/96 16681.50 17226.90 20369.20 25867.90
16965.10 17531.80 20674.70 26669.80
17221.30 17961.30 21764.30 28926.10
17545.10 17941.60 22014.50 29684.00
6/97 17750.30 18470.80 23577.60 34878.60
18027.20 18969.60 24827.20 37532.90
18218.30 19375.50 25423.00 38583.80
18504.40 19677.80 26694.20 43985.60
6/98 18789.30 20049.70 26720.90 45445.90
19044.90 20949.90 25836.40 40964.90
19342.00 21010.70 26740.70 49694.60
19630.20 20970.70 26339.60 52179.30
6/99 20014.90 20886.90 27806.70 55790.10
</TABLE>
<TABLE>
<CAPTION>
ENDED 6/30/99
-----------------------------
FUND S&P 500
------ -------
<S> <C> <C>
One Year 4.04% 22.71%
Five Years 12.80% 27.93%
Ten Years 10.81% 18.78%
Since Inception (8/13/85) 11.75% 18.63%
</TABLE>
Past performance is no guarantee of future performance.
Please see page 13 for important performance and risk disclosures.
11
<PAGE> 667
International Fund October 1, 1990 - June 30, 1999
[INTERNATIONAL FUND LINE GRAPH]
<TABLE>
<CAPTION>
INTERNATIONAL FUND MSCI-EAFE INDEX
------------------ ---------------
<S> <C> <C>
10049.00 11063.00
10643.90 11896.00
6/91 10134.10 11256.00
11413.00 12230.80
12094.30 12446.10
11902.00 10978.70
6/92 12967.30 11221.30
12076.40 11400.80
11772.10 10971.00
13170.60 12296.30
6/93 13922.70 13543.20
14883.30 14450.60
17157.50 14585.00
16448.90 15104.20
6/94 16249.80 15886.60
17265.50 15912.00
16652.50 15760.80
16954.00 16066.60
6/95 18052.60 16196.70
19204.30 16885.10
19964.80 17582.50
20825.30 18102.90
6/96 21412.60 18403.40
21755.20 18385.00
23608.70 18692.00
23823.60 18413.50
6/97 26036.80 20816.50
26781.40 20683.30
24866.50 19076.20
28243.40 21897.50
6/98 28062.70 22145.00
22910.40 19011.50
26461.50 22956.40
26551.40 23291.50
6/99 29243.70 23899.40
</TABLE>
<TABLE>
<CAPTION>
Ended 6/30/99
------------------------------------------
Investor Class Fund MSCI EAFE
-------------- ---- ---------
<S> <C> <C>
One Year 4.22% 7.92%
Five Years 12.48% 8.52%
Since Inception (10/1/90) 13.05% 10.48%
Distributor Class
------------------
Since Inception (6/2/99) 2.06% 3.78%
</TABLE>
Global Equity Fund January 2, 1997 - June 30, 1999
[GLOBAL EQUITY LINE GRAPH]
<TABLE>
<CAPTION>
GLOBAL EQUITY FUND MSCI WORLD INDEX
------------------ ----------------
<S> <C> <C>
12/96 10000.00 10000.00
3/97 10220.00 10040.00
6/97 11232.80 11563.10
9/97 11404.70 11905.30
12/97 10779.70 11623.20
3/98 12241.40 13300.40
6/98 12087.20 13582.40
9/98 9930.82 11966.10
12/98 11502.90 14505.30
3/99 11460.30 15036.20
6/99 12741.60 15766.90
Ended 6/30/99
------------------------------------------
Fund MSCI WORLD
---- ----------
<S> <C> <C>
One Year 5.40% 16.08%
Since Inception (1/2/97) 10.18% 19.97%
</TABLE>
Past performance is no guarantee of future performance.
Please see page 13 for important performance and risk disclosures.
12
<PAGE> 668
IMPORTANT PERFORMANCE AND RISK DISCLOSURES
--------------------------------------------------------------------------------
Total returns and average annual total returns are net of all charges and fees
and assume reinvestment of capital gains distributions and shareholder dividends
at net asset value. The investment advisor pays annual operating expenses of the
Equity Income and Balanced Funds in excess of 0.95% (1.00% before 3/1/99),
Mid-Cap Fund in excess of 1.15% (1.00% before 3/1/99), Global Equity Fund in
excess of 1.25% (1.00% before 3/1/99), Total Return Bond Fund in excess of
0.65%, Low Duration Fund in excess of 0.58%, and Short-Term Investment Fund in
excess of 0.48% of the average net assets of each Fund's Investor Class shares.
The investment advisor pays annual operating expenses of the Distributor Class
shares of the Total Return Bond Fund in excess of 0.90% of average net assets
and, upon commencement of offering the Distributor Class shares, will pay annual
operating expenses in excess of 1.15% of the average net assets of the Balanced
Fund's Distributor Class shares and those in excess of 0.83% of average net
assets of the Low Duration Fund's Distributor Class shares. Were it not to pay
such expenses, net returns would be lower. Investment return and principal will
vary so that shares, when redeemed, may be worth more or less than their
original cost. Past performance is no guarantee of future performance.
The Small Cap, International, Balanced, Total Return Bond and Low Duration Funds
also offer Distributor Class shares which charge a 0.25% annual 12b-1 fee, and
which will have some different expenses and net performance than Investor Class
shares. At June 30, 1999, there was no performance for the Small Cap, Balanced
and Low Duration Funds' Distributor Classes.
Investment by the Small Cap Fund in small companies and the Mid-Cap Fund in
medium-size companies presents greater risk than investment in larger, more
established companies. The Total Return Bond, Low Duration and Short-Term
Investment Funds may invest a portion of their assets in non-investment grade
debt securities commonly referred to as high yield or "junk" bonds. Junk bonds
may be subject to greater market fluctuations and risk of loss of income and
principal than securities in higher rating categories. Investment by the
International, Global Equity, Low Duration, Short-Term Investment and Total
Return Bond Funds in foreign securities involves special risks including
fluctuating foreign exchange rates, foreign government regulations, differing
degrees of liquidity, and the possibility of substantial volatility due to
adverse political, economic or other developments.
13
<PAGE> 669
--------------------------------------------------------------------------------
MARKET INDICES
The following are definitions for indices used in the performance summary charts
as of June 30, 1999. These indices are unmanaged and include the reinvestment of
dividends, but do not reflect the payment of transaction costs and advisory fees
associated with an investment in the Funds. The securities that comprise these
indices may differ substantially from the securities in the Funds' portfolios.
Each index named is not the only index which may be used to characterize
performance of a specific Fund and other indices may portray different
comparative performance.
CONSUMER PRICE INDEX (CPI) is a measure of the average change in prices over
time in a fixed market basket of goods and services (e.g., food, clothing,
shelter, fuel, transportation fares, medical and other day-to-day services).
While not an objective of the Balanced Fund, the Advisor's current goal is a
return at least 4% greater than the rate of inflation as measured by the CPI.
LEHMAN BROTHERS AGGREGATE INDEX is a weighted index comprised of the
Government/Corporate Index, the Mortgage-Backed Securities Index, and the
Asset-Backed Securities Index. The index includes fixed-rate debt issues rated
investment grade or higher. All issues have at least one year to maturity and an
outstanding par value of at least $100 million for U.S. Government issues and
$50 million for all others.
LEHMAN BROTHERS GOVERNMENT/CORPORATE INDEX is a weighted index comprised of
publicly-traded intermediate and long-term government and corporate debt with an
average maturity of 11 years.
MERRILL LYNCH 1-3 YEAR U.S. TREASURY INDEX (ML 1-3) is an index of Treasury
securities with maturities ranging from one to three years which are guaranteed
as to the timely payment of principal and interest by the U.S. Government. The
Low Duration Fund invests in securities that are not reflected in the index or
guaranteed.
MERRILL LYNCH 6 MONTH U.S. TREASURY BILL INDEX (ML 6-mo.) is an index of
Treasury securities with maturities of six months which are guaranteed as to the
timely payment of principal and interest by the U.S. Government. The Short-Term
Investment Fund invests in securities that are not reflected in the index or
guaranteed.
MORGAN STANLEY CAPITAL INTERNATIONAL EUROPE, AUSTRALIA, FAR EAST INDEX is a
arithmetical average weighted by market value of the performance of over 1,000
non-U.S. companies representing 20 stock markets in Europe, Australia, New
Zealand and the Far East.
MSCI WORLD INDEX is an arithmetical average weighted by market value of the
performance of over 1,400 companies listed on stock exchanges in the 22
countries that make up the MSCI Network Indices.
RUSSELL 2000 INDEX is a stock market index comprised of the 2,000 smallest U.S.
domiciled publicly-traded common stocks that are included in the Russell 3000
Index. These common stocks represent approximately 11% of the U.S. equity
market. The Russell 3000 Index is comprised of the 3,000 largest U.S. domiciled
publicly-traded common stocks by market capitalization representing
approximately 98% of the U.S. publicly-traded equity market.
RUSSELL MIDCAP INDEX measures the performance of the 800 smallest securities in
the Russell 1000 Index, which represent approximately 26% of the total market
capitalization of the Russell 1000 Index. The Russell 1000 Index is comprised of
the largest 1,000 companies in the Russell 3000 Index.
S&P 500 INDEX is a capital-weighted index, representing the aggregate market
value of the common equity of 500 stocks primarily traded on the New York Stock
Exchange.
14
<PAGE> 670
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
EQUITY INCOME FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 98.8% Shares Value
------------------------------------------------------------
<S> <C> <C>
AEROSPACE -- 5.5%
............................................................
Lockheed Martin Corporation 87,900 $ 3,274,275
............................................................
Northrop Grumman Corporation 51,700 3,428,356
............................................................
Rockwell International
Corporation 25,000 1,518,750
..................... ...................... -----------
8,221,381
------------------------------------------------------------
APPAREL & TEXTILES -- 0.5%
............................................................
Russell Corporation 40,000 780,000
------------------------------------------------------------
AUTO PARTS -- 4.1%
............................................................
Dana Corporation 62,900 2,897,331
............................................................
Delphi Automotive Systems
Corporation 42,949 797,241
............................................................
Meritor Automotive, Inc. 7,100 181,050
............................................................
TRW Inc. 40,300 2,211,463
..................... ...................... -----------
6,087,085
------------------------------------------------------------
AUTOS & TRUCKS -- 4.6%
............................................................
Ford Motor Company 70,000 3,950,625
............................................................
General Motors Corporation 44,000 2,904,000
..................... ...................... -----------
6,854,625
------------------------------------------------------------
BANKS -- 7.8%
............................................................
Bank One Corporation 57,400 3,418,887
............................................................
First Security Corporation 42,800 1,166,300
............................................................
First Union Corporation 50,400 2,368,800
............................................................
Fleet Financial Group, Inc. 47,000 2,085,625
............................................................
KeyCorp 61,000 1,959,625
............................................................
UnionBanCal Corporation 17,300 624,963
..................... ...................... -----------
11,624,200
------------------------------------------------------------
BEVERAGES -- 0.7%
............................................................
Anheuser-Busch Companies, Inc. 14,500 1,028,594
------------------------------------------------------------
BUILDING & FOREST
PRODUCTS -- 2.7%
............................................................
Georgia-Pacific (Timber Group) 54,000 1,363,500
............................................................
Weyerhaeuser Company 38,000 2,612,500
..................... ...................... -----------
3,976,000
------------------------------------------------------------
CHEMICALS -- 1.9%
............................................................
The Dow Chemical Company 16,000 2,030,000
............................................................
Eastman Chemical Company 16,000 828,000
..................... ...................... -----------
2,858,000
------------------------------------------------------------
CONGLOMERATES -- 1.9%
............................................................
Tenneco, Inc. 120,000 2,865,000
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Shares Value
<S> <C> <C>
ENGINEERING AND CONSTRUCTION -- 1.0%
............................................................
Harsco Corporation 48,595 $ 1,555,040
------------------------------------------------------------
FINANCIAL SERVICES -- 4.8%
............................................................
Associates First Capital
Corporation -- Class A 6,800 301,325
............................................................
Fannie Mae 46,000 3,145,250
............................................................
Household International, Inc. 53,400 2,529,825
............................................................
Transamerica Corporation 16,000 1,200,000
..................... ...................... -----------
7,176,400
------------------------------------------------------------
HOUSEHOLD FURNISHINGS & APPLIANCES -- 2.0%
............................................................
Whirlpool Corporation 41,000 3,034,000
------------------------------------------------------------
INSURANCE -- 5.2%
............................................................
American General Corporation 29,300 2,208,487
............................................................
Lincoln National Corporation 28,000 1,464,750
............................................................
Safeco Corporation 52,000 2,294,500
............................................................
St. Paul Companies, Inc. 57,600 1,832,400
..................... ...................... -----------
7,800,137
------------------------------------------------------------
LEISURE/TOYS -- 0.7%
............................................................
Fortune Brands, Inc. 24,500 1,013,687
------------------------------------------------------------
MACHINERY -- 2.0%
............................................................
New Holland N.V. 170,000 2,911,250
------------------------------------------------------------
METALS & MINING -- 4.4%
............................................................
Alcoa, Inc. 48,000 2,970,000
............................................................
Phelps Dodge Corporation 12,000 743,250
............................................................
Reynolds Metals Company 48,000 2,832,000
..................... ...................... -----------
6,545,250
------------------------------------------------------------
NATURAL GAS -- 0.8%
............................................................
Eastern Enterprises 27,000 1,073,250
------------------------------------------------------------
OIL -- DOMESTIC -- 8.3%
............................................................
Atlantic Richfield Company 23,507 1,964,303
............................................................
Occidental Petroleum
Corporation 133,000 2,809,625
............................................................
Phillips Petroleum Company 61,000 3,069,063
............................................................
Texaco Inc. 18,000 1,125,000
............................................................
USX-Marathon Group, Inc. 72,000 2,344,500
............................................................
Ultramar Diamond Shamrock
Corporation 47,200 1,029,550
..................... ...................... -----------
12,342,041
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
15
<PAGE> 671
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
EQUITY INCOME FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
PAPER -- 3.6%
............................................................
Georgia-Pacific Group 30,000 $ 1,421,250
............................................................
International Paper Company 78,000 3,939,000
..................... ...................... -----------
5,360,250
------------------------------------------------------------
PHOTOGRAPHY & OPTICAL -- 1.8%
............................................................
Eastman Kodak Company 39,700 2,689,675
------------------------------------------------------------
POLLUTION CONTROL -- 2.4%
............................................................
Browning-Ferris Industries,
Inc. 51,000 2,193,000
............................................................
Waste Management, Inc. 26,000 1,397,500
..................... ...................... -----------
3,590,500
------------------------------------------------------------
RAILROADS -- 1.9%
............................................................
CSX Corporation 17,500 792,969
............................................................
Norfolk Southern Corporation 67,000 2,018,375
..................... ...................... -----------
2,811,344
------------------------------------------------------------
RETAIL -- 4.1%
............................................................
Intimate Brands, Inc. 7,350 348,206
............................................................
J.C. Penney Company, Inc. 54,000 2,622,375
............................................................
May Department Stores Company 39,900 1,630,913
............................................................
Sears, Roebuck & Company 32,000 1,426,000
..................... ...................... -----------
6,027,494
------------------------------------------------------------
SAVINGS & LOANS -- 2.0%
............................................................
Washington Mutual, Inc. 85,400 3,021,025
------------------------------------------------------------
STEEL -- 2.7%
............................................................
Allegheny Teledyne, Inc. 41,000 927,625
............................................................
USX-U.S. Steel Group, Inc. 113,000 3,051,000
..................... ...................... -----------
3,978,625
------------------------------------------------------------
TOBACCO -- 3.5%
............................................................
Philip Morris Companies, Inc. 130,000 5,224,375
------------------------------------------------------------
TRUCKING -- 0.4%
............................................................
Ryder System, Inc. 21,000 546,000
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Shares Value
<S> <C> <C>
UTILITY -- ELECTRIC -- 9.1%
............................................................
CMS Energy Corporation 55,000 $ 2,303,125
............................................................
Central & South West
Corporation 48,000 1,122,000
............................................................
DTE Energy Company 38,000 1,520,000
............................................................
Edison International 25,500 682,125
............................................................
Entergy Corporation 25,500 796,875
............................................................
GPU, Inc. 22,000 928,125
............................................................
Illinova Corporation 95,000 2,588,750
............................................................
PECO Energy Company 12,500 523,438
............................................................
P P & L Resources, Inc. 23,000 707,250
............................................................
Public Service Enterprises
Group, Inc. 30,000 1,226,250
............................................................
SCANA Corporation 46,000 1,075,250
..................... ...................... -----------
13,473,188
------------------------------------------------------------
UTILITY -- TELEPHONE -- 8.4%
............................................................
AT&T Corporation 65,000 3,627,813
............................................................
ALLTEL Corporation 40,000 2,860,000
............................................................
Bell Atlantic Corporation 44,500 2,909,187
............................................................
GTE Corporation 14,500 1,098,375
............................................................
SBC Communications, Inc. 33,000 1,914,000
..................... ...................... -----------
12,409,375
..................... ...................... -----------
Total common stock (cost 146,877,791
$114,699,851)
------------------------------------------------------------
VARIABLE RATE Principal
DEMAND NOTES* -- 1.3% Amount
------------------------------------------------------------
General Mills, Inc., 4.8250% $1,982,735 1,982,735
............................................................
Total variable rate demand
notes (cost $1,982,735) 1,982,735
------------------------------------------------------------
Total investments -- 100.1%
(cost $116,682,586) 148,860,526
............................................................
Liabilities in excess of other
assets -- (0.1%) (126,207)
..................... ...................... -----------
$148,734,319
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
* Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rate listed is as of June 30, 1999.
See Notes to the Financial Statements
16
<PAGE> 672
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
MID-CAP FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 95.8% Shares Value
-------------------------------------------------------------
<S> <C> <C>
AEROSPACE -- 3.9%
.............................................................
Northrop Grumman Corporation 4,000 $ 265,250
-------------------------------------------------------------
APPAREL & TEXTILES -- 3.8%
.............................................................
Coats Viyella PLC ADR 44,600 106,509
.............................................................
Russell Corporation 8,100 157,950
....................... ....................... ---------
264,459
-------------------------------------------------------------
AUTO PARTS -- 4.6%
.............................................................
Dana Corporation 2,072 95,441
.............................................................
Lear Corporation # 2,800 139,300
.............................................................
Meritor Automotive, Inc. 3,300 84,150
....................... ....................... ---------
318,891
-------------------------------------------------------------
BANKS -- 6.4%
.............................................................
Compass Bancshares, Inc. 1,725 47,006
.............................................................
Colonial BancGroup, Inc. 6,500 90,594
.............................................................
UnionBanCal Corporation 8,300 299,838
....................... ....................... ---------
437,438
-------------------------------------------------------------
COMMUNICATIONS & MEDIA -- 3.1%
.............................................................
Groupe AB SA ADR # 65,300 212,225
-------------------------------------------------------------
COMPUTER SOFTWARE &
SERVICES -- 5.8%
.............................................................
Cambridge Technology Partners, Inc.
# 1,900 33,369
.............................................................
InaCom Corporation # 19,212 242,551
.............................................................
PeopleSoft, Inc. # 7,100 122,475
....................... ....................... ---------
398,395
-------------------------------------------------------------
ELECTRIC PRODUCTS -- 2.2%
.............................................................
UCAR International, Inc. # 6,000 151,500
-------------------------------------------------------------
FINANCIAL SERVICES -- 2.5%
.............................................................
Radian Group Inc. 3,500 170,843
-------------------------------------------------------------
FOODS -- 9.2%
.............................................................
Dean Foods Company 8,300 344,969
.............................................................
Interstate Bakeries Corporation 5,800 130,138
.............................................................
Nabisco Group Holdings Corporation 8,100 158,456
....................... ....................... ---------
633,563
-------------------------------------------------------------
HEALTHCARE -- DRUGS -- 0.4%
.............................................................
Bergen Brunswig Corporation --Class
A 1,600 27,600
-------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------
Shares Value
<S> <C> <C>
HEALTHCARE -- MISCELLANEOUS -- 3.2%
.............................................................
Beverly Enterprises, Inc. # 9,000 $ 72,562
.............................................................
Total Renal Care Holdings, Inc. # 9,400 146,288
....................... ....................... ---------
218,850
-------------------------------------------------------------
HOUSEHOLD FURNISHINGS & APPLIANCES -- 3.4%
.............................................................
Whirlpool Corporation 3,200 236,800
-------------------------------------------------------------
INSURANCE -- 6.2%
.............................................................
ESG Re Limited 13,900 208,500
.............................................................
Harleysville Group, Inc. 3,400 69,700
.............................................................
IPC Holdings Limited 3,000 60,000
.............................................................
Ohio Casualty Corporation 1,200 43,350
.............................................................
St. Paul Companies, Inc. 1,400 44,538
....................... ....................... ---------
426,088
-------------------------------------------------------------
MACHINERY -- 3.4%
.............................................................
New Holland N.V. 13,700 234,613
-------------------------------------------------------------
METALS & MINING -- 0.9%
.............................................................
Reynolds Metals Company 1,000 59,000
-------------------------------------------------------------
MISCELLANEOUS -- 1.2%
.............................................................
American Coin Merchandising, Inc. # 13,000 84,500
-------------------------------------------------------------
OIL -- DOMESTIC -- 3.2%
.............................................................
Occidental Petroleum Corporation 6,300 133,088
.............................................................
Pennzoil-Quaker State Company 1,100 16,500
.............................................................
USX -- Marathon Group, Inc. 2,100 68,381
....................... ....................... ---------
217,969
-------------------------------------------------------------
OIL & GAS DRILLING -- 8.8%
.............................................................
Amerada Hess Corporation 600 35,700
.............................................................
Diamond Offshore Drilling, Inc. 2,700 76,613
.............................................................
Kerr-McGee Corporation 2,300 115,431
.............................................................
PennzEnergy Company 3,600 60,075
.............................................................
Triton Energy Limited # 29,300 314,975
....................... ....................... ---------
602,794
-------------------------------------------------------------
PAPER -- 2.7%
.............................................................
Chesapeake Corporation 1,800 67,387
.............................................................
Consolidated Papers, Inc. 4,500 120,375
....................... ....................... ---------
187,762
-------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
17
<PAGE> 673
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
MID-CAP FUND
<TABLE>
<CAPTION>
Shares Value
-------------------------------------------------------------
<S> <C> <C>
POLLUTION CONTROL -- 1.5%
.............................................................
Browning-Ferris Industries, Inc. 2,400 $ 103,200
-------------------------------------------------------------
RETAIL -- JEWELRY -- 2.1%
.............................................................
Friedman's Inc. 16,500 143,344
-------------------------------------------------------------
SAVINGS & LOANS -- 1.1%
.............................................................
Charter One Financial, Inc. 2,625 73,008
-------------------------------------------------------------
SECURITY SERVICES -- 1.9%
.............................................................
Pittston Brink's Group 4,800 128,400
-------------------------------------------------------------
STEEL -- 3.0%
.............................................................
USX-U.S. Steel Group, Inc. 7,600 205,200
-------------------------------------------------------------
TOBACCO -- 2.8%
.............................................................
R.J. Reynolds Tobacco Holdings,
Inc. # 4,200 132,300
.............................................................
Universal Corporation/VA 2,200 62,562
....................... ....................... ---------
194,862
-------------------------------------------------------------
TRANSPORTATION -- AIR -- 1.2%
.............................................................
AMR Corporation # 1,200 81,900
-------------------------------------------------------------
TRUCKING -- 0.7%
.............................................................
Ryder System, Inc. 1,800 46,800
-------------------------------------------------------------
UTILITY -- ELECTRIC -- 6.6%
.............................................................
CMP Group Inc. 6,500 170,219
.............................................................
Illinova Corporation 5,600 152,600
.............................................................
P P & L Resources, Inc. 2,339 71,924
.............................................................
SCANA Corporation 2,600 60,775
....................... ....................... ---------
455,518
....................... ....................... ---------
Total common stock (cost 6,580,772
$6,632,207)
-------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------
VARIABLE RATE Principal
DEMAND NOTES* -- 4.9% Amount Value
<S> <C> <C>
General Mills, Inc., 4.8250% $171,873 $ 171,873
.............................................................
Pitney Bowes, Inc., 4.8250% 165,249 165,249
....................... ....................... ---------
Total variable rate demand notes 337,122
(cost $337,122)
-------------------------------------------------------------
Total investments -- 100.7% (cost
$6,969,329) 6,917,894
.............................................................
Liabilities in excess of
other assets -- (0.7)% (47,214)
....................... ....................... ---------
$6,870,680
Total net assets -- 100.0%
-------------------------------------------------------------
</TABLE>
* Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rates listed are as of June 30, 1999.
ADR -- American Depository Receipts.
# -- Non-income producing security.
See Notes to the Financial Statements
18
<PAGE> 674
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
SMALL CAP FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 96.7% Shares Value
------------------------------------------------------------
<S> <C> <C>
AEROSPACE -- 4.8%
............................................................
AVTEAM, Inc. # 347,300 $ 2,539,631
------------------------------------------------------------
AUTO PARTS -- 3.5%
............................................................
Titan International, Inc. 157,900 1,875,063
------------------------------------------------------------
CHEMICALS -- 3.2%
............................................................
The Carbide/Graphite Group, Inc. # 119,500 1,710,344
------------------------------------------------------------
COMMERCIAL SERVICES -- 0.5%
............................................................
FirstService Corporation # 16,100 245,525
------------------------------------------------------------
COMMUNICATIONS & MEDIA -- 1.3%
............................................................
Groupe AB SA ADR # 215,500 700,375
------------------------------------------------------------
COMPUTERS -- 3.1%
............................................................
Creative Technology, Ltd. 46,700 627,531
............................................................
Hutchinson Technology, Inc. # 36,500 1,012,875
...................... ...................... ----------
1,640,406
------------------------------------------------------------
COMPUTER SOFTWARE &
SERVICES -- 10.2%
............................................................
Cambridge Technology Partners, Inc.
# 80,300 1,410,269
............................................................
Engineering Animation, Inc. # 24,200 512,737
............................................................
InaCom Corporation # 239,348 3,021,768
............................................................
Tech Data Corporation # 12,750 487,687
...................... ...................... ----------
5,432,461
------------------------------------------------------------
COMPUTER SYSTEMS -- 1.7%
............................................................
Radisys Corporation # 23,100 898,006
------------------------------------------------------------
ELECTRONICS -- 0.9%
............................................................
Stoneridge, Inc. # 34,900 471,150
------------------------------------------------------------
ENGINEERING AND
CONSTRUCTION -- 0.3%
............................................................
Stone & Webster, Inc. 5,700 151,762
------------------------------------------------------------
ENTERTAINMENT -- 3.2%
............................................................
Midway Games Inc. # 69,300 896,569
............................................................
THQ Inc. # 29,100 836,625
...................... ...................... ----------
1,733,194
------------------------------------------------------------
FINANCE -- MISCELLANEOUS -- 2.2%
............................................................
Executive Risk, Inc. 13,600 1,156,850
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Shares Value
<S> <C> <C>
FOOD, BEVERAGE & TOBACCO -- 8.4%
............................................................
Canandaigua Brands, Inc. # 5,000 $ 262,189
............................................................
Interstate Bakeries Corporation 77,400 1,736,662
............................................................
J & J Snack Foods Corporation # 74,300 1,783,200
............................................................
The Earthgrains Company 27,900 720,169
...................... ...................... ----------
4,502,220
------------------------------------------------------------
HEALTHCARE -- MISCELLANEOUS -- 7.2%
............................................................
Beverly Enterprises, Inc. # 132,500 1,068,281
............................................................
Total Renal Care Holdings, Inc. # 145,300 2,261,231
............................................................
Ventas, Inc. 99,700 535,888
...................... ...................... ----------
3,865,400
------------------------------------------------------------
INSURANCE -- 7.0%
............................................................
ESG Re Limited 206,400 3,096,000
............................................................
Horace Mann Educators Corporation 7,400 201,187
............................................................
Stirling Cooke Brown Holdings
Limited 107,600 443,850
...................... ...................... ----------
3,741,037
------------------------------------------------------------
MACHINERY -- 8.5%
............................................................
Denison International PLC ADR # 138,700 2,132,513
............................................................
Hawk Corporation Class A # 96,300 848,644
............................................................
JLG Industries, Inc. 3,000 61,125
............................................................
New Holland N.V. 88,700 1,518,987
...................... ...................... ----------
4,561,269
------------------------------------------------------------
MISCELLANEOUS -- 4.0%
............................................................
American Coin Merchandising, Inc. # 282,000 1,833,000
............................................................
Mac-Gray Corporation # 33,300 291,375
............................................................
Ralcorp Holdings, Inc. # 2,500 40,156
...................... ...................... ----------
2,164,531
------------------------------------------------------------
OIL EXPLORATION &
PRODUCTION -- 0.6%
............................................................
Abraxas Petroleum Corporation # 74,500 88,469
............................................................
Tom Brown, Inc. # 14,300 222,544
...................... ...................... ----------
311,013
------------------------------------------------------------
OIL & GAS DRILLING -- 1.0%
............................................................
Triton Energy Limited # 51,200 550,400
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
19
<PAGE> 675
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
SMALL CAP FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
PUBLISHING -- 3.0%
............................................................
Playboy Enterprises, Inc. Class A # 34,200 $ 803,700
............................................................
Playboy Enterprises, Inc. # 29,100 772,969
...................... ...................... ----------
1,576,669
------------------------------------------------------------
RETAIL -- APPAREL -- 2.0%
............................................................
Payless ShoeSource, Inc. # 20,400 1,091,400
------------------------------------------------------------
RETAIL -- JEWELRY -- 2.4%
............................................................
Friedman's, Inc. 150,500 1,307,469
------------------------------------------------------------
SECURITY SERVICES -- 6.3%
............................................................
Pittston Brink's Group 124,900 3,341,075
------------------------------------------------------------
STEEL -- 0.9%
............................................................
Armco Inc. # 70,200 465,075
------------------------------------------------------------
TRANSPORTATION -- AIR
FREIGHT -- 3.5%
............................................................
AirNet Systems, Inc. # 139,900 1,888,650
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Shares Value
<S> <C> <C>
UTILITY -- ELECTRIC -- 7.0%
............................................................
Central Hudson Gas & Electric
Corporation 2,000 $ 84,000
............................................................
CMP Group Inc. 119,000 3,116,312
............................................................
Cleco Corporation 2,600 78,975
............................................................
MDU Resources Group, Inc. 4,000 91,250
............................................................
Public Service Company of New
Mexico 4,200 83,475
............................................................
Rochester Gas and Electric
Corporation 3,300 87,656
............................................................
UGI Corporation 4,400 88,825
............................................................
The United Illuminating Company 2,000 84,875
...................... ...................... ----------
3,715,368
...................... ...................... ----------
Total common stock (cost 51,636,343
$60,313,444)
------------------------------------------------------------
Total investments -- 96.7% (cost
$60,313,444) 51,636,343
............................................................
Other assets in excess of
liabilities -- 3.3% 1,740,425
...................... ...................... ----------
$53,376,768
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
ADR -- American Depository Receipts.
# -- Non-income producing security.
See Notes to the Financial Statements
20
<PAGE> 676
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
INTERNATIONAL FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 93.5% Shares Value
------------------------------------------------------------
<S> <C> <C>
AUSTRALIA -- 3.3%
------------------------------------------------------------
BANKS -- 1.6%
............................................................
Australia and New Zealand
Banking Group, Ltd. 2,981,050 $ 21,919,833
------------------------------------------------------------
BUILDING MATERIALS -- 1.7%
............................................................
Pioneer International, Ltd. 9,105,173 23,202,883
..................... ..................... ------------
45,122,716
Total Australia
------------------------------------------------------------
AUSTRIA -- 0.5%
------------------------------------------------------------
STEEL -- 0.5%
............................................................
Boehler -- Uddeholm AG 140,010 6,929,744
..................... ..................... ------------
6,929,744
Total Austria
------------------------------------------------------------
CANADA -- 3.7%
------------------------------------------------------------
BANKS -- 1.2%
............................................................
Canadian Imperial Bank of
Commerce 715,022 16,956,471
------------------------------------------------------------
DIVERSIFIED
INDUSTRIALS -- 1.5%
............................................................
Imasco, Ltd. 733,630 19,677,799
------------------------------------------------------------
METALS & MINERALS -- 1.0%
............................................................
Noranda, Inc. 1,070,329 14,029,040
..................... ..................... ------------
50,663,310
Total Canada
------------------------------------------------------------
FINLAND -- 2.4%
------------------------------------------------------------
FOREST PRODUCTS & PAPER -- 2.4%
............................................................
Metra OYJ 507,332 10,726,388
............................................................
UPM-Kymmene OYJ 780,340 22,373,610
..................... ..................... ------------
33,099,998
Total Finland
------------------------------------------------------------
FRANCE -- 9.5%
------------------------------------------------------------
BANKS -- 2.5%
............................................................
Banque Nationale de Paris 171,685 14,307,083
............................................................
Societe Generale 115,655 20,385,148
..................... ..................... ------------
34,692,231
------------------------------------------------------------
BEVERAGES -- 1.4%
............................................................
Pernod Ricard SA 287,923 19,301,769
------------------------------------------------------------
BUILDING MATERIALS -- 1.5%
............................................................
Lafarge SA 218,032 20,732,828
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Shares Value
<S> <C> <C>
CONSUMER DURABLES -- MISCELLANEOUS -- 1.1%
............................................................
Societe BIC SA 286,125 $ 15,094,156
------------------------------------------------------------
OIL -- INTERNATIONAL -- 3.0%
............................................................
Elf Aquitaine SA 156,755 23,005,607
............................................................
Total SA 138,143 17,823,524
..................... ..................... ------------
40,829,131
..................... ..................... ------------
130,650,115
Total France
------------------------------------------------------------
GERMANY -- 7.5%
------------------------------------------------------------
BANKS -- 1.0%
............................................................
Commerzbank AG 457,680 13,901,275
------------------------------------------------------------
BUILDING MATERIALS -- 1.6%
............................................................
Dyckerhoff AG 41,200 12,450,083
............................................................
Friedrich Grohe AG 32,968 9,316,452
..................... ..................... ------------
21,766,535
------------------------------------------------------------
CHEMICALS -- 2.2%
............................................................
Hoechst AG 482,306 21,837,081
............................................................
SGL Carbon AG # 113,719 8,796,334
..................... ..................... ------------
30,633,415
------------------------------------------------------------
CONSUMER DURABLES -- MISCELLANEOUS -- 0.9%
............................................................
Buderus AG 33,100 13,279,600
------------------------------------------------------------
DIVERSIFIED
INDUSTRIALS -- 1.8%
............................................................
VEBA AG 415,695 24,437,515
..................... ..................... ------------
104,018,340
Total Germany
------------------------------------------------------------
HONG KONG -- 4.4%
------------------------------------------------------------
METALS & MINING -- 0.6%
............................................................
Yanzhou Coal Mining Co., Ltd. 21,746,000 7,707,471
------------------------------------------------------------
PRINTING & PUBLISHING -- 1.2%
............................................................
South China Morning Post
(Holdings), Ltd. 30,941,000 17,346,963
------------------------------------------------------------
REAL ESTATE
DEVELOPMENT -- 2.6%
............................................................
Hang Lung Development Company 12,148,000 15,148,011
............................................................
New World Development Co.,
Ltd. 6,851,000 20,529,424
..................... ..................... ------------
35,677,435
..................... ..................... ------------
60,731,869
Total Hong Kong
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
21
<PAGE> 677
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
INTERNATIONAL FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
IRELAND -- 2.7%
------------------------------------------------------------
FOOD PRODUCERS -- 1.1%
............................................................
Greencore Group PLC 4,885,960 $ 15,117,451
------------------------------------------------------------
PAPER -- 1.6%
............................................................
Jefferson Smurfit Group PLC 9,664,145 22,675,258
..................... ..................... ------------
37,792,709
Total Ireland
------------------------------------------------------------
ITALY -- 3.0%
------------------------------------------------------------
OIL EXPLORATION & PRODUCTION -- 1.3%
............................................................
ENI SPA 3,111,524 18,580,573
------------------------------------------------------------
TELECOMMUNICATIONS -- 1.7%
............................................................
Telecom Italia SPA 1,933,600 20,101,782
............................................................
Telecom Italia SPA -- RNC 586,000 3,179,002
..................... ..................... ------------
23,280,784
..................... ..................... ------------
41,861,357
Total Italy
------------------------------------------------------------
JAPAN -- 8.5%
------------------------------------------------------------
ELECTRONIC COMPONENTS -- 3.5%
............................................................
Nintendo Co., Ltd. 340,800 47,893,364
------------------------------------------------------------
ELECTRONICS -- 1.1%
............................................................
Nichicon Corporation 1,105,000 16,113,075
------------------------------------------------------------
FINANCIAL SERVICES -- 2.1%
............................................................
Promise Company, Ltd. 493,400 29,145,844
------------------------------------------------------------
LEISURE -- TOYS -- 1.8%
............................................................
NAMCO, Ltd. 926,300 24,871,757
..................... ..................... ------------
118,024,040
Total Japan
------------------------------------------------------------
NETHERLANDS -- 7.8%
------------------------------------------------------------
BANKS -- 1.0%
............................................................
ABN AMRO Holding N.V. 648,880 14,053,713
------------------------------------------------------------
CHEMICALS -- 1.5%
............................................................
Akzo Nobel N.V. 473,351 19,918,235
------------------------------------------------------------
ELECTRONICS -- 2.0%
............................................................
Koninklijke (Royal) Philips
Electronics N.V. 276,570 27,283,373
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Shares Value
<S> <C> <C>
INSURANCE -- MULTI-LINE -- 2.3%
............................................................
Fortis (NL) N.V. 302,977 $ 9,358,665
............................................................
ING Groep N.V. 414,711 22,454,958
..................... ..................... ------------
31,813,623
------------------------------------------------------------
TELECOMMUNICATIONS -- 1.0%
............................................................
Koninklijke KPN N.V. 298,195 13,993,268
..................... ..................... ------------
107,062,212
Total Netherlands
------------------------------------------------------------
NORWAY -- 0.6%
------------------------------------------------------------
ENGINEERING & CONSTRUCTION -- 0.6%
............................................................
Kvaerner PLC -- Class A # 400,043 8,232,069
..................... ..................... ------------
8,232,069
Total Norway
------------------------------------------------------------
SINGAPORE -- 2.9%
------------------------------------------------------------
COMPUTERS -- 2.0%
............................................................
Creative Technology, Ltd. 2,107,252 28,316,199
------------------------------------------------------------
DIVERSIFIED
INDUSTRIALS -- 0.9%
............................................................
Jardine Matheson Holdings,
Ltd. 2,534,600 12,673,000
..................... ..................... ------------
40,989,199
Total Singapore
------------------------------------------------------------
SPAIN -- 2.8%
------------------------------------------------------------
BANKS -- 1.4%
............................................................
Banco Santander Central
Hispano, S.A. 1,774,800 18,487,500
------------------------------------------------------------
TELECOMMUNICATIONS -- 1.4%
............................................................
Telefonica de Espana S.A. 404,973 19,509,374
..................... ..................... ------------
37,996,874
Total Spain
------------------------------------------------------------
SWEDEN -- 1.5%
------------------------------------------------------------
ELECTRICAL EQUIPMENT -- 1.5%
............................................................
Electrolux AB -- Class B 985,730 20,637,490
..................... ..................... ------------
20,637,490
Total Sweden
------------------------------------------------------------
SWITZERLAND -- 6.1%
------------------------------------------------------------
BUILDING MATERIALS -- 1.3%
............................................................
Geberit International AG # 78,877 17,986,554
------------------------------------------------------------
INSURANCE -- 0.6%
............................................................
Schweizerische
Rueckversicherungs-
Gesellschaft "registered" 4,634 8,823,260
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
22
<PAGE> 678
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
INTERNATIONAL FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
MACHINERY & EQUIPMENT -- 2.2%
............................................................
SIG Schweizerische Industrie-
Gesellschaft Holding 20,307 $ 12,095,897
............................................................
Sulzer AG "registered" # 29,435 17,892,754
..................... ..................... ------------
29,988,651
------------------------------------------------------------
MEDICAL PRODUCTS & SUPPLIES -- 2.0%
............................................................
Novartis AG "registered' 18,488 26,995,857
..................... ..................... ------------
83,794,322
Total Switzerland
------------------------------------------------------------
UNITED KINGDOM -- 26.3%
------------------------------------------------------------
AUTOS -- 1.2%
............................................................
Lex Service PLC 1,828,630 16,862,367
------------------------------------------------------------
BANKS -- 3.1%
............................................................
Lloyds TSB Group PLC 1,512,287 20,500,738
............................................................
National Westminster Bank PLC 1,034,061 21,923,267
..................... ..................... ------------
42,424,005
------------------------------------------------------------
BUILDING MATERIALS -- 1.5%
............................................................
Hanson PLC 2,275,447 20,211,450
------------------------------------------------------------
CHEMICALS -- 3.4%
............................................................
BOC Group PLC 1,009,808 19,737,735
............................................................
Laporte PLC 2,424,113 27,397,368
..................... ..................... ------------
47,135,103
------------------------------------------------------------
CONSUMER DURABLES -- MISCELLANEOUS -- 1.0%
............................................................
Reckitt & Colman PLC 1,332,381 13,892,970
------------------------------------------------------------
DIVERSIFIED -- 2.0%
............................................................
Cookson Group PLC 8,227,860 27,754,761
------------------------------------------------------------
DIVERSIFIED
INDUSTRIALS -- 3.2%
............................................................
Tomkins PLC 5,996,213 25,992,411
............................................................
Williams PLC 2,638,437 17,425,995
..................... ..................... ------------
43,418,406
------------------------------------------------------------
ENGINEERING & CONSTRUCTION -- 3.1%
............................................................
Invensys PLC 3,888,748 18,404,738
............................................................
TI Group PLC 3,551,130 23,789,884
..................... ..................... ------------
42,194,622
------------------------------------------------------------
FOOD & BEVERAGES -- 1.7%
............................................................
Allied Domecq PLC 2,432,594 23,467,017
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Shares Value
<S> <C> <C>
INSURANCE -- 2.5%
............................................................
Allied Zurich AG PLC 1,304,264 $ 16,395,816
............................................................
CGU PLC 1,286,795 18,589,969
..................... ..................... ------------
34,985,785
------------------------------------------------------------
MEDICAL PRODUCTS & SUPPLIES -- 0.6%
............................................................
Medeva PLC 4,627,140 7,512,538
------------------------------------------------------------
PRINTING & PUBLISHING -- 1.0%
............................................................
United News & Media PLC 1,488,355 14,311,106
------------------------------------------------------------
RETAIL -- FOOD CHAINS -- 0.7%
............................................................
Safeway PLC 2,502,850 10,030,732
------------------------------------------------------------
TOBACCO -- 0.9%
............................................................
B.A.T. Industries PLC 1,338,714 12,587,372
------------------------------------------------------------
WATER -- TREATMENT -- 0.4%
............................................................
Thames Water PLC 367,874 5,833,563
..................... ..................... ------------
362,621,797
Total United Kingdom
..................... ..................... ------------
Total common stock 1,290,228,161
(cost $1,138,929,554)
------------------------------------------------------------
Principal
SHORT-TERM INVESTMENTS -- 2.5% Amount
------------------------------------------------------------
COMMERCIAL PAPER -- 2.2%
------------------------------------------------------------
TRW Incorporated
6.05%, 7/01/1999 $30,000,000 30,000,000
------------------------------------------------------------
VARIABLE RATE DEMAND
NOTES* -- 0.3%
------------------------------------------------------------
Chase Manhattan Bank, 3.3593% 4,683,200 4,683,200
..................... ..................... ------------
Total short-term investments 34,683,200
(cost $34,683,200)
------------------------------------------------------------
Total investments -- 96.0%
(cost $1,173,612,754) 1,324,911,361
............................................................
Other assets in excess of
liabilities -- 4.0% 55,134,613
..................... ..................... ------------
$1,380,045,974
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
# Non-income producing security.
* Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rate listed is as of June 30, 1999.
See Notes to the Financial Statements
23
<PAGE> 679
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
GLOBAL EQUITY FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 98.1% Shares Value
-------------------------------------------------------------
<S> <C> <C>
AUSTRALIA -- 3.5%
-------------------------------------------------------------
BANKS -- 1.7%
.............................................................
Australia and New Zealand Banking
Group, Ltd. 16,940 $ 124,561
-------------------------------------------------------------
BUILDING MATERIALS -- 1.4%
.............................................................
Pioneer International, Ltd. 41,863 106,680
-------------------------------------------------------------
DIVERSIFIED COMPANIES -- 0.4%
.............................................................
Reinsurance Australia Corporation,
Ltd. 39,233 32,720
....................... ....................... ---------
263,961
Total Australia
-------------------------------------------------------------
CANADA -- 1.1%
-------------------------------------------------------------
FOREST PRODUCTS & PAPER -- 0.0%
.............................................................
Nexfor, Inc. 1 6
-------------------------------------------------------------
METALS & MINERALS -- 1.1%
.............................................................
Noranda, Inc. 6,385 83,690
-------------------------------------------------------------
OIL EXPLORATION &
PRODUCTION -- 0.0%
.............................................................
Canadian Hunter Exploration Ltd. # 1 11
....................... ....................... ---------
83,707
Total Canada
-------------------------------------------------------------
FRANCE -- 5.8%
-------------------------------------------------------------
BANKS -- 2.3%
.............................................................
Banque Nationale de Paris 820 68,333
.............................................................
Societe Generale 625 110,161
....................... ....................... ---------
178,494
-------------------------------------------------------------
BEVERAGES -- 1.1%
.............................................................
Pernod Ricard SA 1,200 80,446
-------------------------------------------------------------
BUILDING MATERIALS -- 1.5%
.............................................................
Lafarge SA 1,202 114,299
-------------------------------------------------------------
OIL -- INTERNATIONAL -- 0.9%
.............................................................
Total SA 514 66,317
....................... ....................... ---------
439,556
Total France
-------------------------------------------------------------
GERMANY -- 5.2%
-------------------------------------------------------------
BANKS -- 1.0%
.............................................................
Commerzbank AG 2,500 75,933
-------------------------------------------------------------
CHEMICALS -- 1.7%
.............................................................
Hoechst AG 2,759 124,918
-------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------
Shares Value
<S> <C> <C>
DIVERSIFIED INDUSTRIALS -- 1.6%
.............................................................
VEBA AG 2,014 $ 118,397
-------------------------------------------------------------
MEDICAL PRODUCTS -- 0.9%
.............................................................
Draegerwerk AG 4,985 70,436
....................... ....................... ---------
389,684
Total Germany
-------------------------------------------------------------
HONG KONG -- 3.5%
-------------------------------------------------------------
BANKS -- 1.5%
.............................................................
Dao Heng Bank Group, Ltd. 25,500 114,372
-------------------------------------------------------------
REAL ESTATE DEVELOPMENT -- 1.3%
.............................................................
New World Development Co., Ltd. 33,000 98,886
-------------------------------------------------------------
RETAIL -- SPECIALTY -- 0.7%
.............................................................
Dickson Concepts International,
Ltd. 73,500 52,102
....................... ....................... ---------
265,360
Total Hong Kong
-------------------------------------------------------------
IRELAND -- 2.9%
-------------------------------------------------------------
FOOD PRODUCERS -- 0.9%
.............................................................
Greencore Group PLC 21,160 65,470
-------------------------------------------------------------
PAPER -- 2.0%
.............................................................
Jefferson Smurfit Group PLC 63,990 150,142
....................... ....................... ---------
215,612
Total Ireland
-------------------------------------------------------------
ITALY -- 2.7%
-------------------------------------------------------------
OIL EXPLORATION &
PRODUCTION -- 1.0%
.............................................................
ENI SPA 12,000 71,658
-------------------------------------------------------------
TELECOMMUNICATIONS -- 1.7%
.............................................................
Telecom Italia SPA 10,600 110,198
.............................................................
Telecom Italia SPA -- RNC 3,425 18,580
....................... ....................... ---------
128,778
....................... ....................... ---------
200,436
Total Italy
-------------------------------------------------------------
JAPAN -- 7.5%
-------------------------------------------------------------
AUTO PARTS -- 1.0%
.............................................................
NIFCO, Inc. 8,000 76,867
-------------------------------------------------------------
ELECTRONIC COMPONENTS -- 3.2%
.............................................................
Nintendo Co., Ltd. 1,700 238,905
-------------------------------------------------------------
ELECTRONICS -- 1.6%
.............................................................
Nichicon Corporation 8,000 116,656
-------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
24
<PAGE> 680
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
GLOBAL EQUITY FUND
<TABLE>
<CAPTION>
Shares Value
-------------------------------------------------------------
<S> <C> <C>
FINANCIAL SERVICES -- 1.7%
.............................................................
Promise Company, Ltd. 2,200 $ 129,957
....................... ....................... ---------
562,385
Total Japan
-------------------------------------------------------------
NETHERLANDS -- 6.5%
-------------------------------------------------------------
BANKS -- 1.0%
.............................................................
ABN AMRO Holding N.V. 3,585 77,645
-------------------------------------------------------------
CHEMICALS -- 1.3%
.............................................................
Akzo Nobel N.V. 2,420 101,832
-------------------------------------------------------------
ELECTRONICS -- 1.8%
.............................................................
Koninklijke (Royal) Philips
Electronics N.V. 1,343 132,505
-------------------------------------------------------------
INSURANCE -- MULTI-LINE -- 1.6%
.............................................................
ING Groep N.V. 2,255 122,099
-------------------------------------------------------------
TELECOMMUNICATIONS -- 0.8%
.............................................................
Koninklijke KPN N.V. 1,300 61,005
....................... ....................... ---------
495,086
Total Netherlands
-------------------------------------------------------------
NEW ZEALAND -- 1.3%
-------------------------------------------------------------
BUILDING MATERIALS -- 1.3%
.............................................................
Fletcher Challenge Building 69,015 100,573
....................... ....................... ---------
100,573
Total New Zealand
-------------------------------------------------------------
SINGAPORE -- 2.9%
-------------------------------------------------------------
COMPUTERS -- 2.0%
.............................................................
Creative Technology, Ltd. 11,200 150,500
-------------------------------------------------------------
DIVERSIFIED INDUSTRIALS -- 0.9%
.............................................................
Jardine Matheson Holdings, Ltd. 14,000 70,000
....................... ....................... ---------
220,500
Total Singapore
-------------------------------------------------------------
SPAIN -- 1.4%
-------------------------------------------------------------
TELECOMMUNICATIONS -- 1.4%
.............................................................
Telefonica de Espana S.A. 2,244 108,104
....................... ....................... ---------
108,104
Total Spain
-------------------------------------------------------------
SWEDEN -- 1.5%
-------------------------------------------------------------
ELECTRICAL EQUIPMENT -- 1.5%
.............................................................
Electrolux AB -- Class B 5,525 115,673
....................... ....................... ---------
115,673
Total Sweden
-------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------
Shares Value
<S> <C> <C>
SWITZERLAND -- 6.8%
-------------------------------------------------------------
BUILDING MATERIALS -- 2.2%
.............................................................
Forbo Holding AG "registered" 161 $ 64,002
.............................................................
Geberit International AG # 451 102,843
....................... ....................... ---------
166,845
-------------------------------------------------------------
INSURANCE -- 0.7%
.............................................................
Schweizerische Rueckversicherungs-
Gesellschaft "registered" 27 51,409
-------------------------------------------------------------
MACHINERY & EQUIPMENT -- 2.0%
.............................................................
Saurer AG "registered" # 141 76,278
.............................................................
SIG Schweizerische
Industrie-Gesellschaft Holding 126 75,052
....................... ....................... ---------
151,330
-------------------------------------------------------------
MEDICAL PRODUCTS & SUPPLIES -- 1.9%
.............................................................
Novartis AG "registered" 99 144,558
....................... ....................... ---------
514,142
Total Switzerland
-------------------------------------------------------------
UNITED KINGDOM -- 20.4%
-------------------------------------------------------------
APPAREL & TEXTILES -- 1.6%
.............................................................
Coats Viyella PLC 154,380 124,108
-------------------------------------------------------------
BANKS -- 3.1%
.............................................................
Lloyds TSB Group PLC 8,337 113,017
.............................................................
National Westminster Bank PLC 5,700 120,847
....................... ....................... ---------
233,864
-------------------------------------------------------------
BUILDING MATERIALS -- 1.5%
.............................................................
Hanson PLC 12,770 113,428
-------------------------------------------------------------
DIVERSIFIED -- 1.2%
.............................................................
Cookson Group PLC 27,000 91,078
-------------------------------------------------------------
DIVERSIFIED INDUSTRIALS -- 2.9%
.............................................................
Elementis PLC 55,010 90,180
.............................................................
Tomkins PLC 29,832 129,316
....................... ....................... ---------
219,496
-------------------------------------------------------------
ENGINEERING & CONSTRUCTION -- 2.5%
.............................................................
Invensys PLC 11,106 52,563
.............................................................
TI Group PLC 20,540 137,603
....................... ....................... ---------
190,166
-------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
25
<PAGE> 681
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
GLOBAL EQUITY FUND
<TABLE>
<CAPTION>
Shares Value
-------------------------------------------------------------
<S> <C> <C>
FOOD & BEVERAGES -- 1.9%
.............................................................
Allied Domecq PLC 12,690 $ 122,419
.............................................................
Tesco PLC 7,520 19,351
....................... ....................... ---------
141,770
-------------------------------------------------------------
INSURANCE -- 2.2%
.............................................................
Allied Zurich AG PLC 5,870 73,791
.............................................................
CGU PLC 6,340 91,592
....................... ....................... ---------
165,383
-------------------------------------------------------------
MEDICAL PRODUCTS & SUPPLIES -- 0.6%
.............................................................
Medeva PLC 25,878 42,015
-------------------------------------------------------------
PRINTING & PUBLISHING -- 1.0%
.............................................................
United News & Media PLC 8,276 79,577
-------------------------------------------------------------
TOBACCO -- 0.9%
.............................................................
B.A.T. Industries PLC 7,230 67,981
-------------------------------------------------------------
WATER -- TREATMENT -- 1.0%
.............................................................
Pennon Group PLC 4,518 75,632
....................... ....................... ---------
1,544,498
Total United Kingdom
-------------------------------------------------------------
UNITED STATES -- 25.1%
-------------------------------------------------------------
AEROSPACE -- 1.0%
.............................................................
Northrop Grumman Corporation 1,100 72,944
-------------------------------------------------------------
AUTO PARTS -- 1.5%
.............................................................
Dana Corporation 2,400 110,550
-------------------------------------------------------------
AUTOS & TRUCKS -- 0.9%
.............................................................
Ford Motor Company 1,260 71,111
-------------------------------------------------------------
BANKS -- 1.7%
.............................................................
Bank One Corporation 2,106 125,439
-------------------------------------------------------------
BUILDING & FOREST PRODUCTS -- 1.3%
.............................................................
Weyerhaeuser Company 1,450 99,688
-------------------------------------------------------------
CONGLOMERATES -- 1.3%
.............................................................
Tenneco, Inc. 4,000 95,500
-------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------
Shares Value
<S> <C> <C>
FINANCIAL SERVICES -- 1.4%
.............................................................
Household International, Inc. 2,210 $ 104,699
-------------------------------------------------------------
INSURANCE -- 1.1%
.............................................................
Safeco Corporation 1,800 79,425
-------------------------------------------------------------
MACHINERY -- 2.2%
.............................................................
New Holland N.V. 9,750 166,969
-------------------------------------------------------------
METALS & MINING -- 1.6%
.............................................................
Alcoa, Inc. 2,000 123,750
-------------------------------------------------------------
OIL -- DOMESTIC -- 2.2%
.............................................................
Occidental Petroleum Corporation 3,400 71,825
.............................................................
Phillips Petroleum Company 1,840 92,575
....................... ....................... ---------
164,400
-------------------------------------------------------------
PHOTOGRAPHY & OPTICAL -- 1.3%
.............................................................
Eastman Kodak Company 1,400 94,850
-------------------------------------------------------------
SAVINGS & LOANS -- 0.9%
.............................................................
Fannie Mae 1,050 71,794
-------------------------------------------------------------
TOBACCO -- 1.5%
.............................................................
Philip Morris Companies, Inc. 2,905 116,745
-------------------------------------------------------------
UTILITY -- ELECTRIC -- 0.9%
.............................................................
GPU, Inc. 1,590 67,078
-------------------------------------------------------------
UTILITY -- TELEPHONE -- 4.3%
.............................................................
AT&T Corporation 1,950 108,834
.............................................................
ALLTEL Corporation 1,800 128,700
.............................................................
GTE Corporation 1,200 90,900
....................... ....................... ---------
328,434
....................... ....................... ---------
1,893,376
Total United States
-------------------------------------------------------------
Total common stock
(cost $6,810,227) 7,412,653
-------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
26
<PAGE> 682
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
GLOBAL EQUITY FUND
SHORT-TERM Principal
INVESTMENTS -- 1.4% Amount Value
-------------------------------------------------------------
VARIABLE RATE DEMAND NOTES* -- 1.4%
-------------------------------------------------------------
Chase Manhattan Bank, 3.3593% $107,718 $ 107,718
-------------------------------------------------------------
CASH EQUIVALENTS -- 0.0%
-------------------------------------------------------------
Chase Bank Domestic Liquidity Fund 689 689
....................... ....................... ---------
Total short-term investments (cost 108,407
$108,407)
-------------------------------------------------------------
Total investments -- 99.5%
(cost $6,918,634) 7,521,060
.............................................................
Other assets in excess of
liabilities -- 0.5% 40,836
....................... ....................... ---------
$7,561,896
Total net assets -- 100.0%
-------------------------------------------------------------
# Non-income producing security.
* Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rate listed is as of June 30, 1999.
See Notes to the Financial Statements
27
<PAGE> 683
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
BALANCED FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 47.1% Shares Value
------------------------------------------------------------
<S> <C> <C>
AEROSPACE -- 2.3%
............................................................
Lockheed Martin Corporation 23,300 $ 867,925
............................................................
Northrop Grumman Corporation 15,400 1,021,212
............................................................
Rockwell International
Corporation 5,800 352,350
...................... ...................... ----------
2,241,487
------------------------------------------------------------
APPAREL & TEXTILES -- 0.3%
............................................................
Russell Corporation 15,000 292,500
------------------------------------------------------------
AUTO PARTS -- 1.8%
............................................................
Dana Corporation 15,800 727,788
............................................................
Delphi Automotive Systems
Corporation 13,294 246,770
............................................................
Meritor Automotive, Inc. 2,000 51,000
............................................................
TRW Inc. 13,600 746,300
...................... ...................... ----------
1,771,858
------------------------------------------------------------
AUTOS & TRUCKS -- 2.2%
............................................................
Ford Motor Company 21,000 1,185,188
............................................................
General Motors Corporation 14,300 943,800
...................... ...................... ----------
2,128,988
------------------------------------------------------------
BANKS -- 2.5%
............................................................
Bank One Corporation 17,300 1,030,431
............................................................
First Security Corporation 8,200 223,450
............................................................
First Union Corporation 15,000 705,000
............................................................
KeyCorp 8,600 276,275
............................................................
UnionBanCal Corporation 5,900 213,137
...................... ...................... ----------
2,448,293
------------------------------------------------------------
BEVERAGES -- 0.6%
............................................................
Anheuser-Busch Companies, Inc. 9,000 638,438
------------------------------------------------------------
BUILDING & FOREST
PRODUCTS -- 1.2%
............................................................
Georgia-Pacific Corporation
(Timber Group) 13,000 328,250
............................................................
Weyerhaeuser Company 12,300 845,625
...................... ...................... ----------
1,173,875
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Shares Value
<S> <C> <C>
CHEMICALS -- 1.3%
............................................................
The Dow Chemical Company 5,200 $ 659,750
............................................................
Eastman Chemical Company 9,400 486,450
............................................................
Millennium Chemicals, Inc. 4,442 104,665
...................... ...................... ----------
1,250,865
------------------------------------------------------------
CONGLOMERATES -- 1.0%
............................................................
Tenneco, Inc. 39,600 945,450
------------------------------------------------------------
ENGINEERING &
CONSTRUCTION -- 0.5%
............................................................
Harsco Corporation 14,000 448,000
------------------------------------------------------------
FINANCIAL SERVICES -- 2.0%
............................................................
Associates First Capital
Corporation -- Class A 2,400 106,350
............................................................
Fannie Mae 12,500 854,688
............................................................
Fleet Financial Group, Inc. 600 26,625
............................................................
Household International, Inc. 11,200 530,600
............................................................
Transamerica Corporation 6,000 450,000
...................... ...................... ----------
1,968,263
------------------------------------------------------------
HEALTHCARE -- DRUGS -- 0.2%
............................................................
American Home Products
Corporation 600 34,500
............................................................
Bristol Myers Squibb Company 1,700 119,744
...................... ...................... ----------
154,244
------------------------------------------------------------
HEALTHCARE -- MEDICAL PRODUCTS -- 0.1%
............................................................
Baxter International, Inc. 2,200 133,375
------------------------------------------------------------
HOUSEHOLD FURNISHINGS & APPLIANCES -- 1.0%
............................................................
Whirlpool Corporation 13,000 962,000
------------------------------------------------------------
INSURANCE -- 3.0%
............................................................
American General Corporation 9,100 685,913
............................................................
Harleysville Group, Inc. 14,500 297,250
............................................................
Lincoln National Corporation 10,400 544,050
............................................................
Safeco Corporation 18,500 816,312
............................................................
St. Paul Companies, Inc. 20,600 655,337
...................... ...................... ----------
2,998,862
------------------------------------------------------------
LEISURE/TOYS -- 0.5%
............................................................
Fortune Brands, Inc. 13,000 537,875
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
28
<PAGE> 684
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
BALANCED FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
MACHINERY -- 1.1%
............................................................
Deere & Company 1,400 $ 55,475
............................................................
New Holland N.V. 57,200 979,550
...................... ...................... ----------
1,035,025
------------------------------------------------------------
METALS & MINING -- 2.3%
............................................................
Alcoa, Inc. 14,000 866,250
............................................................
Phelps Dodge Corporation 8,400 520,275
............................................................
Reynolds Metals Company 14,500 855,500
...................... ...................... ----------
2,242,025
------------------------------------------------------------
OIL -- DOMESTIC -- 3.7%
............................................................
Atlantic Richfield Company 6,200 518,088
............................................................
Occidental Petroleum
Corporation 26,500 559,812
............................................................
Phillips Petroleum Company 22,500 1,132,031
............................................................
Texaco Inc. 4,500 281,250
............................................................
USX-Marathon Group, Inc. 25,000 814,062
............................................................
Ultramar Diamond Shamrock
Corporation 14,700 320,644
...................... ...................... ----------
3,625,887
------------------------------------------------------------
PAPER -- 1.8%
............................................................
Georgia-Pacific Group 10,000 473,750
............................................................
International Paper Company 26,000 1,313,000
...................... ...................... ----------
1,786,750
------------------------------------------------------------
PHOTOGRAPHY & OPTICAL -- 0.8%
............................................................
Eastman Kodak Company 11,600 785,900
------------------------------------------------------------
POLLUTION CONTROL -- 1.4%
............................................................
Browning-Ferris Industries,
Inc. 18,400 791,200
............................................................
Waste Management, Inc. 10,000 537,500
...................... ...................... ----------
1,328,700
------------------------------------------------------------
RAILROADS -- 1.1%
............................................................
CSX Corporation 9,700 439,531
............................................................
Norfolk Southern Corporation 22,000 662,750
...................... ...................... ----------
1,102,281
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Shares Value
<S> <C> <C>
RETAIL -- 2.0%
............................................................
Intimate Brands, Inc. 2,940 $ 139,283
............................................................
J.C. Penney Company, Inc. 19,100 927,544
............................................................
May Department Stores Company 12,600 515,025
............................................................
Sears, Roebuck & Company 8,800 392,150
...................... ...................... ----------
1,974,002
------------------------------------------------------------
SAVINGS & LOANS -- 0.9%
............................................................
Washington Mutual, Inc. 24,300 859,612
------------------------------------------------------------
STEEL -- 0.8%
............................................................
USX-U.S. Steel Group, Inc. 29,000 783,000
------------------------------------------------------------
TOBACCO -- 1.9%
............................................................
Philip Morris Companies, Inc. 47,400 1,904,887
------------------------------------------------------------
TRUCKING -- 0.1%
............................................................
Ryder System, Inc. 4,500 117,000
------------------------------------------------------------
UTILITY -- ELECTRIC -- 5.0%
............................................................
CMS Energy Corporation 9,500 397,813
............................................................
Central & South West
Corporation 14,500 338,937
............................................................
DTE Energy Company 12,000 480,000
............................................................
Edison International 19,000 508,250
............................................................
Entergy Corporation 7,700 240,625
............................................................
GPU, Inc. 5,800 244,687
............................................................
Illinova Corporation 28,000 763,000
............................................................
PECO Energy Company 14,000 586,250
............................................................
P P & L Resources, Inc. 10,000 307,500
............................................................
PacifiCorp 12,000 220,500
............................................................
Public Service Enterprises
Group, Inc. 7,000 286,125
............................................................
SCANA Corporation 14,000 327,250
............................................................
Texas Utilities Company 6,300 259,875
...................... ...................... ----------
4,960,812
------------------------------------------------------------
UTILITY -- GAS PIPELINE -- 0.2%
............................................................
Peoples Energy Corporation 4,500 169,594
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
29
<PAGE> 685
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
BALANCED FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
UTILITY -- TELEPHONE -- 3.5%
............................................................
AT&T Corporation 15,800 $ 881,837
............................................................
ALLTEL Corporation 9,400 672,100
............................................................
Bell Atlantic Corporation 12,500 817,188
............................................................
GTE Corporation 4,000 303,000
............................................................
SBC Communications, Inc. 13,000 754,000
...................... ...................... ----------
3,428,125
------------------------------------------------------------
Total common stock (cost
$38,969,491) 46,197,973
------------------------------------------------------------
Principal
CORPORATE BONDS -- 14.6% Amount
------------------------------------------------------------
BANKS -- 1.5%
............................................................
MBNA Corporation, 5.505%,
6/17/2002 # $ 1,500,000 1,492,602
------------------------------------------------------------
EUROBANKS -- 6.1%
............................................................
Foreningsbanken Kredit AB, CLB
12/18/2001, 5.92625%,
12/29/2049 # 2,500,000 2,474,991
............................................................
Nordbanken, CLB 10/25/2001
5.92625%, 10/29/2049 # 2,000,000 1,956,940
............................................................
Okobank, CLB 9/09/2002
5.59875%, 9/29/2049 # 1,500,000 1,510,722
...................... ...................... ----------
5,942,653
------------------------------------------------------------
FINANCIAL SERVICES -- 3.5%
............................................................
Countrywide Home Loans, Inc.,
6.84%, 10/22/2004 2,500,000 2,483,303
............................................................
Lehman Brothers Holdings,
5.50125%, 6/01/2001 # 900,000 897,442
...................... ...................... ----------
3,380,745
------------------------------------------------------------
RETAIL -- 1.2%
............................................................
Rite Aid Corp. (Acquired
12/16/1998, cost $747,645),
6.00%, 12/15/2005 r 750,000 695,127
............................................................
Rite Aid Corp. 7.125%,
1/15/2007 475,000 462,860
...................... ...................... ----------
1,157,987
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
TRANSPORTATION -- 2.3%
............................................................
Delta Air Lines ETC:
9.90%, 1/02/2002 $ 150,000 $ 159,729
10.50%, 4/30/2016 750,000 923,674
............................................................
Northwest Airlines, Inc.,
11.30%, 12/21/2012 1,049,292 1,216,657
...................... ...................... ----------
2,300,060
------------------------------------------------------------
Total corporate bonds (cost
$15,656,856) 14,274,047
------------------------------------------------------------
GOVERNMENT AGENCY
MORTGAGE-BACKED
SECURITIES -- 6.0%
------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 3.4%
............................................................
Federal Home Loan Mortgage
Corporation
1588 SA, 7.48888%, 9/15/2023
# 700,000 564,527
............................................................
2067 PD, 6.50%, 9/15/2026 2,900,000 2,809,361
...................... ...................... ----------
3,373,888
------------------------------------------------------------
PASS-THROUGH SECURITIES -- 2.4%
............................................................
Federal National Mortgage
Association
Pool #313608, 6.50%,
7/01/2012 2,360,375 2,329,921
------------------------------------------------------------
STRIPPED MORTGAGE-BACKED SECURITIES -- 0.2%
............................................................
Federal National Mortgage
Association
1994-53 E (PO), 0.00%,
11/25/2023 214,503 210,946
------------------------------------------------------------
Total government agency
mortgage-backed securities
(cost $6,062,799) 5,914,755
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
30
<PAGE> 686
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
BALANCED FUND
NON-AGENCY
MORTGAGE-BACKED Principal
SECURITIES -- 13.7% Amount Value
------------------------------------------------------------
ASSET-BACKED SECURITIES -- 9.7%
............................................................
Ditech Home Loan Owner Trust,
CLB 1997-1 A3, 6.71%,
8/15/2018 $ 1,750,000 $ 1,755,679
............................................................
GMAC Commercial Mortgage
Securities Inc., 1999-C2 A2,
6.945%, 9/15/2033 1,150,000 1,148,879
............................................................
GREAT 1998-1 A1 (Acquired
7/02/98, cost $1,106,571)
7.33%, 9/15/2007 r + 1,106,571 331,971
............................................................
Green Tree Financial
Corporation, CLB 1996-5 B2,
8.45%, 7/15/2027 1,549,754 1,353,299
............................................................
Heilig-Meyers Master Trust
(Acquired 2/20/1998, cost
$1,399,872), CLB 1998-1A A,
6.125%, 1/20/2007 r 1,400,000 1,376,739
............................................................
Nomura Asset Securities
Corporation:
CLB 1995-MD3 A1B, 8.15%,
3/04/2020 1,000,000 1,053,465
............................................................
CLB 1998-D6 A1B, 6.59%,
3/17/2028 2,500,000 2,431,463
...................... ...................... ----------
9,451,495
------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 2.4%
............................................................
Independent National Mortgage
Corporation, CLB 1996-D A2,
7.00%, 5/25/2026 9,114 9,106
............................................................
PNC Mortgage Securities
Corporation, CLB 1996-1 A11,
7.50%, 6/25/2026 1,986,978 1,979,040
............................................................
Prudential Home Mortgage
Securities, CLB 1993-54,
Class A17, 3.77545%,
1/25/2024 # 500,000 394,688
...................... ...................... ----------
2,382,834
------------------------------------------------------------
STRIPPED MORTGAGE-BACKED SECURITIES -- 1.6%
............................................................
Chase Commercial Mortgage
Securities Corporation, CLB
1997-1 X (IO), 1.438176%,
4/19/2015 # 21,952,535 1,536,677
------------------------------------------------------------
Total non-agency
mortgage-backed securities
(cost $13,518,409) 13,371,006
------------------------------------------------------------
PREFERRED STOCKS -- 0.9% Shares Value
------------------------------------------------------------
Home Ownership Funding 2,
(Acquired 2/20/1997, Cost
$1,000,000) r 1,000 $ 861,000
------------------------------------------------------------
U.S. TREASURY Principal
OBLIGATIONS -- 17.2% Amount
------------------------------------------------------------
U.S. Treasury Notes:
4.00%, 10/31/2000 $12,500,000 12,245,605
............................................................
5.75%, 4/30/2003 3,150,000 3,153,937
............................................................
6.50%, 10/15/2006 1,350,000 1,393,454
------------------------------------------------------------
Total U.S. Treasury obligations
(cost $16,882,919) 16,792,996
------------------------------------------------------------
SHORT-TERM INVESTMENTS -- 0.0%
------------------------------------------------------------
VARIABLE RATE DEMAND NOTES* -- 0.0%
............................................................
General Mills, Inc., 4.8250% 7,874 7,874
............................................................
Sara Lee, Corp., 4.8200% 465 465
...................... ...................... ----------
Total short-term investments 8,339
(cost $8,339)
------------------------------------------------------------
Total investments -- 99.5%
(cost $92,098,813) 97,420,116
............................................................
Other assets in excess of
liabilities -- 0.5% 477,986
...................... ...................... ----------
$97,898,102
Total net assets -- 100.0%
------------------------------------------------------------
# Variable rate security. The rate listed is as of June 30, 1999.
* Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rates listed are as of June 30, 1999.
IO -- Interest Only.
PO -- Principal Only.
CLB -- Callable.
r -- Restricted Security. Purchased in a private placement transaction; resale
to the public may require registration or may extend only to qualified
institutional buyers.
+ -- Security Fair Valued under procedures established by the Board of Trustees
(See Note 1).
See Notes to the Financial Statements
31
<PAGE> 687
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
TOTAL RETURN BOND FUND
<TABLE>
<CAPTION>
CORPORATE BONDS Principal
AND NOTES -- 33.5% Amount Value
------------------------------------------------------------
<S> <C> <C>
BANKS -- 2.6%
............................................................
MBNA Corporation, 5.505%,
6/17/2002 # $ 500,000 $ 497,534
............................................................
Sovereign Bancorp, CLB 6.625%,
3/15/2001 1,750,000 1,744,405
............................................................
Unibanco Grand Cayman (Acquired
4/21/1999, cost $1,050,809),
10.75%, 4/28/2000 r 1,050,000 1,057,875
..................... ...................... ----------
3,299,814
------------------------------------------------------------
CABLE -- 4.5%
............................................................
Charter Communication Holdings
LLC (Acquired 3/12/1999, cost
$2,592,070), CLB 4/01/2004,
8.625%, 4/01/2009 r 2,600,000 2,509,000
............................................................
CSC Holdings Inc., 7.25%,
7/15/2008 2,200,000 2,101,000
............................................................
USA Networks Inc., 6.75%,
11/15/2005 1,000,000 960,843
..................... ...................... ----------
5,570,843
------------------------------------------------------------
EUROBANKS -- 1.0%
............................................................
Nordbanken, CLB 9/27/2001
5.9925%, 9/29/2049 # 1,300,000 1,282,112
------------------------------------------------------------
FINANCIAL SERVICES -- 7.9%
............................................................
AT & T Capital Corp., 5.34%,
10/24/2000 # 500,000 499,769
............................................................
Countrywide Home Loans, Inc.,
6.25%, 4/15/2009 2,000,000 1,845,204
............................................................
Countrywide Home Loans, Inc.,
6.85%, 6/15/2004 1,700,000 1,701,525
............................................................
Golden State Holdings, CLB
8/1/2000, 5.995%, 8/01/2003 # 3,000,000 2,947,218
............................................................
Lehman Brothers Holdings,
6.20%, 1/15/2002 1,900,000 1,871,276
............................................................
Pan Pacific Ind. Inv. PLC
(Acquired 6/18/1999, cost
$971,987), 0.00%, 4/28/2007 r 2,000,000 990,960
..................... ...................... ----------
9,855,952
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Principal
Amount Value
<S> <C> <C>
INDUSTRIAL -- 3.0%
............................................................
Coca-Cola Femsa SA, 8.95%,
11/01/2006 $1,110,000 $ 1,101,925
............................................................
Lennar Corp., CLB 7.625%,
3/01/2009 2,750,000 2,612,505
..................... ...................... ----------
3,714,430
------------------------------------------------------------
MISCELLANEOUS -- 1.5%
............................................................
Liberty Property LP, CLB 7.75%,
4/15/2009 1,200,000 1,154,710
............................................................
Republic of Brazil, 11.625%,
4/15/2004 750,000 697,500
..................... ...................... ----------
1,852,210
------------------------------------------------------------
RETAIL -- 4.3%
............................................................
Great Atlantic & Pacific Tea,
7.70%, 1/15/2004 2,500,000 2,465,855
............................................................
Rite Aid Corp.:
(Acquired 12/16/1998, cost
$1,246,075), 6.00%,
12/15/2005 r 1,250,000 1,158,545
............................................................
(Acquired 3/30/1999, cost
$964,707), CLB 6.00%,
12/15/2005 r 1,000,000 926,836
............................................................
7.125%, 1/15/2007 850,000 828,276
..................... ...................... ----------
5,379,512
------------------------------------------------------------
SAVINGS & LOANS -- 0.4%
............................................................
Western Financial Savings, CLB
7/1/2000, 8.50%, 7/01/2003 500,000 457,604
------------------------------------------------------------
STEEL -- 2.2%
............................................................
Pohang Iron & Steel, 6.625%,
7/01/2003 2,900,000 2,745,218
------------------------------------------------------------
TELECOMMUNICATIONS -- 2.6%
............................................................
Comcast Cellular Holdings, CLB
5/01/2002, 9.50%, 5/01/2007 1,300,000 1,460,875
............................................................
Telecom Argentina Stet. Fran.
(Acquired 6/25/1999, cost
$998,750), 9.75%, 7/12/2001 r 1,000,000 1,000,000
............................................................
MCI Worldcom, Inc., CLB
1/15/2001, 8.875%, 1/15/2006 775,000 822,559
..................... ...................... ----------
3,283,434
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
32
<PAGE> 688
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
TOTAL RETURN BOND FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
TRANSPORTATION -- 1.9%
............................................................
Bombardier Capital Inc.
(Acquired 1/22/1999, cost
$1,496,910), CLB 6.00%,
1/15/2002 r $1,500,000 $ 1,476,006
............................................................
Delta Air Lines ETC:
CLB 9.90%, 1/02/2002 250,000 266,214
............................................................
10.50%, 4/30/2016 500,000 615,782
..................... ...................... ----------
2,358,002
------------------------------------------------------------
UTILITIES -- 1.6%
............................................................
CMS Energy Corp., CLB 8.00%,
7/01/2001# 2,000,000 1,996,286
------------------------------------------------------------
Total corporate bonds and notes
(cost $42,743,995) 41,795,417
------------------------------------------------------------
GOVERNMENT AGENCY
MORTGAGE-BACKED
SECURITIES -- 22.8%
------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 22.5%
............................................................
Federal Home Loan Mortgage
Corporation:
............................................................
1564 SE, CLB 9.12167%,
8/15/2008 # 119,179 122,195
............................................................
1565 OC, CLB 6.84544%,
8/15/2008 # 1,827,135 1,736,051
............................................................
1261 J, CLB 8.00%, 7/15/2021 703,629 725,247
............................................................
1573 GC, CLB 11.51138%,
1/15/2023 # 546,583 530,566
............................................................
1588 SA, 7.48888%, 9/15/2023
# 1,625,000 1,310,510
............................................................
2067 PD, 6.50%, 9/15/2026 1,200,000 1,162,494
............................................................
2118 Z, CLB 6.50%, 12/15/2028 605,555 517,785
............................................................
Pool #C00716, 6.00%,
2/01/2029 4,003,829 3,780,210
............................................................
Pool #C25556, 6.50%,
4/01/2029 4,983,343 4,829,393
............................................................
Pool #E00617, 5.50%,
1/01/2014 4,438,693 4,211,206
............................................................
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Principal
Amount Value
<S> <C> <C>
Federal National Mortgage
Association:
Pool #313608, 6.50%,
7/01/2012 $2,360,375 $ 2,329,921
............................................................
1994-27 SD, 6.9478%,
3/25/2023 # 2,515,648 2,264,644
............................................................
G93-27 SB, 7.7434%, 8/25/2023
# 43,813 35,322
............................................................
Pool #481469, 6.00%,
2/01/2029 4,247,907 4,005,284
............................................................
1999-13 ZD, 9.7203%,
4/25/2029 # 433,562 451,952
..................... ...................... ----------
28,012,780
------------------------------------------------------------
STRIPPED MORTGAGE-BACKED SECURITIES -- 0.3%
............................................................
Federal National Mortgage
Association:
G93-32 E, 0.00% (PO),
9/25/2023 353,496 334,922
............................................................
1998-48 CI (IO), 6.50%,
8/25/2028 190,840 35,049
..................... ...................... ----------
369,971
------------------------------------------------------------
Total government agency
mortgage-backed securities
(cost $29,163,799) 28,382,751
------------------------------------------------------------
NON-AGENCY MORTGAGE-BACKED
SECURITIES -- 23.2%
------------------------------------------------------------
ASSET-BACKED
SECURITIES -- 17.7%
............................................................
Associates Manufactured Housing
Pass-Through Certificates,
CLB 1996-2 A4, 6.60%,
6/15/2027 500,000 502,207
............................................................
CIT Marine Trust, CLB 1999-A
A2, 5.80%, 4/15/2010 2,000,000 1,994,290
............................................................
Commercial Financial Services
Securitized Multiple Asset
Rated Trust (Acquired
9/24/1997, cost $360,984),
1997-5 A1, 7.72%, 6/15/2005 r
+ 361,069 108,321
............................................................
Commercial Mortgage Acceptance
Corporation (Acquired
3/13/1998, cost $282,837),
CLB 1996-C2 A2, 7.0357%,
9/15/2023 # r 279,733 284,036
............................................................
Commercial Resecuritization
Trust (Acquired 2/10/1999,
cost $967,760), CLB 1999-ABC1
A, 6.74%, 1/27/2009 r 977,998 953,548
............................................................
</TABLE>
See Notes to the Financial Statements
33
<PAGE> 689
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
TOTAL RETURN BOND FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
CPS Auto Trust, CLB 1998-1 A,
6.00%, 8/15/2003 $ 330,961 $ 331,085
............................................................
The C.S. First Boston Mortgage
Securities Corp. Commercial
Mortgage Pass-Through
Certificates, 1998-C1 A1B,
6.48%, 5/17/2008 750,000 723,139
............................................................
Delta Funding Home Equity Loan
Trust, CLB 5.98%, 2/15/2023 2,000,000 1,985,370
............................................................
Ditech Home Loan Owner Trust,
CLB 1997-1 A3, 6.71%,
8/15/2018 600,000 601,947
............................................................
GMAC Commercial Mortgage
Securities Inc., CLB 1999-C2
A2, 6.945%, 9/15/2033 2,600,000 2,597,465
............................................................
GREAT (Acquired 7/02/1998, cost
$158,082), 1998-1 A1, 7.33%,
9/15/2007 r + 158,082 47,425
............................................................
Green Tree Financial
Corporation:
1995-4 A4, CLB 6.75%,
6/15/2025 382,658 385,013
............................................................
1996-5 B2, CLB 8.45%,
7/15/2027 799,873 698,477
............................................................
Green Tree Recreational,
Equipment & Consumer Trust,
CLB 1996-B CTFS, 7.70%,
7/15/2018 450,000 433,811
............................................................
Heilig-Meyers Master Trust
(Acquired 2/20/1998, cost
$499,954), CLB 1998-1A A,
6.125%, 1/20/2007 r 500,000 491,693
............................................................
Nomura Asset Securities
Corporation:
1995-MD3 A1B, CLB 8.15%,
3/04/2020 750,000 790,099
............................................................
1998-D6 A1B, CLB 6.59%,
3/17/2028 2,850,000 2,771,867
............................................................
Nomura Depositor Trust
(Acquired 6/28/1999, cost
$1,183,500), CLB 1998-ST1 A2,
5.475%, 1/15/2003 # r 1,200,000 1,183,500
............................................................
Nomura Depositor Trust
(Acquired 6/28/1999, cost
$486,914), CLB 1998-ST1 A3,
5.5675%, 1/15/2003 # r 500,000 485,390
............................................................
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Principal
Amount Value
<S> <C> <C>
Resolution Trust Corporation,
1994-C2 G, CLB 8.00%,
4/25/2025 $ 514,528 $ 518,533
............................................................
1994-C1 E, CLB 8.00%,
6/25/2026 1,997,828 1,974,729
............................................................
Structured Asset Securities
Corporation, 1993-C1 C,
6.60%, CLB 10/25/2024 1,100,091 1,093,215
............................................................
The Ugly Duckling Auto Grantor
Trust, (Acquired 12/18/1998,
cost $1,072,044), CLB 1998-D
A, 5.90%, 5/15/2003 r 1,133,905 1,136,870
..................... ...................... ----------
22,092,030
------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 5.5%
............................................................
Blackrock Capital Finance LP
(Acquired 6/23/1997, cost
$171,004), CLB 1997-AW (AP),
7.9377%, 12/25/2035 # r 172,053 179,013
............................................................
CMC Securities Corporation IV,
CLB 1994-G A4, 7.00%,
9/25/2024 200,000 190,421
............................................................
Citicorp Mortgage Securities,
Inc., CLB 1997-3 A2, 6.92%,
8/25/2027 62,935 63,121
............................................................
Collateralized Mortgage
Obligations Trust, CLB 57 D,
9.90%, 2/01/2019 259,015 272,363
............................................................
GE Capital Mortgage Services,
Inc., 1994-24 A4, 7.00%,
7/25/2024 169,843 161,933
............................................................
Housing Securities, Inc.:
1994-1 AB2, (Acquired
3/03/1995, cost $288,664),
CLB 6.50%, 3/25/2009 r 437,369 323,653
............................................................
1994-2 B1, CLB 6.50%,
7/25/2009 228,915 180,843
............................................................
Independent National Mortgage
Corporation, CLB 1995-F A5,
8.25%, 5/25/2010 750,000 766,270
............................................................
Ocwen Residential MBS Corp.
(Acquired 6/18/1998, cost
$564,912), CLB 1998-R2 AP,
6.1474%, 11/25/2034 r # 565,619 570,774
............................................................
Prudential Home Mortgage
Securities CLB 1993-50 A11,
8.75%, 11/25/2023 # 3,312,928 3,263,234
............................................................
</TABLE>
See Notes to the Financial Statements
34
<PAGE> 690
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
TOTAL RETURN BOND FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
Prudential Home Mortgage
Securities CLB 1993-54 A17,
3.77545%, 1/25/2024 # $1,150,000 $ 907,781
..................... ...................... ----------
6,879,406
------------------------------------------------------------
Total non-agency
mortgage-backed securities
(cost $29,689,970) 28,971,436
------------------------------------------------------------
PREFERRED STOCKS -- 0.4% Shares
------------------------------------------------------------
Home Ownership Funding 2,
(Acquired 2/20/1997, cost
$500,000) r 500 430,500
------------------------------------------------------------
U.S. TREASURY Principal
OBLIGATIONS -- 14.1% Amount
------------------------------------------------------------
U.S. Treasury Bonds: 6.375%,
8/15/2027 $ 375,000 383,203
............................................................
U.S. Treasury Notes: 5.75%,
4/30/2003 9,500,000 9,511,875
............................................................
7.25%, 8/15/2004 2,750,000 2,921,875
............................................................
6.50%, 10/15/2006 3,950,000 4,077,143
............................................................
U.S. Treasury Strips: 0.00%,
2/15/2009 1,200,000 668,627
..................... ...................... ----------
Total U.S. Treasury obligations 17,562,723
(cost $17,904,412)
------------------------------------------------------------
SHORT-TERM INVESTMENTS -- 5.7%
------------------------------------------------------------
COMMERCIAL PAPER -- 5.7%
............................................................
Conseco, Inc., 5.42%, 7/01/1999
4(2) 400,000 400,000
............................................................
TRW Inc., 6.05%, 7/01/1999 4(2) 6,000,000 6,000,000
............................................................
Tyson Foods, Inc., 6.05%,
7/01/1999 700,000 700,000
..................... ...................... ----------
7,100,000
Total commercial paper
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
VARIABLE RATE DEMAND NOTES* -- 0.0%
............................................................
General Mills, Inc., 4.825%,
12/31/2031 $ 42,434 $ 42,434
------------------------------------------------------------
Total short term investments
(cost $7,142,434) 7,142,434
------------------------------------------------------------
Total investments -- 99.7%
(cost $127,144,610) 124,285,261
............................................................
Other assets in excess of
liabilities -- 0.3% 384,363
..................... ...................... ----------
$124,669,624
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
# Variable rate security. The rate listed is as of June 30, 1999.
* Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rates listed are as of June 30, 1999.
IO -- Interest Only.
PO -- Principal Only.
CLB -- Callable.
r -- Restricted Security. Purchased in a private placement transaction; resale
to the public may require registration or may extend only to qualified
institutional buyers.
4(2) -- Restricted Security requiring resale to institutional investors.
+ -- Security Fair Valued under procedures established by the Board of Trustees
(See Note 1).
See Notes to the Financial Statements
35
<PAGE> 691
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
CORPORATE BONDS Principal
AND NOTES -- 37.2% Amount Value
------------------------------------------------------------
<S> <C> <C>
AUTO -- 1.2%
............................................................
TRW, Inc., (Acquired
6/18/1999, cost $5,100,000),
5.5987%, 6/28/2000 # r $ 5,100,000 $ 5,102,550
------------------------------------------------------------
BANKS -- 4.5%
............................................................
Korea Development Bank,
9.60%, 12/01/2000 4,220,000 4,366,223
............................................................
MBNA Corporation,
5.505%, 6/17/2002 # 1,125,000 1,119,452
............................................................
MBNA Global Capital
Securities, CLB 2/01/2007,
5.795%, 2/01/2027 # 2,000,000 1,740,560
............................................................
Sovereign Bancorp, CLB,
6.625%, 3/15/2001 7,150,000 7,127,141
............................................................
Unibanco Grand Cayman,
(Acquired 4/21/1999, cost
$4,003,082), 10.75%,
4/28/2000 r 4,000,000 4,030,000
..................... ...................... -----------
18,383,376
------------------------------------------------------------
CABLE -- 1.6%
............................................................
TCI Communications, Inc.,
8.00%, 8/01/2005 4,600,000 4,852,388
............................................................
USA Networks Inc.
6.75%, 11/15/2005 1,700,000 1,633,433
..................... ...................... -----------
6,485,821
------------------------------------------------------------
EUROBANKS -- 6.0%
............................................................
Foreningsbanken Kredit AB, CLB
12/18/2001, 5.92625%,
12/29/2049 # 5,750,000 5,692,480
............................................................
Nordbanken, CLB 10/25/2001,
5.595%, 10/29/2049 # 6,680,000 6,536,180
............................................................
Okobank:
CLB 9/09/2002, 5.5987%,
9/29/2049,# 3,750,000 3,776,805
............................................................
CLB 10/14/1999, 6.45%,
10/29/2049, # 2,000,000 2,006,900
............................................................
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Principal
Amount Value
<S> <C> <C>
Skandinavinska Enskilda
Banken, CLB 6/28/2003,
6.26375%, 6/29/2049 # $ 3,500,000 $ 3,431,960
............................................................
Svenska Handls Banken, CLB
3/03/2002, 5.5687%,
3/29/2049 # 3,250,000 3,162,406
..................... ...................... -----------
24,606,731
------------------------------------------------------------
FINANCIAL SERVICES -- 10.8%
............................................................
AT & T Capital Corp.,
5.34%, 10/24/2000 # 2,750,000 2,748,730
............................................................
Case Credit Corporation,
6.15%, 3/01/2002 4,000,000 3,938,900
............................................................
Countrywide Home Loans, Inc.,
5.69%, 3/16/2005 # 5,000,000 4,987,650
............................................................
Golden State Holdings, CLB
8/01/2000, 5.995%, 8/01/2003
# 9,900,000 9,725,819
............................................................
Lehman Brothers Holdings,
5.50125%, 6/01/2001 # 800,000 797,726
............................................................
Lehman Brothers Holdings,
6.20%, 1/15/2002 9,100,000 8,962,426
............................................................
Pan Pacific Ind. Inv. Plc.,
(Acquired 6/18/1999, cost
$3,887,947), 0.00%,
4/28/2007 r 8,000,000 3,963,840
............................................................
Providian National Bank, CLB
4/10/2000, 5.60%, 4/10/2001
# 4,000,000 4,000,908
............................................................
U.S. West Capital Funding:
(Acquired 6/03/1999, cost
$5,000,000), CLB 9/15/1999,
5.546%, 6/15/2000 # r 5,000,000 4,997,900
............................................................
(Acquired 6/14/1999, cost
$249,985) CLB 9/15/1999,
5.546%, 6/15/2000 # r 250,000 249,895
..................... ...................... -----------
44,373,794
------------------------------------------------------------
INDUSTRIAL -- 1.0%
............................................................
Coca-Cola Femsa SA,
8.95%, 11/01/2006 2,875,000 2,854,084
............................................................
Suiza Foods Corp., CLB
12/15/2001, 10.00%,
12/15/2006 1,000,000 1,120,000
..................... ...................... -----------
3,974,084
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
36
<PAGE> 692
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
MISCELLANEOUS -- 0.6%
............................................................
Republic of Brazil,
11.625%, 4/15/2004 $ 2,700,000 $ 2,511,000
------------------------------------------------------------
RETAIL -- 3.9%
............................................................
Great Atlantic & Pacific Tea,
7.70%, 1/15/2004 6,433,000 6,345,138
............................................................
Rite Aid Corp.,
(Acquired 12/16/1998, cost
$3,943,167), 5.50%,
12/15/2000 r 3,950,000 3,874,721
............................................................
6.70%, 12/15/2001 4,200,000 4,184,170
............................................................
6.70%, 12/15/2001 1,450,000 1,444,535
..................... ...................... -----------
15,848,564
------------------------------------------------------------
STEEL -- 2.4%
............................................................
Pohang Iron & Steel,
6.625%, 7/01/2003 10,530,000 9,967,982
------------------------------------------------------------
TELECOMMUNICATIONS -- 2.4%
............................................................
Comcast Cellular Holdings, CLB
5/01/2002, 9.50%, 5/01/2007 5,010,000 5,629,988
............................................................
Telecom Argentina Stet. Fran.
(Acquired 6/25/1999, cost
$3,995,000), 9.75%,
7/12/2001 r 4,000,000 4,000,000
..................... ...................... -----------
9,629,988
------------------------------------------------------------
TRANSPORTATION -- 1.6%
............................................................
Bombardier Capital, Inc., CLB
(Acquired 1/22/1999, cost
$6,711,147), 6.00%,
1/15/2002 r 6,725,000 6,617,427
------------------------------------------------------------
UTILITIES -- 1.2%
............................................................
CMS Energy Corp., CLB,
8.00%, 7/01/2001 # 5,000,000 4,990,715
..................... ...................... -----------
Total corporate bonds and
notes 152,492,032
(cost $153,969,651)
------------------------------------------------------------
GOVERNMENT AGENCY
MORTGAGE-BACKED Principal
SECURITIES -- 11.7% Amount Value
------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 11.4%
............................................................
Federal Home Loan Mortgage Corporation:
............................................................
1564 SB, 8.4066%, 8/15/2008
# $ 771,272 $ 778,112
............................................................
Pool #E00617, 5.50%,
1/01/2014 12,921,527 12,259,289
............................................................
1336 H, 7.75%, 1/15/2021 174,071 176,702
............................................................
1477 P, 10.5233%, 3/15/2023
# 25,680 25,191
............................................................
1617 D, 6.50%, 11/15/2023 71,000 66,756
............................................................
2118 Z, CLB 6.50%,
12/15/2028, 2,961,148 2,531,958
............................................................
2141 WZ, 6.50%, 4/15/2029 2,619,864 2,560,944
............................................................
Federal National Mortgage
Association:
............................................................
1991-153 N, 7.50%, 2/25/2007 207,422 209,534
............................................................
1993-6 S, 10.6575%,
1/25/2008 # 876,208 853,821
............................................................
Pool #313608 , 6.50%,
7/01/2012 7,411,577 7,315,952
............................................................
Pool #413738, 6.50%,
1/01/2013 12,956,886 12,789,716
............................................................
1988-26 C, 7.50%, 7/25/2018 28,164 28,320
............................................................
1991-147 K, 7.00%, 1/25/2021 2,005 2,014
............................................................
1992-138 O, 7.50%, 7/25/2022 9,403 9,391
............................................................
1993-45 SB, 9.82%, 4/25/2023
# 592,169 573,177
............................................................
1997-59 SU, 8.6883%,
9/25/2023 # 893,675 875,208
............................................................
1994-60 D, 7.00%, 4/25/2024 30,000 29,080
............................................................
1997-76 FT, 5.43125%,
9/17/2027 # 973,868 936,683
............................................................
1999-13 ZC, 7.65919%,
4/25/2029 # 3,887,494 3,911,096
............................................................
1999-13 ZD, 9.72053%,
4/25/2029 # 932,157 971,696
..................... ...................... -----------
46,904,640
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
37
<PAGE> 693
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
STRIPPED MORTGAGE-BACKED SECURITIES -- 0.3%
............................................................
Federal National Mortgage
Association:
............................................................
1993-72 J (IO), 6.50%,
12/25/2006 $ 578,532 $ 26,424
............................................................
1993-97 L (IO), 7.50%,
5/25/2023 516,525 15,989
............................................................
1994-53 E (PO), 0.00%,
11/25/2023 1,131,506 1,112,741
............................................................
1998-48 CI (IO), 6.50%,
8/25/2028 756,185 138,879
..................... ...................... -----------
1,294,033
------------------------------------------------------------
Total government agency
mortgage-backed securities
(cost $49,199,491) 48,198,673
------------------------------------------------------------
NON-AGENCY MORTGAGE-BACKED
SECURITIES -- 31.4%
------------------------------------------------------------
ASSET-BACKED
SECURITIES -- 26.2%
............................................................
ACC Automobile Receivables
Trust, CLB, (Acquired
6/24/1999, cost
$2,601,604),1997-C A, 6.40%,
3/17/2004 r 2,595,925 2,601,605
............................................................
BankBoston Home Equity Loan
Trust, CLB, 1998-1 A1,
6.46%, 4/25/2012 1,331,112 1,330,533
............................................................
Champion Auto Grantor Trust
(Acquired 3/18/1998, cost
$951,512), CLB, 1998-A A,
6.11%, 10/15/2002 r 951,527 952,419
............................................................
CIT Marine Trust, CLB, 1999-A
A2, 5.80%, 4/15/2010 4,200,000 4,188,009
............................................................
Cityscape Home Equity Loan
Trust, CLB, 1996-4 A10,
7.40%, 9/25/2027 3,219,438 3,185,733
............................................................
Commercial Financial Services
Securitized Multiple Asset
Rated Trust (Acquired
9/24/1997, cost $2,256,682),
1997-5 A1, 7.72%, 6/15/2005
r + 2,256,682 677,005
............................................................
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Principal
Amount Value
<S> <C> <C>
Commercial Mortgage Acceptance
Corporation, CLB, (Acquired
3/13/1998, cost $1,212,157),
1996-C2 A2, 7.0357%,
9/15/2023 # r $ 1,198,857 $ 1,217,298
............................................................
Commercial Mortgage Asset
Trust, CLB, 1999-C1 A1,
6.25%, 8/17/2006 1,975,243 1,944,064
............................................................
Commercial Resecuritization
Trust, CLB, (Acquired
2/10/1999, cost
$3,871,038),1999-ABC1 A,
6.74%, 1/27/2009 r 3,911,992 3,814,192
............................................................
Contimortgage Home Equity Loan
Trust, CLB, 1998-1 A5,
6.43%, 4/15/2016 7,550,000 7,520,442
............................................................
Countrywide Home Equity Loan
Trust, CLB, 1999-A CTFS,
5.3075%, 4/15/2025 # 1,230,961 1,230,769
............................................................
CPS Auto Trust, CLB, 1998-1 A,
6.00%, 8/15/2003 1,323,843 1,324,340
............................................................
Ditech Home Loan Owner Trust,
CLB, 1997-1 A2, 6.59%,
4/15/2013 1,711,466 1,715,941
............................................................
Ditech Home Loan Owner Trust,
CLB, 1997-1 A3, 6.71%,
8/15/2018 3,280,000 3,290,644
............................................................
Firstplus Home Loan Trust,
CLB, 1998-4 A4, 6.32%,
3/10/2017 5,000,000 4,978,975
............................................................
First Tennessee Auto Grantor
Trust, CLB, (Acquired
4/17/1998, cost $1,429,464),
1998-A A, 6.134%, 4/15/2003
r 1,429,464 1,435,145
............................................................
GREAT, (Acquired 7/02/1998,
cost $2,709,970), 1998-1 A1,
7.330%, 9/15/2007 r + 2,709,970 812,991
............................................................
Green Tree Financial
Corporation, CLB:
1995-4 A4, 6.75%, 6/15/2025 5,199,359 5,231,361
............................................................
1996-5 B2, 8.45%, 7/15/2027 4,145,001 3,619,560
............................................................
Green Tree Recreational,
Equipment & Consumer Trust,
CLB:
1996-C A1, 5.2275%,
10/15/2017 7,531,759 7,524,114
............................................................
1996-B CTFS, 7.70%,
7/15/2018 2,250,000 2,169,056
............................................................
</TABLE>
See Notes to the Financial Statements
38
<PAGE> 694
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
Heilig-Meyers Master Trust
(Acquired 2/20/1998, cost
$4,099,626), 1998-1A A,
6.125%, 1/20/2007 r $ 4,100,000 $ 4,031,879
............................................................
The Money Store Residential
Trust, CLB, 1998-I A2,
6.20%, 3/15/2008 2,250,000 2,250,281
............................................................
Nationslink Funding
Corporation, CLB, 1999-SL
A2, 6.0960%, 12/10/2001 2,050,000 2,043,922
............................................................
Nationslink Funding
Corporation, CLB, 1999-SL
A1V, 5.3025%, 4/10/2007 # 2,741,593 2,742,512
............................................................
Nomura Asset Securities
Corporation, CLB, 1995-MD3
A1B, 8.15%, 3/04/2020 2,750,000 2,897,029
............................................................
Nomura Depositor Trust, CLB,
(Acquired 6/28/1999, cost
$12,405,588), 1998-ST1 A3,
5.5675%, 1/15/2003 # r 12,738,992 12,366,771
............................................................
Resolution Trust Corporation,
CLB:
1992-C3 A3, 6.275%,
8/25/2023 # 184,279 184,279
............................................................
1992-C8 A2, 6.475%,
12/25/2023 # 601,483 602,815
............................................................
1994-C2 G, 8.00%, 4/25/2025 857,546 864,222
............................................................
1994-C1 E, 8.00%, 6/25/2026 6,813,205 6,734,431
............................................................
1994-C1 F, 8.00%, 6/25/2026 1,940,349 1,886,514
............................................................
Structured Asset Securities
Corporation, CLB, 1993-C1 C,
6.60%, 10/25/2024 4,250,350 4,223,785
............................................................
The Ugly Duckling Auto Grantor
Trust, CLB, (Acquired
12/18/1998, cost
$5,667,752), 1998-D A,
5.90%, 5/15/2003 r 5,669,524 5,684,349
..................... ...................... -----------
107,276,985
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------
Principal
Amount Value
<S> <C> <C>
COLLATERALIZED MORTGAGE OBLIGATIONS -- 4.2%
............................................................
Blackrock Capital Finance
L.P., CLB, (Acquired
6/23/1997, Cost $940,524),
1997-R2 AW (AP), 7.9377%,
12/25/2035 # r $ 946,291 $ 984,570
............................................................
Citicorp Mortgage Securities,
Inc., CLB, 1997-3 A2, 6.92%,
8/25/2027 534,951 536,531
............................................................
Countrywide Funding
Corporation, CLB, 1994-17
A9, 8.00%, 7/25/2024 4,000 4,079
............................................................
First Union-Lehman Brothers
Commercial Mortgage
Trust,CLB, 1997-C1 A1,
7.15%, 2/18/2004 5,702,441 5,773,921
............................................................
Housing Securities, Inc., CLB,
1994-2 B1, 6.50%, 7/25/2009 204,928 161,893
............................................................
Independent National Mortgage
Corporation, CLB:
1995-A A4, 8.75%, 3/25/2025 13,069 13,210
............................................................
1996-D A2, 7.00%, 5/25/2026 39,061 39,027
............................................................
Morgan Stanley Mortgage Trust,
CLB, 8.9712%, 6/22/2018 962,170 978,326
............................................................
Ocwen Residential MBS Corp.,
CLB, (Acquired 6/18/1998,
cost $3,530,699), 1998-R2
AP, 6.1474%, 11/25/2034 # r 3,535,118 3,567,337
............................................................
Prudential Home Mortgage
Securities, Co., CLB,
1993-36 A10, 7.25%,
10/25/2023 372,501 374,365
............................................................
Residential Funding Mortgage
Securities, Inc., CLB:
1992-S5 A5, 7.50%, 2/25/2007 344,635 343,572
............................................................
1993-S9 A8, 9.479165%,
2/25/2008 # 58,127 58,127
............................................................
1998-S17 A6, 6.75%,
8/25/2028 2,316,820 2,321,095
............................................................
Salomon Brothers Mortgage
Securities VII, 1994-6 A1,
5.9511%, 5/25/2024 # 1,028,671 1,030,579
............................................................
</TABLE>
See Notes to the Financial Statements
39
<PAGE> 695
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
Structured Mortgage Asset
Residential Trust, CLB:
1992-3A AA, 8.00%,
10/25/2007 $ 109,594 $ 111,726
............................................................
1991-1 H, 8.25%, 6/25/2022 91,697 93,320
............................................................
1993-5A AA, 6.76079%,
6/25/2024 # 35,917 34,221
............................................................
Walsh Acceptance, CLB,
(Acquired 3/06/1997, cost
$1,107,663), 1997-2 A,
6.125%, 3/01/2027 # r 1,099,077 967,188
..................... ...................... -----------
17,393,087
------------------------------------------------------------
PASS-THROUGH
SECURITIES -- 0.1%
............................................................
Citicorp Mortgage Securities,
Inc., CLB:
............................................................
1988-16 A1, 10.00%,
11/25/2018 26,519 27,868
............................................................
1989-8 A1, 10.50%, 6/25/2019 294,596 312,869
..................... ...................... -----------
340,737
------------------------------------------------------------
STRIPPED MORTGAGE-BACKED SECURITIES -- 0.9%
............................................................
Asset Securitization
Corporation, 1997-D5 PS1
(IO), 1.396031%,
2/14/2041 # 14,702,676 1,360,071
............................................................
Chase Commercial Mortgage
Securities Corporation, CLB,
1997-1 X (IO), 1.4381%,
4/19/2015 # 24,292,939 1,700,506
............................................................
CS First Boston Mortgage
Securities Corporation, CLB,
(Acquired 8/14/1997, cost
$979,319), 1995-WF1 AX (IO),
3.3321%,
12/21/2027 # r 15,259,492 681,916
..................... ...................... -----------
3,742,493
------------------------------------------------------------
Total non-agency
mortgage-backed securities
(cost $134,650,061) 128,753,302
------------------------------------------------------------
PREFERRED STOCK -- 0.3% Shares
------------------------------------------------------------
Home Ownership Funding 2,
(Acquired 2/20/1997, cost
$1,500,000) r 1,500 1,291,500
------------------------------------------------------------
U.S. TREASURY Principal
OBLIGATIONS -- 17.7% Amount Value
------------------------------------------------------------
U.S. TREASURY NOTES:
............................................................
5.50%, 3/31/2000 $19,500,000 $ 19,548,750
............................................................
4.00%, 10/31/2000 20,000,000 19,592,969
............................................................
6.25%, 06/30/2002 30,775,000 31,275,094
............................................................
5.75%, 10/31/2002 2,000,000 2,005,000
..................... ...................... -----------
Total U.S. Treasury
obligations (cost 72,421,813
$72,335,249)
------------------------------------------------------------
SHORT-TERM INVESTMENTS -- 7.5%
------------------------------------------------------------
COMMERCIAL PAPER -- 7.5%
............................................................
Conseco, Inc., 5.42%,
7/01/1999 4(2) 6,900,000 6,900,000
............................................................
MCI Communications
Corporation, 5.78%,
1/27/2000 4(2) 8,000,000 7,730,267
............................................................
TRW Inc., 6.05%, 7/01/1999
4(2) 16,100,000 16,100,000
..................... ...................... -----------
30,730,267
Total commercial paper
------------------------------------------------------------
VARIABLE DEMAND NOTES
* -- 0.0%
............................................................
Pitney Bowes, Inc., 4.825%,
12/31/2031 72,075 72,075
------------------------------------------------------------
Total short-term investments
(cost $30,802,342) 30,802,342
------------------------------------------------------------
Total investments -- 105.8%
(cost $442,456,794) 433,959,662
............................................................
Liabilities in excess of other
assets -- (5.8)% (23,972,255)
..................... ...................... -----------
$409,987,407
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
# Variable rate security. The rate listed is as of June 30, 1999.
* Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rate listed is as of June 30, 1999.
IO -- Interest Only.
PO -- Principal Only.
CLB -- Callable.
r -- Restricted Security. Purchased in a private placement transaction; resale
to the public may require registration or may extend only to qualified
institutional buyers.
4(2) -- Restricted Security requiring resale to institutional investors.
+ -- Security Fair Valued under procedures established by the Board of Trustees
(See Note 1).
See Notes to the Financial Statements
40
<PAGE> 696
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
SHORT-TERM INVESTMENT FUND
<TABLE>
<CAPTION>
CORPORATE BONDS Principal
AND NOTES -- 36.1% Amount Value
-------------------------------------------------------------
<S> <C> <C>
AUTO -- 1.9%
.............................................................
TRW Inc.(Acquired 6/18/1999, cost
$1,000,000), 5.5987%, 6/28/2000
# r $1,000,000 $ 1,000,500
-------------------------------------------------------------
BANKS -- 5.2%
.............................................................
Korea Development Bank, 9.60%,
12/01/2000 675,000 698,389
.............................................................
MBNA Corporation, 5.505%,
6/17/2002 # 500,000 497,534
.............................................................
Providian National Bank, CLB
4/10/2000, 5.60%, 4/10/2001 # 1,000,000 1,000,227
.............................................................
Unibanco Grand Cayman (Acquired
4/21/1999, cost $450,371),
10.75%, 4/28/2000 r 450,000 453,375
...................... ....................... ----------
2,649,525
-------------------------------------------------------------
EUROBANKS -- 7.6%
.............................................................
Foreningsbanken Kredit AB, CLB
12/18/2001, 5.92625%,
12/29/2049 # 750,000 742,497
.............................................................
Nordbanken, CLB 10/25/2001,
5.5950%, 10/29/2049 # 550,000 538,158
.............................................................
Okobank, CLB 9/09/2002 5.59875%,
9/29/2049 # 1,050,000 1,057,505
.............................................................
Skandinavinska Enskilda Banken,
CLB 6/28/2003, 6.26375%,
6/29/2049 # 800,000 784,448
.............................................................
Svenska Hndls Banken, CLB
3/03/2002, 5.5687%, 3/29/2049 # 750,000 729,786
...................... ....................... ----------
3,852,394
-------------------------------------------------------------
FINANCIAL SERVICES -- 20.4%
.............................................................
Associates Corp. NA, 5.12%,
5/17/2002 # 1,000,000 999,376
.............................................................
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------
Principal
Amount Value
<S> <C> <C>
AT & T Capital Corp., 5.34%,
10/24/2000 # $ 500,000 $ 499,769
.............................................................
AT & T Capital Corp., 5.17%,
04/09/2001 # 750,000 750,067
.............................................................
Bear Stearns Co. Inc., 5.425%,
3/15/2002 # 1,500,000 1,499,652
.............................................................
Countrywide Home Loans, Inc.,
5.6900%, 3/16/2005 # 750,000 748,147
.............................................................
Golden State Holdings, CLB
8/01/2000, 5.995%, 8/01/2003 # 1,900,000 1,866,571
.............................................................
Lehman Brothers Holdings,
5.50125%, 6/01/2001# 900,000 897,442
.............................................................
Lehman Brothers Holdings, 6.20%,
1/15/2002 900,000 886,394
.............................................................
Orix Credit Alliance (Acquired
4/06/1999, cost $750,000),
6.40%, 1/31/2000 r 750,000 747,002
.............................................................
Pan Pacific Ind. Inv. PLC
(Acquired 6/18/1999, cost
$485,993), 0.00%, 4/28/2007 r 1,000,000 495,480
.............................................................
US West Capital Funding (Acquired
6/03/1999, cost $1,000,000),
5.54625%, CLB 9/15/1999,
6/15/2000 # r 1,000,000 999,580
...................... ....................... ----------
10,389,480
-------------------------------------------------------------
UTILITIES -- 1.0%
.............................................................
CMS Energy Corp., 8.00%, CLB
7/01/2001# 500,000 499,071
-------------------------------------------------------------
Total corporate bonds and notes
(cost $18,407,352) 18,390,970
-------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
41
<PAGE> 697
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
SHORT-TERM INVESTMENT FUND
GOVERNMENT AGENCY
MORTGAGE-BACKED Principal
SECURITIES -- 5.4% Amount Value
-------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 3.0%
.............................................................
Federal Home Loan Mortgage
Corporation, CLB 2118 Z, 6.50%,
12/15/2028 $ 370,144 $ 316,495
.............................................................
Federal National Mortgage
Association: 1993-142 SA,
9.33832%,
10/25/2022 # 179,912 177,102
.............................................................
1999-13 ZC, 7.65919%, 4/25/2029
# 1,017,333 1,023,509
...................... ....................... ----------
1,517,106
-------------------------------------------------------------
PASS-THROUGH SECURITIES -- 2.3%
.............................................................
Federal Housing Authority
Project, 7.43%, 2/01/2023 132,776 134,818
.............................................................
Government National Mortgage
Association:
8570, 6.1250%, 10/20/2019 # 222,853 227,434
.............................................................
8346, 6.1250%, 12/20/2023 # 788,060 801,767
...................... ....................... ----------
1,164,019
-------------------------------------------------------------
STRIPPED MORTGAGE-BACKED SECURITIES -- 0.1%
.............................................................
Federal National Mortgage
Association:
1993-129 J (IO), 6.50%,
2/25/2007 626,849 45,090
.............................................................
1993-97 L (IO), 7.50%,
5/25/2023 190,496 5,897
...................... ....................... ----------
50,987
-------------------------------------------------------------
Total government agency mortgage-
backed securities (cost
$2,773,673) 2,732,112
-------------------------------------------------------------
NON-AGENCY
MORTGAGE-BACKED
SECURITIES -- 35.7%
-------------------------------------------------------------
ASSET-BACKED SECURITIES -- 34.4%
.............................................................
ACC Automobile Receivables Trust
(Acquired 6/24/1999, cost
$991,087), CLB 1997-C A, 6.40%,
3/17/2004 r 988,924 991,088
.............................................................
Americredit Automobile
Receivables Trust, CLB 1998-A
A2, 5.0725%, 11/05/2001 # 844,304 844,603
.............................................................
Americredit Automobile
Receivables Trust, CLB 1999-A
A2, 5.383%, 4/05/2002 900,000 899,617
.............................................................
<TABLE>
<CAPTION>
Principal
Amount Value
-------------------------------------------------------------
<S> <C> <C>
Associates Manufactured Housing
Pass-Through Certificates, CLB
1996-2 A4, 6.60%, 6/15/2027 $ 500,000 $ 502,208
.............................................................
BankBoston Home Equity Loan
Trust, CLB 1998-1 A1, 6.46%,
4/25/2012 459,004 458,805
.............................................................
Champion Auto Grantor Trust
(Acquired 10/28/1997, cost
$57,203), CLB 1997-D A, 6.27%,
9/15/2002 r 57,203 57,239
.............................................................
CIT Marine Trust, CLB 1999-A A1,
5.45%, 9/15/2006 965,036 965,600
.............................................................
Commercial Financial Services
Securitized Multiple Asset
Rated Trust (Acquired
9/24/1997, cost $361,069),
1997-5 A1, 7.72%, 6/15/2005 r + 361,069 108,321
.............................................................
Countrywide Home Equity Loan
Trust, CLB 1999-A CTFS 5.3075%,
4/15/2025 # 984,769 984,615
.............................................................
Ditech Home Loan Owner Trust, CLB
1997-1 A2, 6.59%, 4/15/2013 684,586 686,376
.............................................................
First Tennessee Auto Grantor
Trust (Acquired 4/17/1998, cost
$386,342), CLB 1998-A A,
6.134%, 4/15/2003 r 386,342 387,877
.............................................................
Green Tree Home Improvement Loan
Trust, CLB 1997-A HEA5, 7.21%,
3/15/2028 840,634 847,893
.............................................................
Green Tree Recreational,
Equipment & Consumer Trust, CLB
1996-C A1, 5.2275%, 10/15/2017
# 876,423 875,533
.............................................................
Harley-Davidson Eaglemark
Motorcycle Trust, CLB 1999-1
A1, 5.25%, 7/15/2003 913,696 909,927
.............................................................
Nationslink Funding Corporation,
CLB 1999-SL A1V, 5.3025%,
4/10/2007 # 740,971 741,219
.............................................................
Navistar Financial Corp. Owner
Trust, CLB 1996-B A3, 6.33%,
4/21/2003 411,538 413,384
.............................................................
Nomura Asset Securities
Corporation, CLB 1995-MD3 A1A,
8.17%, 3/04/2020 819,020 845,396
.............................................................
</TABLE>
See Notes to the Financial Statements
42
<PAGE> 698
SCHEDULE OF INVESTMENTS -- JUNE 30, 1999
--------------------------------------------------------------------------------
SHORT-TERM INVESTMENT FUND
<TABLE>
<CAPTION>
Principal
Amount Value
-------------------------------------------------------------
<S> <C> <C>
Nomura Depositor Trust (Acquired
6/28/1999, cost $1,084,875),
CLB 1998-ST1 A2, 5.4075%,
1/15/2003 # r $1,100,000 $ 1,084,875
.............................................................
Peco Energy Transition Trust, CLB
1999-A A3, 5.1875%, 3/1/2006 # 1,000,000 997,085
.............................................................
Resolution Trust Corporation:
1992-C3 A3, CLB 6.275%,
8/25/2023 # 307,131 307,131
.............................................................
1992-C8 A2, CLB 6.475%,
12/25/2023 # 816,678 818,487
.............................................................
1994-C2 G, CLB 8.00%, 4/25/2025 343,018 345,689
.............................................................
Structured Asset Securities
Corporation, CLB 1993-C1 C,
6.60%, 10/25/2024 500,041 496,916
.............................................................
The Ugly Duckling Auto Grantor
Trust (Acquired 12/18/1998,
cost $755,700), CLB 1998-D A,
5.90%, 5/15/2003 r 755,936 757,913
.............................................................
Duck Auto Grantor Trust (Acquired
4/21/1999, cost $470,840), CLB
1999-A A, 5.65%, 3/15/2004 r 470,914 470,723
.............................................................
Union Acceptance Corporation, CLB
1998-C A2, 5.44%, 10/09/2001 712,572 713,103
...................... ....................... ----------
17,511,623
-------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 1.3%
.............................................................
Residential Funding Mortgage
Securities Inc., CLB 1998-S17
A6, 6.75%, 8/25/2028 231,682 232,109
.............................................................
Salomon Brothers Mortgage
Securities CLB VI, 1986-1 A,
6.00%, 12/25/2011 280,679 279,776
.............................................................
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------
Principal
Amount Value
<S> <C> <C>
Walsh Acceptance (Acquired
3/06/1997, cost $184,611), CLB
1997-2 A, 6.125%, 3/01/2027 # r $ 183,179 $ 161,198
...................... ....................... ----------
673,083
-------------------------------------------------------------
Total non-agency mortgage-backed
securities (cost $18,466,089) 18,184,706
-------------------------------------------------------------
U.S. TREASURY
OBLIGATIONS -- 9.0%
-------------------------------------------------------------
U.S. Treasury Notes:
5.75%, 10/31/2000 2,600,000 2,610,564
6.25%, 6/30/2002 1,925,000 1,956,281
...................... ....................... ----------
Total U.S. Treasury Notes (cost 4,566,845
$4,596,045)
-------------------------------------------------------------
SHORT-TERM INVESTMENTS -- 25.9%
-------------------------------------------------------------
COMMERCIAL PAPER -- 25.9%
.............................................................
Conseco, Inc., 5.42%, 7/01/1999
4(2) 2,500,000 2,500,000
.............................................................
Firstar Corporation, 5.25%,
7/22/1999 4(2) 2,200,000 2,193,262
.............................................................
MCI Communications Corporation,
5.78%, 1/27/2000 4(2) 1,100,000 1,062,912
.............................................................
Ratheon Company, 5.10%, 7/01/1999
4(2) 2,500,000 2,500,000
.............................................................
TRW Inc., 6.05%, 7/01/1999 4(2) 2,500,000 2,500,000
.............................................................
Tyson Foods, Inc., 6.05%,
7/01/1999 2,400,000 2,400,000
...................... ....................... ----------
Total short-term investments 13,156,174
(cost $13,156,174)
-------------------------------------------------------------
Total investments -- 112.1% (cost
$57,399,333) 57,030,807
.............................................................
Liabilities in excess of other
assets -- (12.1%) (6,174,462)
...................... ....................... ----------
$50,856,345
Total net assets -- 100.0%
-------------------------------------------------------------
</TABLE>
# Variable rate security. The rate listed is as of June 30, 1999.
IO -- Interest Only.
CLB -- Callable.
r -- Restricted Security. Purchased in a private placement transaction; resale
to the public may require registration or may extend only to qualified
institutional buyers.
4(2) -- Restricted Security requiring resale to institutional investors.
+ -- Security Fair Valued under procedures established by the Board of Trustees
(See Note 1).
See Notes to the Financial Statements
43
<PAGE> 699
STATEMENT OF ASSETS AND LIABILITIES
--------------------------------------------------------------------------------
JUNE 30, 1999
<TABLE>
<CAPTION>
Equity
Income Mid-Cap Small
Fund Fund Cap Fund
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ASSETS:
Investments, at value*.................................... $148,860,526 $6,917,894 $51,636,343
Cash...................................................... -- -- --
Dividends and interest receivable......................... 359,122 11,939 24,801
Receivable for investments sold........................... 7,221,964 -- 1,331,569
Receivable for Fund shares sold........................... 41,300 16,574 826,173
Prepaid expenses.......................................... 13,921 7,050 22,159
------------ ---------- -----------
Total assets.......................................... 156,496,833 6,953,457 53,841,045
------------ ---------- -----------
LIABILITIES:
Payable for forward currency exchange contracts........... -- -- --
Payable to Advisor........................................ 99,245 -- 36,678
Payable for investments purchased......................... 6,754,735 60,748 340,111
Payable for Fund shares repurchased....................... 838,780 10,153 40,520
Dividends payable......................................... -- -- --
Accrued expenses and other liabilities.................... 69,754 11,876 46,968
------------ ---------- -----------
Total liabilities..................................... 7,762,514 82,777 464,277
------------ ---------- -----------
Net assets............................................ $148,734,319 $6,870,680 $53,376,768
============ ========== ===========
NET ASSETS CONSIST OF:
Paid in capital........................................... $101,687,250 $7,028,474 $69,722,301
Undistributed (distributions in excess of) net investment
income.................................................. 43,953 86,963 --
Undistributed net realized gain (loss) on securities...... 14,825,176 (193,322) (7,668,432)
Net unrealized appreciation (depreciation) of securities
and foreign currency.................................... 32,177,940 (51,435) (8,677,101)
------------ ---------- -----------
Net assets............................................ $148,734,319 $6,870,680 $53,376,768
============ ========== ===========
CALCULATION OF NET ASSET VALUE PER SHARE -- INVESTOR CLASS:
Net assets................................................ $148,734,319 $6,870,680 $53,376,768
Shares outstanding (unlimited shares of no par value
authorized)............................................. 7,451,017 571,338 2,539,030
Net asset value per share (offering and redemption
price).................................................. $ 19.96 $ 12.03 $ 21.02
============ ========== ===========
CALCULATION OF NET ASSET VALUE PER SHARE -- DISTRIBUTOR
CLASS:
Net assets................................................
Shares outstanding (unlimited shares of no par value
authorized).............................................
Net asset value per share (offering and redemption
price)..................................................
*Cost of Investments........................................ $116,682,586 $6,969,329 $60,313,444
============ ========== ===========
</TABLE>
See Notes to the Financial Statements
44
<PAGE> 700
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Total Low Short-Term
International Global Equity Balanced Return Bond Duration Investment
Fund Fund Fund Fund Fund Fund
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$1,324,911,361 $7,521,060 $ 97,420,116 $124,285,261 $433,959,662 $57,030,807
-- 16,178 -- -- -- --
6,524,231 31,345 763,365 1,357,260 4,859,874 263,858
5,224,109 -- 12,586,495 184 20,279,671 3,121
49,114,266 -- 19,901 2,450,458 1,327,510 50,406
88,812 8,852 21,362 20,043 43,297 10,288
-------------- ---------- ------------ ------------ ------------ -----------
1,385,862,779 7,577,435 110,811,239 128,113,206 460,470,014 57,358,480
-------------- ---------- ------------ ------------ ------------ -----------
-- 428 -- -- -- --
824,747 86 52,950 25,950 99,035 11,578
2,666,784 -- 12,337,237 2,679,857 37,285,739 1,433,349
1,395,831 -- 467,695 538,138 12,787,124 4,997,014
-- -- -- 137,281 100,292 36,770
929,443 15,025 55,255 62,356 210,417 23,424
-------------- ---------- ------------ ------------ ------------ -----------
5,816,805 15,539 12,913,137 3,443,582 50,482,607 6,502,135
-------------- ---------- ------------ ------------ ------------ -----------
$1,380,045,974 $7,561,896 $ 97,898,102 $124,669,624 $409,987,407 $50,856,345
============== ========== ============ ============ ============ ===========
$1,170,840,321 $6,791,031 $ 88,791,457 $128,981,397 $419,909,000 $51,417,475
12,552,468 125,981 72,755 (79,637) 596,912 (18,601)
45,477,625 43,374 3,712,587 (1,372,787) (2,021,373) (174,003)
151,175,560 601,510 5,321,303 (2,859,349) (8,497,132) (368,526)
-------------- ---------- ------------ ------------ ------------ -----------
$1,380,045,974 $7,561,896 $ 97,898,102 $124,669,624 $409,987,407 $50,856,345
============== ========== ============ ============ ============ ===========
$1,378,899,059 $7,561,896 $ 97,898,102 $124,319,616 $409,987,407 $50,856,345
53,595,475 638,927 5,153,281 9,673,381 41,363,601 5,062,821
$ 25.73 $ 11.84 $ 19.00 $ 12.85 $ 9.91 $ 10.05
============== ========== ============ ============ ============ ===========
$ 1,146,915 $ 350,008
44,593 27,233
$ 25.72 $ 12.85
============== ============
$1,173,612,754 $6,918,634 $ 92,098,813 $127,144,610 $442,456,794 $57,399,333
============== ========== ============ ============ ============ ===========
</TABLE>
See Notes to the Financial Statements
45
<PAGE> 701
STATEMENT OF OPERATIONS
--------------------------------------------------------------------------------
YEAR ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
Equity Small
Income Mid-Cap Cap
Fund Fund Fund
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INVESTMENT INCOME
Income*
Dividends............................................... $ 4,613,052 $ 140,304 $ 397,179
Interest................................................ 96,121 12,380 68,572
------------ --------- ------------
Total income........................................ 4,709,173 152,684 465,751
------------ --------- ------------
Expenses
Advisory fee............................................ 1,178,513 46,081 442,635
Legal and auditing fees................................. 17,870 1,007 14,116
Custodian fees and expenses............................. 41,443 4,085 28,757
Accounting and transfer agent fees and expenses......... 90,191 49,592 122,017
Administration fee...................................... 58,925 1,713 25,625
Trustees' fees and expenses............................. 7,929 1,992 3,677
Reports to shareholders................................. 15,477 963 23,997
Registration fees....................................... 20,160 18,251 40,691
Distribution fees -- Distributor Class.................. -- -- --
Other expenses.......................................... 4,360 383 1,524
------------ --------- ------------
Total expenses...................................... 1,434,868 124,067 703,039
Less, expense reimbursement............................. (2,088) (59,578) (84,856)
------------ --------- ------------
Net expenses........................................ 1,432,780 64,489 618,183
------------ --------- ------------
Net investment income (loss)............................ 3,276,393 88,195 (152,432)
------------ --------- ------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain (loss) on securities and foreign
currency.............................................. 18,492,251 (192,150) (7,393,487)
Net change in unrealized appreciation (depreciation) of
securities and foreign currency....................... (11,950,809) 309,930 (9,556,411)
------------ --------- ------------
Net gain (loss) on investments............................ 6,541,442 117,780 (16,949,898)
------------ --------- ------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM
OPERATIONS................................................ $ 9,817,835 $ 205,975 $(17,102,330)
============ ========= ============
*Net of Foreign Taxes Withheld.............................. $ 15,172 $ 1,751 $ 12,760
============ ========= ============
</TABLE>
See Notes to the Financial Statements
46
<PAGE> 702
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Global Total Low Short-Term
International Equity Balanced Return Bond Duration Investment
Fund Fund Fund Fund Fund Fund
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$ 36,458,801 $266,131 $ 1,508,116 $ 62,528 $ 187,582 $ --
2,899,944 1,580 3,627,224 5,429,419 23,070,713 2,553,946
------------ -------- ----------- ----------- ------------ ----------
39,358,745 267,711 5,135,340 5,491,947 23,258,295 2,553,946
------------ -------- ----------- ----------- ------------ ----------
10,084,942 52,154 774,800 467,665 1,699,295 169,705
232,864 1,085 14,867 12,186 60,292 5,616
827,737 11,951 35,204 29,672 89,115 18,784
944,477 54,728 95,712 95,292 255,881 52,003
250,009 2,366 41,047 28,763 137,731 13,769
55,403 2,092 6,077 5,382 18,221 3,814
266,658 1,360 12,163 8,705 43,198 4,509
46,228 17,940 27,191 27,991 50,776 20,164
208 -- -- 63 -- --
43,638 429 1,776 1,394 6,713 954
------------ -------- ----------- ----------- ------------ ----------
12,752,164 144,105 1,008,837 677,113 2,361,222 289,318
-- (68,393) (26,952) (125,162) (230,145) (85,670)
------------ -------- ----------- ----------- ------------ ----------
12,752,164 75,712 981,885 551,951 2,131,077 203,648
------------ -------- ----------- ----------- ------------ ----------
26,606,581 191,999 4,153,455 4,939,996 21,127,218 2,350,298
------------ -------- ----------- ----------- ------------ ----------
70,779,798 80,356 3,908,674 (572,730) (737,715) (50,623)
(42,099,206) 75,740 (3,677,845) (3,760,047) (9,809,554) (407,341)
------------ -------- ----------- ----------- ------------ ----------
28,680,592 156,096 230,829 (4,332,777) (10,547,269) (457,964)
------------ -------- ----------- ----------- ------------ ----------
$ 55,287,173 $348,095 $ 4,384,284 $ 607,219 $ 10,579,949 $1,892,334
============ ======== =========== =========== ============ ==========
$ 2,147,066 $ 13,239 $ 4,767 $ -- $ -- $ --
============ ======== =========== =========== ============ ==========
</TABLE>
See Notes to the Financial Statements
47
<PAGE> 703
STATEMENT OF CHANGES IN NET ASSETS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Equity Income Fund Mid-Cap Fund
----------------------------- -----------------------------
Year Ended Year Ended Year Ended Year Ended
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OPERATIONS:
Net investment income (loss)..................... $ 3,276,393 $ 3,776,239 $ 88,195 $ 64,398
Net realized gain (loss) on securities and
foreign currency transactions.................. 18,492,251 29,878,073 (192,150) 928,847
Net change in unrealized appreciation
(depreciation) of securities and foreign
currency....................................... (11,950,809) 5,189,945 309,930 (555,561)
------------ ------------ ----------- ----------
Net increase (decrease) in net assets
resulting from operations.................. 9,817,835 38,844,257 205,975 437,684
------------ ------------ ----------- ----------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
Net investment income............................ (3,285,265) (3,812,071) -- (66,341)
Net realized gain on securities transactions..... (24,468,165) (26,619,074) (807,762) (129,478)
------------ ------------ ----------- ----------
Total dividends and distributions............ (27,753,430) (30,431,145) (807,762) (195,819)
------------ ------------ ----------- ----------
FUND SHARE TRANSACTIONS:
Net proceeds from shares sold.................... 45,268,422 23,627,560 3,117,822 6,338,383
Shares issued in connection with payment of
dividends and distributions.................... 25,424,531 29,778,874 806,204 194,620
Cost of shares redeemed.......................... (79,277,624) (72,438,773) (3,990,739) (1,222,885)
------------ ------------ ----------- ----------
Net increase (decrease) in net assets from
Fund share transactions.................... (8,584,671) (19,032,339) (66,713) 5,310,118
------------ ------------ ----------- ----------
Total increase (decrease) in net assets.............. (26,520,266) (10,619,227) (668,500) 5,551,983
NET ASSETS:
Beginning of year................................ 175,254,585 185,873,812 7,539,180 1,987,197
------------ ------------ ----------- ----------
End of year*..................................... $148,734,319 $175,254,585 $ 6,870,680 $7,539,180
============ ============ =========== ==========
*Including undistributed (distributions in excess of)
net investment income of: $ 43,953 $ 52,825 $ 86,963 $ --
============ ============ =========== ==========
CHANGES IN SHARES OUTSTANDING -- INVESTOR CLASS:
Shares sold...................................... 2,249,985 1,065,609 290,589 489,941
Shares issued in connection with payment of
dividends and distributions.................... 1,400,456 1,451,197 83,631 15,545
Shares redeemed.................................. (4,157,729) (3,307,554) (386,607) (92,361)
------------ ------------ ----------- ----------
Net increase (decrease)...................... (507,288) (790,748) (12,387) 413,125
============ ============ =========== ==========
CHANGES IN SHARES OUTSTANDING -- DISTRIBUTOR CLASS:
Shares sold......................................
Shares issued in connection with payment of
dividends and distributions....................
Shares redeemed..................................
Net increase.................................
</TABLE>
** Attributable to Investor Class only.
*** Net proceeds from shares sold includes $1,126,235 related to the Distributor
Class.
See Notes to the Financial Statements
48
<PAGE> 704
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Small Cap Fund International Fund Global Equity Fund
----------------------------- --------------------------------- -----------------------------
Year Ended Year Ended Year Ended Year Ended Year Ended Year Ended
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$ (152,432) $ (154,400) $ 26,606,581 $ 27,073,883 $ 191,999 $ 111,802
(7,393,487) 9,968,991 70,779,798 3,289,299 80,356 121,357
(9,556,411) (3,968,125) (42,099,206) 70,706,856 75,740 225,531
------------ ------------ --------------- --------------- ----------- ----------
(17,102,330) 5,846,466 55,287,173 101,070,038 348,095 458,690
------------ ------------ --------------- --------------- ----------- ----------
-- (111,869) (14,481,803) (32,976,929) (76,144) (175,171)
(4,099,720) (5,072,568) (19,626,614) -- (15,242) (91,582)
------------ ------------ --------------- --------------- ----------- ----------
(4,099,720) (5,184,437) (34,108,417)** (32,976,929) (91,386) (266,753)
------------ ------------ --------------- --------------- ----------- ----------
92,751,659 140,132,855 2,003,135,366*** 1,292,839,186 857,258 4,309,902
3,981,064 5,017,869 29,138,880 29,643,512 90,117 263,932
(117,067,181) (78,429,678) (2,150,212,412) (802,298,868) (987,473) (1,150,082)
------------ ------------ --------------- --------------- ----------- ----------
(20,334,458) 66,721,046 (117,938,166) 520,183,830 (40,098) 3,423,752
------------ ------------ --------------- --------------- ----------- ----------
(41,536,508) 67,383,075 (96,759,410) 588,276,939 216,611 3,615,689
94,913,276 27,530,201 1,476,805,384 888,528,445 7,345,285 3,729,596
------------ ------------ --------------- --------------- ----------- ----------
$ 53,376,768 $ 94,913,276 $ 1,380,045,974 $ 1,476,805,384 $ 7,561,896 $7,345,285
============ ============ =============== =============== =========== ==========
$ -- $ -- $ 12,552,468 $ (6,410,587) $ 125,981 $ (24,779)
============ ============ =============== =============== =========== ==========
4,577,685 5,096,875 85,591,643 52,830,892 79,898 388,720
208,433 207,693 1,297,951 1,253,628 8,656 25,235
(5,831,667) (2,875,106) (91,604,448) (32,528,515) (95,127) (104,646)
------------ ------------ --------------- --------------- ----------- ----------
(1,045,549) 2,429,462 (4,714,854) 21,556,005 (6,573) 309,309
============ ============ =============== =============== =========== ==========
44,593
--
--
---------------
44,593
===============
</TABLE>
See Notes to the Financial Statements
49
<PAGE> 705
STATEMENT OF CHANGES IN NET ASSETS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Balanced Fund
--------------------------------------------
Year Ended Year Ended
June 30, 1999 June 30, 1998
----------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Net investment income................................... $ 4,153,455 $ 4,562,817
Net realized gain (loss) on securities transactions..... 3,908,674 5,754,835
Net change in unrealized appreciation (depreciation) of
securities............................................. (3,677,845) 2,122,314
------------ ------------
Net increase in net assets resulting from
operations.......................................... 4,384,284 12,439,966
------------ ------------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- INVESTOR
CLASS:
Net investment income................................... (4,073,380) (4,563,299)
Net realized gain on securities transactions............ (4,515,885) (5,598,223)
------------ ------------
Total dividends and distributions................... (8,589,265) (10,161,522)
------------ ------------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- DISTRIBUTOR
CLASS:
Net investment income...................................
FUND SHARE TRANSACTIONS:
Net proceeds from shares sold........................... 28,758,855 34,493,608
Shares issued in connection with payment of dividends
and distributions...................................... 8,305,107 9,851,285
Cost of shares redeemed................................. (39,556,292) (32,186,438)
------------ ------------
Net increase (decrease) in net assets from Fund
share transactions.................................. (2,492,330) 12,158,455
------------ ------------
Total increase (decrease) in net assets..................... (6,697,311) 14,436,899
NET ASSETS:
Beginning of year....................................... 104,595,413 90,158,514
------------ ------------
End of year*............................................ $ 97,898,102 $104,595,413
============ ============
*Including undistributed (distributions in excess of) net
investment income of: $ 72,755 $ 1,426
============ ============
CHANGES IN SHARES OUTSTANDING -- INVESTOR CLASS:
Shares sold............................................. 1,518,693 1,728,761
Shares issued in connection with payment of dividends
and distributions...................................... 445,955 508,237
Shares redeemed......................................... (2,083,905) (1,616,205)
------------ ------------
Net increase (decrease)............................. (119,257) 620,793
============ ============
CHANGES IN SHARES OUTSTANDING -- DISTRIBUTOR CLASS:
Shares sold.............................................
Shares issued in connection with payment of dividends
and distributions......................................
Shares redeemed.........................................
Net increase........................................
</TABLE>
** Net proceeds from shares sold and shares issued in connection with payment of
dividends and distributions include $349,125 and $1,610, respectively,
related to the Distributor Class.
See Notes to the Financial Statements
50
<PAGE> 706
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Total Return Bond Fund Low Duration Fund Short-Term Investment Fund
----------------------------- ----------------------------- -----------------------------
Year Ended Year Ended Year Ended Year Ended Year Ended Year Ended
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$ 4,939,996 $ 1,532,385 $ 21,127,218 $ 12,919,157 $ 2,350,298 $ 1,509,613
(572,730) 318,597 (737,715) 1,052,667 (50,623) (42,539)
(3,760,047) 504,670 (9,809,554) (221,716) (407,341) (20,572)
------------ ----------- ------------- ------------- ------------- ------------
607,219 2,355,652 10,579,949 13,750,108 1,892,334 1,446,502
------------ ----------- ------------- ------------- ------------- ------------
(5,340,145) (1,622,000) (21,925,763) (13,340,819) (2,307,426) (1,509,613)
(611,925) -- (642,509) (1,045,647) -- --
------------ ----------- ------------- ------------- ------------- ------------
(5,952,070) (1,622,000) (22,568,272) (14,386,466) (2,307,426) (1,509,613)
------------ ----------- ------------- ------------- ------------- ------------
(1,610)
------------
125,455,048** 33,566,256 535,272,087 182,933,522 121,678,835 50,189,024
5,443,498** 1,101,255 22,210,113 12,908,812 1,750,451 894,623
(46,130,262) (4,460,475) (388,657,005) (113,269,472) (100,196,327) (44,698,826)
------------ ----------- ------------- ------------- ------------- ------------
84,768,284 30,207,036 168,825,195 82,572,862 23,232,959 6,384,821
------------ ----------- ------------- ------------- ------------- ------------
79,421,823 30,940,688 156,836,872 81,936,504 22,817,867 6,321,710
45,247,801 14,307,113 253,150,535 171,214,031 28,038,478 21,716,768
------------ ----------- ------------- ------------- ------------- ------------
$124,669,624 $45,247,801 $ 409,987,407 $ 253,150,535 $ 50,856,345 $ 28,038,478
============ =========== ============= ============= ============= ============
$ (79,637) $ 34,272 $ 596,912 $ -- $ (18,601) $ (72,392)
============ =========== ============= ============= ============= ============
9,353,948 2,516,857 52,973,512 17,898,633 12,032,563 4,944,329
408,076 82,830 2,201,641 1,263,801 173,571 88,164
(3,450,832) (334,936) (38,637,818) (11,074,513) (9,911,294) (4,404,554)
------------ ----------- ------------- ------------- ------------- ------------
6,311,192 2,264,751 16,537,335 8,087,921 2,294,840 627,939
============ =========== ============= ============= ============= ============
27,108
125
--
------------
27,233
============
</TABLE>
See Notes to the Financial Statements
51
<PAGE> 707
NOTES TO THE FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
JUNE 30, 1999
NOTE 1.
ACCOUNTING POLICIES. Hotchkis and Wiley Funds (the "Trust") is registered under
the Investment Company Act of 1940 as a diversified, open-end, management
investment company. The Trust was organized as a Massachusetts business trust on
August 22, 1984 and consists of ten series of shares comprising the Balanced
Fund, the Small Cap Fund, the Equity Income Fund, the International Fund, the
Total Return Bond Fund, the Low Duration Fund, the Short-Term Investment Fund,
the Mid-Cap Fund, the Global Equity Fund and the Equity Fund for Insurance
Companies (collectively, the "Funds"), the assets of which are invested in
separate, independently managed portfolios. The accompanying financial
statements exclude financial information for the Equity Fund for Insurance
Companies; financial statements for that Fund are reported on separately.
Investment operations of the Funds began on August 13, 1985 (the Balanced Fund),
September 20, 1985 (the Small Cap Fund), June 24, 1987 (the Equity Income Fund),
October 1, 1990 (the International Fund), January 29, 1993 (the Equity Fund for
Insurance Companies), May 18, 1993 (the Low Duration Fund and the Short-Term
Investment Fund), December 6, 1994 (the Total Return Bond Fund), and January 2,
1997 (the Mid-Cap Fund and the Global Equity Fund).
The Balanced Fund seeks to preserve capital while producing a high total return.
The Small Cap Fund seeks capital appreciation. The Equity Income Fund seeks to
provide current income and long-term growth of income, accompanied by growth of
capital. The International Fund seeks to provide current income and long-term
growth of income, accompanied by growth of capital. The Total Return Bond Fund
seeks to maximize long-term total return. The Low Duration Fund seeks to
maximize total return, consistent with preservation of capital. The Short-Term
Investment Fund seeks to maximize total return, consistent with preservation of
capital. The Mid-Cap Fund seeks to provide current income and long-term growth
of income, accompanied by growth of capital. The Global Equity Fund seeks to
provide current income and long-term growth of income, accompanied by growth of
capital. The following is a summary of significant accounting policies followed
by the Funds in the preparation of the financial statements.
Effective April 1, 1999, the Balanced, Small Cap, International, Total Return
Bond and Low Duration Funds have issued two classes of shares: Investor Class
and Distributor Class. Distributor Class shares are subject to an annual Rule
12b-1 fee of 0.25% of average net assets. Investor Class shares do not pay a
12b-1 fee. Each class of shares for each Fund has identical rights and
privileges except with respect to Rule 12b-1 fees paid by the Distributor Class,
voting rights on matters pertaining to a single class of shares and the exchange
privileges of each class of shares. As of June 30, 1999, the Balanced, Small Cap
and Low Duration Funds had no Distributor Class activity except for the purchase
of one share by Hotchkis and Wiley (the "Advisor") representing net assets of
$19, $21, and $10, respectively.
SECURITY VALUATION: Portfolio securities that are listed on a securities
exchange (whether domestic or foreign) or The Nasdaq Stock Market ("NSM") are
valued at the last sale price as of 4:00 p.m., Eastern time, or, in the absence
of recorded sales, at the average of readily available closing bid and asked
prices on such exchange or NSM. Unlisted securities that are not included in NSM
are valued at the average of the quoted bid and asked price in the over-the-
counter market. Fixed-income securities are normally valued on the basis of
quotes obtained from brokers and dealers or pricing services. Certain
fixed-income securities for which daily market quotations are not readily
available may be valued pursuant to guidelines established by the Board of
Trustees, with reference to fixed-income securities whose prices are more
readily obtainable or an appropriate matrix utilizing similar factors. As a
broader market does
52
<PAGE> 708
not exist, the proceeds received upon the disposal of such securities may differ
from quoted values previously furnished by such market makers. Securities for
which market quotations are not otherwise available are valued at fair value as
determined in good faith by the Advisor under procedures established by the
Board of Trustees. Short-term investments which mature in less than 60 days are
valued at amortized cost (unless the Board of Trustees determines that this
method does not represent fair value), if their original maturity was 60 days or
less, or by amortizing the values as of the 61st day prior to maturity, if their
original term to maturity exceeded 60 days. Investments quoted in foreign
currency are valued daily in U.S. dollars on the basis of the foreign currency
exchange rate prevailing at the time of valuation.
FOREIGN CURRENCY TRANSLATIONS: The books and records of the Funds are maintained
in U.S. dollars. For the International Fund and the Global Equity Fund, foreign
currency transactions are translated into U.S. dollars on the following basis:
(i) market value of investment securities, assets and liabilities at the daily
rates of exchange, and (ii) purchases and sales of investment securities,
dividend and interest income and certain expenses at the rates of exchange
prevailing on the respective dates of such transactions. The International Fund
and the Global Equity Fund do not isolate and treat as ordinary income that
portion of the results of operations arising as a result of changes in the
exchange rate from the fluctuations arising from changes in the market prices of
securities held during the period. However, for federal income tax purposes, the
International Fund and the Global Equity Fund do isolate and treat as ordinary
income the effect of changes in foreign exchange rates arising from actual
foreign currency transactions and the effect of changes in foreign exchange
rates arising from trade date and settlement date differences.
FORWARD CURRENCY EXCHANGE CONTRACTS: The International Fund and the Global
Equity Fund utilize forward currency exchange contracts for the purpose of
hedging foreign currency risk. Under these contracts, they are obligated to
exchange currencies at specific future dates. Risks arise from the possible
inability of counter-parties to meet the terms of their contracts and from
movements in currency values.
FEDERAL INCOME TAXES: It is each Fund's policy to meet the requirements of the
Internal Revenue Code applicable to regulated investment companies and each Fund
intends to distribute substantially all of its investment company net taxable
income and net capital gains to shareholders. Therefore, no federal income tax
provision is required.
INCOME AND EXPENSE ALLOCATION: Common expenses incurred by the Funds are
allocated among the Funds based upon (i) relative average net assets, (ii) as
incurred on a specific identification basis, or (iii) evenly among the Funds,
depending on the nature of the expenditure. Net investment income, other than
class specific expenses, and realized and unrealized gains and losses are
allocated daily to each class of shares based upon the relative net asset value
of outstanding shares of each class of shares at the beginning of the day (after
adjusting for the current day's capital share activity of the respective class).
RESTRICTED SECURITIES: The Balanced, Total Return Bond, Low Duration and
Short-Term Investment Funds own investment securities which are unregistered and
thus restricted as to resale. Where future disposition of these securities
requires registration under the Securities Act of 1933, the Funds have the right
to include these securities in such registration, generally without cost to the
Funds. The Funds have no right to require registration of unregistered
securities. At June 30, 1999, the Balanced, Total Return Bond, Low Duration and
Short-Term Investment Funds had restricted securities with an aggregate market
value of $3,264,837, $15,313,945, $73,922,498 and $7,715,171, respectively,
representing 3%, 12%, 18% and 15% of the net assets of each Fund, respectively.
Of these amounts, the Balanced, Total Return Bond, Low Duration and Short-Term
Investment Funds had restricted securities that were determined to be illiquid
pursuant to guidelines adopted by the Board of Trustees with an
53
<PAGE> 709
aggregate market value of $331,971, $155,745, $3,300,993 and $404,337,
respectively, representing 0.3%, 0.1%, 0.8% and 0.8% of the net assets of each
Fund, respectively.
WHEN-ISSUED SECURITIES: The Funds may purchase securities on a when-issued or
delayed delivery basis. Although the payment and interest terms of these
securities are established at the time the purchaser enters into the agreement,
these securities may be delivered and paid for at a future date, generally
within 45 days. The Funds record purchases of when-issued securities and reflect
the values of such securities in determining net asset value in the same manner
as other portfolio securities. The Funds maintain at all times cash or other
liquid assets in an amount at least equal to the amount of outstanding
commitments for when-issued securities.
USE OF ESTIMATES: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
DISTRIBUTIONS TO SHAREHOLDERS: Dividends from net investment income are declared
and paid monthly for the Total Return Bond, Low Duration and Short-Term
Investment Funds, declared and paid quarterly for the Balanced and Equity Income
Funds and declared and paid annually for the Mid-Cap, Small Cap, International
and Global Equity Funds. Distributions of net realized capital gains, if any,
will be declared and paid at least annually. The Funds may utilize earnings and
profits distributed to shareholders on redemption of shares as part of the
dividends paid deduction.
OTHER: Security and shareholder transactions are recorded on trade date.
Realized gains and losses on sales of investments are calculated on the
identified cost basis. Dividend income and dividends and distributions to
shareholders are recorded on the ex-dividend date. Interest income is recognized
on the accrual basis. Generally accepted accounting principles require that
permanent financial reporting and tax differences relating to shareholder
distributions be reclassified within the capital accounts.
NOTE 2.
INVESTMENT ADVISORY AGREEMENTS. Each Fund has an investment advisory agreement
with the Advisor with whom certain officers and Trustees of the Trust are
affiliated. The Advisor is a division of Merrill Lynch Asset Management, L.P.,
an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. The Advisor
receives a fee, computed daily and payable monthly, at the annual rates
presented below as applied to each Fund's daily net assets. The Advisor has
voluntarily agreed to pay all operating expenses in excess of the annual rates
presented below as applied to each
54
<PAGE> 710
Fund's daily net assets. The annual expense caps for some of the Funds changed
effective March 1, 1999. For the year ended June 30, 1999, the Advisor
reimbursed the following expenses:
<TABLE>
<CAPTION>
International
Fund -- International
Equity Income Mid-Cap Small Cap Investor Fund --Distributor Global Equity Balanced
Fund Fund Fund Class Class Fund Fund
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Annual Advisory Rate....... 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75%
Annual Cap on Expenses --
prior to March 1......... 1.00% 1.00% 1.00% 1.00% -- 1.00% 1.00%
Annual Cap on Expenses --
subsequent to March 1.... 0.95% 1.15% -- -- -- 1.25% 0.95%
Expenses Reimbursed........ $2,088 $59,578 $84,856 $0 $0 $68,393 $26,952
</TABLE>
<TABLE>
<CAPTION>
Total Return Total Return
Bond Fund -- Bond Fund -- Low Duration Short-Term
Investor Class Distributor Class Fund Investment Fund
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Annual Advisory Rate......................... 0.55% 0.55% 0.46% 0.40%
Annual Cap on Expenses -- prior to March 1... 0.65% -- 0.58% 0.48%
Annual Cap on Expenses -- subsequent to March
1.......................................... 0.65% 0.90% 0.58% 0.48%
Expenses Reimbursed.......................... $125,093 $69 $230,145 $85,670
</TABLE>
The Trust has adopted a plan pursuant to Rule 12b-1 under the Investment Company
Act of 1940 (the "12b-1 Plan") that allows the Distributor Class of the Small
Cap, International, Balanced, Total Return Bond and Low Duration Funds to make
payments to administrators, broker/dealers or other institutions that provide
accounting, recordkeeping or other services to investors and that have an
administration services agreement with the Trust or the Advisor to make
Distributor Class shares available to their clients ("Recipients"). Recipients
are paid an annual rate of 0.25% of the average net assets of the Distributor
Class shares invested through the Recipient as compensation for providing
distribution-related services such as advertising, printing and mailing
prospectuses to potential investors and training sales personnel regarding the
Funds. During the period ended June 30, 1999, the Distributor Class of the
International and Total Return Bond Funds incurred expenses of $208 and $63,
respectively, pursuant to the 12b-1 Plan.
Certain authorized agents of the Funds charge a fee for accounting and
shareholder services that they provide to the Funds on behalf of certain
shareholders; the portion of this fee paid by the Funds is included within
Accounting and transfer agent fees and expenses in the Statement of Operations.
The Advisor has entered into subadvisory agreements with Mercury Asset
Management International Limited and Merrill Lynch Asset Management U.K.
Limited, affiliated investment advisors that are indirect subsidiaries of
Merrill Lynch & Co., Inc. The subadvisory arrangements are for investment
research, recommendations, and other investment-related services to be provided
to the International and Global Equity Funds. There is no increase in the
aggregate fees paid by the Funds for these services.
The International and Global Equity Funds paid commissions on Fund transactions
to an affiliated broker in the amounts of $328,247 and $173, respectively,
during the year ended June 30, 1999.
55
<PAGE> 711
As permitted under Rule 10f-3 of the Investment Company Act of 1940, the Board
of Trustees of the Trust has adopted procedures which allow the Funds, under
certain conditions described in the Rule, to acquire newly-issued securities
from a member of an underwriting group in which an affiliated underwriter
participates.
NOTE 3.
SECURITIES TRANSACTIONS. Purchases and sales of investment securities, other
than short-term investments, for the year ended June 30, 1999 were as follows:
<TABLE>
<CAPTION>
Purchases Sales
------------------------------ ------------------------------
Fund U.S. Government Other U.S. Government Other
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Equity Income Fund.............................. -- $ 27,289,577 -- $ 60,758,419
Mid-Cap Fund.................................... -- 6,756,175 -- 7,362,305
Small Cap Fund.................................. -- 61,652,661 -- 85,862,362
International Fund.............................. -- 526,880,293 -- 640,486,123
Global Equity Fund.............................. -- 2,750,821 -- 2,781,463
Balanced Fund................................... $112,137,782 24,637,111 $105,585,575 37,520,070
Total Return Bond Fund.......................... 158,522,021 110,173,269 127,775,304 62,817,428
Low Duration Fund............................... 531,227,253 329,611,371 476,477,567 207,104,333
Short-Term Investment Fund...................... 26,202,362 41,028,878 24,339,321 19,196,120
</TABLE>
As of June 30, 1999, unrealized appreciation (depreciation) for federal income
tax purposes was as follows:
<TABLE>
<CAPTION>
Net Appreciation Appreciated Depreciated
Fund (Depreciation) Securities Securities
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Equity Income Fund.......................................... $ 31,907,975 $38,196,720 $ (6,288,745)
Mid-Cap Fund................................................ (82,447) 648,455 (730,902)
Small Cap Fund.............................................. (10,444,080) 3,228,820 (13,672,900)
International Fund.......................................... 139,098,914 219,815,064 (80,716,150)
Global Equity Fund.......................................... 556,460 1,191,669 (635,209)
Balanced Fund............................................... 5,267,232 9,682,465 (4,415,233)
Total Return Bond Fund...................................... (2,859,349) 394,539 (3,253,888)
Low Duration Fund........................................... (8,501,116) 1,227,971 (9,729,087)
Short-Term Investment Fund.................................. (368,526) 99,480 (468,006)
</TABLE>
At June 30, 1999, the cost of investments for federal income tax purposes was
$116,952,551, $7,000,341, $62,080,423, $1,185,812,447, $6,964,600, $92,152,884,
$127,144,610, $442,460,778 and $57,399,333 for the Equity Income, Mid-Cap, Small
Cap, International, Global Equity, Balanced, Total Return Bond, Low Duration and
Short-Term Investment Funds, respectively. Any differences between book and tax
are due primarily to wash sale losses. In addition, the cost basis differences
in the International Fund and Global Equity Fund are due to mark-to-market
adjustments for passive foreign investment companies.
56
<PAGE> 712
At June 30, 1999, the following Funds deferred, on a tax basis, post-October
losses of:
<TABLE>
<CAPTION>
Fund Post-October Losses
-----------------------------------------------------------------------------------
<S> <C>
Mid-Cap Fund................................................ $ 339,647
Small Cap Fund.............................................. 4,058,500
Total Return Bond Fund...................................... 1,372,787
Low Duration Fund........................................... 1,293,682
Short-Term Investment Fund.................................. 73,268
</TABLE>
Such amounts may be used to offset future capital gains.
At June 30, 1999, the Small Cap Fund had accumulated net realized capital loss
carryovers of $1,842,953 expiring in 2007. The Low Duration Fund had accumulated
net realized capital loss carryovers of $723,707 expiring in 2007. The
Short-Term Investment Fund had accumulated net realized capital loss carryovers
of $61,761 expiring in 2004 and $38,974 expiring in 2005. The Short-Term
Investment Fund utilized capital loss carryovers of $5,206 in 1999. To the
extent that the Funds realize future net capital gains, those gains will be
offset by any unused capital loss carryover.
NOTE 4.
FORWARD CURRENCY EXCHANGE CONTRACT. At June 30, 1999, the Global Equity Fund had
entered into a "portfolio hedge" forward currency exchange contract that
obligates the Fund to deliver and receive currency at a specified future date.
The net unrealized depreciation of $428 is included in the net unrealized
appreciation (depreciation) section of the accompanying financial statements.
The terms of the open contract are as follows:
<TABLE>
<CAPTION>
Currency to U.S. $ Value at Currency to U.S. $ Value at
Settlement Date be Delivered June 30, 1999 be Received June 30, 1999
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
8/31/99.............. 29,548,500 Japanese Yen $246,501 U.S. Dollars $246,073
</TABLE>
NOTE 5.
FEDERAL TAX DISCLOSURE (UNAUDITED). For the year ended June 30, 1999, the
following percent of dividends distributed were derived from interest on U.S.
government securities which is generally exempt from state income tax: Balanced
Fund 9%, Total Return Bond Fund 18%, Low Duration Fund 16% and Short-Term
Investment Fund 9%. For the year ended June 30, 1999, the following percent of
ordinary distributions paid qualifies for the dividend received deduction
available to corporate shareholders: Equity Income Fund 100%, Mid-Cap Fund 12%,
Small Cap Fund 3%, Global Equity Fund 26%, Balanced Fund 35%, Total Return Bond
Fund 1% and Low Duration Fund 1%.
During the year ended June 30, 1999, the International Fund generated
$39,260,565 of foreign source income and paid $2,147,066 of foreign taxes. The
Fund elects to pass foreign taxes through to the Fund's shareholders for their
1999 tax returns. Updated data will be sent with 1999 Forms 1099-DIV to enable
shareholders to have information to claim either a foreign tax credit or to take
a foreign tax deduction on their 1999 income tax returns.
57
<PAGE> 713
During the year ended June 30, 1999, the following Funds paid capital gain
dividends (taxable as long-term capital gains).
<TABLE>
<CAPTION>
Fund Per Share
-------------------------------------------------------------------------
<S> <C>
Equity Income Fund.......................................... $2.8078
Mid-Cap Fund................................................ $0.3471
Small Cap Fund.............................................. $1.0951
International Fund.......................................... $0.3357
Global Equity Fund.......................................... $0.0227
Balanced Fund............................................... $0.7148
Total Return Bond Fund...................................... $0.0058
Low Duration Fund........................................... $0.0038
</TABLE>
Information regarding these distributions was provided with the 1998 Forms
1099-DIV sent to shareholders in January 1999.
58
<PAGE> 714
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------------
EQUITY INCOME FUND 1999 1998 1997 1996 1995
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year.......................... $22.02 $21.25 $18.91 $17.24 $15.07
------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................................... 0.41 0.46 0.49 0.45(1) 0.49
Net realized and unrealized gain on investments......... 0.82 4.02 4.15 2.89 2.48
------ ------ ------ ------ ------
Total from investment operations........................ 1.23 4.48 4.64 3.34 2.97
------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income).................. (0.41) (0.46) (0.48) (0.57) (0.44)
Distributions (from realized gains)..................... (2.88) (3.25) (1.82) (1.10) (0.36)
------ ------ ------ ------ ------
Total distributions..................................... (3.29) (3.71) (2.30) (1.67) (0.80)
------ ------ ------ ------ ------
Net Asset Value, End of Year................................ $19.96 $22.02 $21.25 $18.91 $17.24
====== ====== ====== ====== ======
TOTAL RETURN................................................ 7.32% 22.60% 26.15% 20.04% 20.49%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (millions).......................... $148.7 $175.3 $185.9 $182.5 $127.1
Ratio of expenses to average net assets:
Before expense reimbursement............................ 0.91% 0.87% 0.88% 0.98% 1.02%
After expense reimbursement............................. 0.91% 0.87% 0.88% 0.98% 1.00%
Ratio of net investment income to average net assets:
Before expense reimbursement............................ 2.09% 1.99% 2.49% 2.56% 3.11%
After expense reimbursement............................. 2.09% 1.99% 2.49% 2.56% 3.14%
Portfolio turnover rate..................................... 18% 23% 44% 24% 50%
</TABLE>
(1)Net investment income per share is calculated using ending balances prior to
consideration of adjustments for permanent book and tax differences.
See Notes to the Financial Statements
59
<PAGE> 715
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30, January 2, 1997*
-------------------- through
MID-CAP FUND 1999 1998 June 30, 1997
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period........................ $12.92 $11.65 $10.00
------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................................... 0.16 0.13 0.07
Net realized and unrealized gain on investments......... 0.46 1.60 1.64
------ ------ ------
Total from investment operations........................ 0.62 1.73 1.71
------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income).................. -- (0.14) (0.06)
Distributions (from realized gains)..................... (1.51) (0.32) --
------ ------ ------
Total distributions..................................... (1.51) (0.46) (0.06)
------ ------ ------
Net Asset Value, End of Period.............................. $12.03 $12.92 $11.65
====== ====== ======
TOTAL RETURN................................................ 7.66% 15.00% 17.15%++
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions)........................ $6.9 $7.5 $2.0
Ratio of expenses to average net assets:
Before expense reimbursement............................ 2.02% 2.72% 8.26%+
After expense reimbursement............................. 1.05% 1.00% 1.00%+
Ratio of net investment income (loss) to average net assets:
Before expense reimbursement............................ 0.46% (0.52)% (5.39)%+
After expense reimbursement............................. 1.43% 1.20% 1.87%+
Portfolio turnover rate..................................... 113% 71% 23%++
</TABLE>
* Commencement of operations.
+ Annualized.
++ Not Annualized.
See Notes to the Financial Statements
60
<PAGE> 716
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------------
SMALL CAP FUND 1999 1998 1997 1996 1995
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year.......................... $26.48 $23.83 $21.33 $21.53 $19.53
------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss)............................ (0.05)(2) (0.06)(1) 0.03 0.05(1) (0.06)
Net realized and unrealized gain (loss) on
investments........................................... (3.88) 5.13 5.62 2.80 2.84
------ ------ ------ ------ ------
Total from investment operations........................ (3.93) 5.07 5.65 2.85 2.78
------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income).................. -- (0.05) (0.09) -- --
Distributions (from realized gains)..................... (1.53) (2.37) (3.06) (3.05) (0.78)
------ ------ ------ ------ ------
Total distributions..................................... (1.53) (2.42) (3.15) (3.05) (0.78)
------ ------ ------ ------ ------
Net Asset Value, End of Year................................ $21.02 $26.48 $23.83 $21.33 $21.53
====== ====== ====== ====== ======
TOTAL RETURN................................................ (14.26)% 22.24% 29.74% 14.24% 14.79%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (millions).......................... $53.4 $94.9 $27.5 $16.5 $20.5
Ratio of expenses to average net assets:
Before expense reimbursement............................ 1.19% 0.94% 1.30% 1.21% 1.49%
After expense reimbursement............................. 1.05% 0.94% 1.00% 1.00% 1.00%
Ratio of net investment income (loss) to average net assets:
Before expense reimbursement............................ (0.40)% (0.23)% (0.20)% 0.03% (0.82)%
After expense reimbursement............................. (0.26)% (0.23)% 0.10% 0.24% (0.34)%
Portfolio turnover rate..................................... 105% 85% 88% 119% 81%
</TABLE>
(1) Net investment income per share represents net investment income divided by
the average shares outstanding throughout the year.
(2) Net investment income per share is calculated using ending balances prior to
consideration of adjustments for permanent book and tax differences.
See Notes to the Financial Statements
61
<PAGE> 717
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Distributor Class Investor Class
Investor Class June 2, 1999* Year Ended June 30,
Year Ended through --------------------------------------------
INTERNATIONAL FUND June 30, 1999 June 30, 1999 1998 1997 1996 1995
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period.......... $ 25.33 $25.20 $ 24.17 $20.44 $17.70 $16.79
-------- ------ -------- ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income..................... 0.59 0.05 0.59 0.59(1) 0.56(1) 0.28
Net realized and unrealized gain on
investments............................. 0.40 0.47 1.23 3.78 2.51 1.52
-------- ------ -------- ------ ------ ------
Total from investment operations.......... 0.99 0.52 1.82 4.37 3.07 1.80
-------- ------ -------- ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income).... (0.25) -- (0.66) (0.48) (0.14) (0.44)
Distributions (from realized gains)....... (0.34) -- -- (0.16) (0.19) (0.45)
-------- ------ -------- ------ ------ ------
Total distributions....................... (0.59) -- (0.66) (0.64) (0.33) (0.89)
-------- ------ -------- ------ ------ ------
Net Asset Value, End of Period................ $ 25.73 $25.72 $ 25.33 $24.17 $20.44 $17.70
======== ====== ======== ====== ====== ======
TOTAL RETURN.................................. 4.22% 2.06%++ 7.77% 21.59% 18.61% 11.08%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (millions)............ $1,378.9 $1.1 $1,476.8 $888.5 $331.0 $51.5
Ratio of expenses to average net assets:
Before expense reimbursement.............. 0.95% 1.30%+ 0.89% 1.07% 1.11% 1.39%
After expense reimbursement............... 0.95% 1.30%+ 0.89% 1.00% 1.00% 1.00%
Ratio of net investment income to average net
assets:
Before expense reimbursement.............. 1.98% 2.77%+ 2.32% 2.59% 2.67% 2.45%
After expense reimbursement............... 1.98% 2.77%+ 2.32% 2.66% 2.78% 2.83%
Portfolio turnover rate....................... 41%+++ 41%+++ 20% 18% 12% 24%
</TABLE>
(1) Net investment income per share represents net investment income divided by
the average shares outstanding throughout the year.
* Commencement of operations.
+ Annualized.
++ Not Annualized.
+++ Portfolio turnover is calculated on the basis of the Fund as a whole without
distinguishing between the classes of shares issued.
See Notes to the Financial Statements
62
<PAGE> 718
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30, January 2, 1997*
------------------------------ through
GLOBAL EQUITY FUND 1999 1998 June 30, 1997
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period........................ $11.38 $11.09 $10.00
------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................................... 0.35 0.28 0.14
Net realized and unrealized gain on investments......... 0.24 0.51 1.09
------ ------ ------
Total from investment operations........................ 0.59 0.79 1.23
------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income).................. (0.11) (0.32) (0.14)
Distributions (from realized gains)..................... (0.02) (0.18) --
------ ------ ------
Total distributions..................................... (0.13) (0.50) (0.14)
------ ------ ------
Net Asset Value, End of Period.............................. $11.84 $11.38 $11.09
====== ====== ======
TOTAL RETURN................................................ 5.40% 7.61% 12.32%++
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions)........................ $7.6 $7.3 $3.7
Ratio of expenses to average net assets:
Before expense reimbursement............................ 2.07% 2.88% 4.43%+
After expense reimbursement............................. 1.09% 1.00% 1.00%+
Ratio of net investment income to average net assets:
Before expense reimbursement............................ 1.78% 0.00% 0.07%+
After expense reimbursement............................. 2.76% 1.88% 3.50%+
Portfolio turnover rate..................................... 40% 54% 18%++
</TABLE>
* Commencement of operations.
+ Annualized.
++ Not Annualized.
See Notes to the Financial Statements
63
<PAGE> 719
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------------
BALANCED FUND 1999 1998 1997 1996 1995
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year.......................... $19.84 $19.38 $18.27 $16.74 $15.71
------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................................... 0.77 0.89 0.90(1) 0.94 0.89
Net realized and unrealized gain (loss) on
investments........................................... (0.04) 1.58 1.86 1.53 1.53
------ ------ ------ ------ ------
Total from investment operations........................ 0.73 2.47 2.76 2.47 2.42
------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income).................. (0.75) (0.90) (0.99) (0.92) (0.80)
Distributions (from realized gains)..................... (0.82) (1.11) (0.66) (0.02) (0.57)
Return of capital....................................... -- -- -- -- (0.02)
------ ------ ------ ------ ------
Total distributions..................................... (1.57) (2.01) (1.65) (0.94) (1.39)
------ ------ ------ ------ ------
Net Asset Value, End of Year................................ $19.00 $19.84 $19.38 $18.27 $16.74
====== ====== ====== ====== ======
TOTAL RETURN................................................ 4.04% 13.29% 15.75% 15.04% 16.40%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (millions).......................... $97.9 $104.6 $90.2 $70.6 $32.1
Ratio of expenses to average net assets:
Before expense reimbursement............................ 0.98% 0.93% 0.98% 1.06% 1.19%
After expense reimbursement............................. 0.95% 0.93% 0.98% 1.00% 1.00%
Ratio of net investment income to average net assets:
Before expense reimbursement............................ 3.99% 4.49% 4.77% 5.20% 5.44%
After expense reimbursement............................. 4.02% 4.49% 4.77% 5.26% 5.63%
Portfolio turnover rate..................................... 135% 121% 117% 92% 51%
</TABLE>
(1) Net investment income per share is calculated using ending balances prior to
consideration of adjustments for permanent book and tax differences.
See Notes to the Financial Statements
64
<PAGE> 720
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Distributor Class Investor Class Investor Class
Investor Class June 2, 1999* Year Ended June 30, December 6, 1994*
Year Ended through ------------------------ through
TOTAL RETURN BOND FUND June 30, 1999 June 30, 1999 1998 1997 1996 June 30, 1995
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period....... $13.46 $12.88 $13.04 $12.78 $12.94 $12.00
------ ------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income.................. 0.81 0.06 0.89 0.99 0.84(1) 0.46
Net realized and unrealized gain (loss)
on investments....................... (0.49) (0.03) 0.50 0.30 0.06 0.94
------ ------ ------ ------ ------ ------
Total from investment operations....... 0.32 0.03 1.39 1.29 0.90 1.40
------ ------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment
income).............................. (0.83) (0.06) (0.97) (0.92) (0.93) (0.46)
Distributions (from realized gains).... (0.10) -- -- (0.11) (0.13) --
------ ------ ------ ------ ------ ------
Total distributions.................... (0.93) (0.06) (0.97) (1.03) (1.06) (0.46)
------ ------ ------ ------ ------ ------
Net Asset Value, End of Period............. $12.85 $12.85 $13.46 $13.04 $12.78 $12.94
====== ====== ====== ====== ====== ======
TOTAL RETURN............................... 2.30% 0.23%++ 11.04% 10.48% 7.05% 11.88%++
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions)....... $124.3 $0.4 $45.2 $14.3 $43.4 $15.3
Ratio of expenses to average net assets:
Before expense reimbursement........... 0.79% 1.18%+ 1.02% 0.95% 0.98% 2.93%+
After expense reimbursement............ 0.65% 0.90%+ 0.65% 0.65% 0.68% 0.80%+
Ratio of net investment income to average
net assets:
Before expense reimbursement........... 5.64% 5.98%+ 6.28% 6.78% 6.86% 4.92%+
After expense reimbursement............ 5.78% 6.26%+ 6.65% 7.08% 7.16% 7.05%+
Portfolio turnover rate.................... 233%+++ 233%+++ 195% 173% 51% 68%++
</TABLE>
* Commencement of operations.
(1) Net investment income per share is calculated using ending balances prior
to consideration of adjustments for permanent book and tax differences.
+ Annualized.
++ Not Annualized.
+++ Portfolio turnover is calculated on the basis of the Fund as a whole without
distinguishing between the classes of shares issued.
See Notes to the Financial Statements
65
<PAGE> 721
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------------------
LOW DURATION FUND 1999 1998 1997 1996 1995
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year.......................... $10.20 $10.23 $10.12 $10.15 $ 9.93
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................................... 0.60 0.66 0.66 0.68 0.75
Net realized and unrealized gain (loss) on
investments........................................... (0.28) 0.05 0.10 0.06 0.23
------ ------ ------ ------ ------
Total from investment operations........................ 0.32 0.71 0.76 0.74 0.98
------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income).................. (0.59) (0.68) (0.64) (0.72) (0.75)
Distributions (from realized gains)..................... (0.02) (0.06) (0.01) (0.05) (0.01)
------ ------ ------ ------ ------
Total distributions..................................... (0.61) (0.74) (0.65) (0.77) (0.76)
------ ------ ------ ------ ------
Net Asset Value, End of Year................................ $ 9.91 $10.20 $10.23 $10.12 $10.15
====== ====== ====== ====== ======
TOTAL RETURN................................................ 3.15% 7.19% 7.79% 7.47% 10.23%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (millions).......................... $410.0 $253.2 $171.2 $189.2 $123.3
Ratio of expenses to average net assets:
Before expense reimbursement............................ 0.64% 0.65% 0.66% 0.60% 0.75%
After expense reimbursement............................. 0.58% 0.58% 0.58% 0.58% 0.58%
Ratio of net investment income to average net assets:
Before expense reimbursement............................ 5.65% 6.39% 6.26% 7.07% 7.43%
After expense reimbursement............................. 5.71% 6.46% 6.34% 7.09% 7.61%
Portfolio turnover rate..................................... 201% 119% 202% 50% 71%
</TABLE>
See Notes to the Financial Statements
66
<PAGE> 722
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------
SHORT-TERM INVESTMENT FUND 1999 1998 1997 1996 1995
--------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year.......................... $10.13 $10.15 $10.17 $10.12 $10.21
------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................................... 0.57 0.63 0.58 0.66 0.66
Net realized and unrealized gain (loss) on
investments........................................... (0.11) 0.00 (0.01) 0.05 (0.09)
------ ------ ------ ------ ------
Total from investment operations........................ 0.46 0.63 0.57 0.71 0.57
------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income).................. (0.54) (0.65) (0.59) (0.66) (0.66)
Return of capital....................................... -- -- -- (0.00) --
------ ------ ------ ------ ------
Total distributions..................................... (0.54) (0.65) (0.59) (0.66) (0.66)
------ ------ ------ ------ ------
Net Asset Value, End of Year................................ $10.05 $10.13 $10.15 $10.17 $10.12
====== ====== ====== ====== ======
TOTAL RETURN................................................ 4.70% 6.37% 5.77% 7.23% 5.78%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (millions).......................... $50.9 $28.0 $21.7 $18.7 $19.8
Ratio of expenses to average net assets:
Before expense reimbursement............................ 0.68% 0.92% 0.96% 0.88% 1.26%
After expense reimbursement............................. 0.48% 0.48% 0.48% 0.48% 0.48%
Ratio of net investment income to average net assets:
Before expense reimbursement............................ 5.32% 5.92% 5.34% 6.15% 5.74%
After expense reimbursement............................. 5.52% 6.36% 5.82% 6.55% 6.52%
Portfolio turnover rate..................................... 144% 121% 154% 60% 81%
</TABLE>
See Notes to the Financial Statements
67
<PAGE> 723
HOTCHKIS
AND WILEY FUNDS
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Trustees and Shareholders of Hotchkis and Wiley Funds:
In our opinion, the accompanying statements of assets and liabilities, including
the schedules of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of the Equity Income Fund, the Mid-Cap
Fund, the Small Cap Fund, the International Fund, the Global Equity Fund, the
Balanced Fund, the Total Return Bond Fund, the Low Duration Fund and the
Short-Term Investment Fund (nine of the ten portfolios of Hotchkis and Wiley
Funds, the "Funds") at June 30, 1999, the results of each of their operations,
the changes in each of their net assets and the financial highlights for each of
the periods indicated, in conformity with generally accepted accounting
principles. These financial statements and financial highlights (hereafter
referred to as "financial statements") are the responsibility of the Funds'
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at June 30, 1999 by correspondence with the
custodian, provide a reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
Milwaukee, WI
August 11, 1999
68
<PAGE> 724
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS
June 30, 1999
<TABLE>
<CAPTION>
COMMON STOCKS--99.6% SHARES VALUE
------------------------------------------------------------------------------------
<S> <C> <C>
AEROSPACE--4.8%
Lockheed Martin Corporation............................ 21,700 $ 808,325
Northrop Grumman Corporation........................... 13,800 915,112
Rockwell International Corporation..................... 6,000 364,500
-----------
2,087,937
-----------
APPAREL & TEXTILES--0.7%
Russell Corporation.................................... 15,300 298,350
-----------
AUTO PARTS--3.8%
Dana Corporation....................................... 16,600 764,637
Delphi Automotive Systems Corporation.................. 12,525 232,495
Meritor Automotive, Inc. .............................. 1,900 48,450
TRW Inc. .............................................. 11,400 625,575
-----------
1,671,157
-----------
AUTOS & TRUCKS--4.7%
Ford Motor Company..................................... 20,600 1,162,612
General Motors Corporation............................. 13,200 871,200
-----------
2,033,812
-----------
BANKS--7.1%
Bank One Corporation................................... 18,200 1,084,037
First Security Corporation............................. 8,200 223,450
First Union Corporation................................ 13,370 628,390
Fleet Financial Group, Inc. ........................... 12,000 532,500
KeyCorp................................................ 14,200 456,175
UnionBanCal Corporation................................ 5,000 180,625
-----------
3,105,177
-----------
BEVERAGES--1.0%
Anheuser-Busch Companies, Inc. ........................ 6,000 425,625
-----------
BUILDING & FOREST PRODUCTS--2.5%
Georgia-Pacific Corporation (Timber Group)............. 10,900 275,225
Weyerhaeuser Company................................... 11,800 811,250
-----------
1,086,475
-----------
</TABLE>
See Notes to the Financial Statements.
1
<PAGE> 725
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS, CONTINUED
June 30, 1999
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
CHEMICALS--3.0%
The Dow Chemical Company............................... 5,300 $ 672,437
duPont (E.I.) de Nemours & Company..................... 3,000 204,937
Eastman Chemical Company............................... 8,100 419,175
-----------
1,296,549
-----------
CONGLOMERATES--1.7%
Tenneco, Inc. ......................................... 32,000 764,000
-----------
DRUGS--0.9%
American Home Products Corporation..................... 6,500 373,750
-----------
ENGINEERING & CONSTRUCTION--0.7%
Harsco Corporation..................................... 9,300 297,600
-----------
FINANCIAL SERVICES--4.8%
Associates First Capital Corporation--Class A.......... 1,342 59,467
Fannie Mae............................................. 12,300 841,013
Household International, Inc........................... 16,119 763,637
Transamerica Corporation............................... 6,100 457,500
-----------
2,121,617
-----------
HOUSEHOLD FURNISHINGS & APPLIANCES--2.2%
Whirlpool Corporation.................................. 12,900 954,600
-----------
INSURANCE--5.0%
American General Corporation........................... 7,687 579,407
Lincoln National Corporation........................... 10,000 523,125
Safeco Corporation..................................... 15,600 688,350
St. Paul Companies, Inc. .............................. 12,000 381,750
-----------
2,172,632
-----------
LEISURE/TOYS--0.9%
Fortune Brands, Inc. .................................. 10,000 413,750
-----------
MACHINERY--1.9%
New Holland N.V. ...................................... 47,200 808,300
-----------
MEDICAL PRODUCTS & SUPPLIES--0.9%
Baxter International, Inc. ............................ 6,700 406,188
-----------
</TABLE>
See Notes to the Financial Statements.
2
<PAGE> 726
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS, CONTINUED
June 30, 1999
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
METALS & MINING--4.3%
Alcoa, Inc. ........................................... 14,100 $ 872,438
Phelps Dodge Corporation............................... 3,200 198,200
Reynolds Metals Company................................ 13,900 820,100
-----------
1,890,738
-----------
NATURAL GAS--1.2%
Eastern Enterprises.................................... 13,600 540,600
-----------
OIL--DOMESTIC--8.1%
Atlantic Richfield Company............................. 5,900 493,019
Occidental Petroleum Corporation....................... 35,200 743,600
Phillips Petroleum Company............................. 20,300 1,021,344
Texaco Inc. ........................................... 4,500 281,250
USX-Marathon Group, Inc................................ 21,100 687,069
Ultramar Diamond Shamrock Corporation.................. 13,300 290,106
-----------
3,516,388
-----------
PAPER--3.4%
Georgia-Pacific Group.................................. 9,400 445,325
International Paper Company............................ 20,465 1,033,483
-----------
1,478,808
-----------
PHOTOGRAPHY & OPTICAL--1.7%
Eastman Kodak Company.................................. 11,200 758,800
-----------
POLLUTION CONTROL--2.8%
Browning-Ferris Industries, Inc. ...................... 15,772 678,196
Waste Management, Inc. ................................ 9,930 533,738
-----------
1,211,934
-----------
RAILROADS--1.6%
CSX Corporation........................................ 3,100 140,469
Norfolk Southern Corporation........................... 19,100 575,388
-----------
715,857
-----------
RETAIL--3.8%
Intimate Brands, Inc................................... 2,940 139,283
J.C. Penney Company, Inc............................... 13,600 660,450
May Department Stores Company.......................... 12,400 506,850
Sears, Roebuck & Company............................... 8,000 356,500
-----------
1,663,083
-----------
</TABLE>
See Notes to the Financial Statements.
3
<PAGE> 727
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS, CONTINUED
June 30, 1999
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
SAVINGS & LOANS--1.8%
Washington Mutual, Inc. ............................... 22,124 $ 782,636
-----------
STEEL--1.7%
USX-U.S. Steel Group, Inc.............................. 27,800 750,600
-----------
TOBACCO--3.5%
Philip Morris Companies, Inc. ......................... 37,700 1,515,069
-----------
TRUCKING--0.4%
Ryder System, Inc. .................................... 8,000 208,000
-----------
UTILITY--ELECTRIC--9.9%
CMS Energy Corporation................................. 12,600 527,625
Central & South West Corporation....................... 7,000 163,625
DTE Energy Company..................................... 4,000 160,000
Edison International................................... 7,100 189,925
Entergy Corporation.................................... 7,400 231,250
GPU, Inc. ............................................. 5,400 227,813
Illinova Corporation................................... 28,700 782,075
PECO Energy Company.................................... 12,900 540,188
P P & L Resources, Inc................................. 12,937 397,812
PacifiCorp............................................. 6,600 121,275
Public Service Enterprises Group, Inc. ................ 10,600 433,275
SCANA Corporation...................................... 13,200 308,550
Texas Utilities Company................................ 5,502 226,958
-----------
4,310,371
-----------
UTILITY--TELEPHONE--8.8%
AT&T Corporation....................................... 20,250 1,130,203
ALLTEL Corporation..................................... 12,600 900,900
Bell Atlantic Corporation.............................. 11,980 783,193
GTE Corporation........................................ 1,400 106,050
SBC Communications, Inc. .............................. 16,090 933,220
-----------
3,853,566
-----------
Total common stocks (cost $31,438,354)................. 43,513,969
-----------
</TABLE>
See Notes to the Financial Statements.
4
<PAGE> 728
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS, CONTINUED
June 30, 1999
<TABLE>
<CAPTION>
PRINCIPAL
VARIABLE RATE DEMAND NOTES*--0.2% AMOUNT VALUE
--------------------------------------------------------------------------------------
<S> <C> <C>
General Mills, Inc., 4.8250%........................... $40,040 $ 40,040
Pitney Bowes, Inc., 4.8250%............................ 55,674 55,674
-----------
Total variable rate demand notes (cost $95,714)........ 95,714
-----------
Total investments--99.8% (cost $31,534,068)................. 43,609,683
Other assets in excess of liabilities--0.2%................. 69,673
-----------
TOTAL NET ASSETS--100.0%............................... $43,679,356
===========
</TABLE>
---------------
<TABLE>
<C> <S>
* Variable rate demand notes are considered short-term
obligations and are payable on demand. Interest rates change
periodically on specified dates. The rates listed are as of
June 30, 1999.
</TABLE>
See Notes to the Financial Statements.
5
<PAGE> 729
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES
June 30, 1999
<TABLE>
<S> <C>
ASSETS:
Investments, at value (cost $31,534,068)............... $43,609,683
Dividends and interest receivable...................... 98,888
Prepaid expenses....................................... 10,171
-----------
Total assets...................................... 43,718,742
-----------
LIABILITIES:
Payable to Advisor..................................... 11,817
Payable for investments purchased...................... 14,846
Accrued expenses and other liabilities................. 12,723
-----------
Total liabilities................................. 39,386
-----------
Net assets........................................ $43,679,356
===========
NET ASSETS CONSIST OF:
Paid in capital........................................ $30,194,127
Undistributed net investment income.................... 0
Undistributed net realized gains on investments........ 1,409,614
Net unrealized appreciation on investments............. 12,075,615
-----------
Net assets........................................ $43,679,356
===========
CALCULATION OF NET ASSET VALUE PER SHARE:
Shares outstanding (unlimited shares of no par value
authorized)........................................... 2,501,148
Net asset value per share (offering and redemption
price)................................................ $ 17.46
===========
</TABLE>
See Notes to the Financial Statements.
6
<PAGE> 730
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
Year Ended June 30, 1999
<TABLE>
<S> <C>
INVESTMENT INCOME
Income *
Dividends.............................................. $1,152,537
Interest............................................... 9,264
----------
Total income...................................... 1,161,801
----------
Expenses
Advisory fee........................................... 206,371
Legal and auditing fees................................ 2,655
Custodian fees and expenses............................ 10,771
Accounting fee......................................... 20,785
Administration fee..................................... 3,187
Trustees' fees and expenses............................ 2,986
Reports to shareholders................................ 8,865
Other expenses......................................... 1,848
----------
Total expenses.................................... 257,468
Less, expense reimbursement............................ (51,097)
----------
Net expenses...................................... 206,371
----------
Net investment income..................................... 955,430
----------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on securities transactions........... 1,951,485
Net change in unrealized appreciation of securities.... 76,985
----------
Net gain on investments........................... 2,028,470
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $2,983,900
==========
---------------
* Net of Foreign Taxes withheld............................. $ 3,944
==========
</TABLE>
See Notes to the Financial Statements.
7
<PAGE> 731
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
JUNE 30, 1999 JUNE 30, 1998
------------- -------------
<S> <C> <C>
OPERATIONS:
Net investment income.................................. $ 955,430 $ 857,023
Net realized gain on securities transactions........... 1,951,485 3,890,091
Net change in unrealized appreciation of securities.... 76,985 3,049,489
----------- -----------
Net increase in net assets resulting from
operations...................................... 2,983,900 7,796,603
----------- -----------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
Net investment income.................................. (957,593) (862,305)
Net realized gain on securities transactions........... (3,955,702) (2,201,788)
----------- -----------
Total dividends and distributions................. (4,913,295) (3,064,093)
----------- -----------
FUND SHARE TRANSACTIONS:
Net proceeds from shares sold.......................... 0 0
Shares issued in connection with payment of dividends
and distributions.................................... 4,913,295 3,064,093
Cost of shares redeemed................................ (29,999) (30,000)
----------- -----------
Net increase in net assets from Fund share
transactions.................................... 4,883,296 3,034,093
----------- -----------
Total increase in net assets................................ 2,953,901 7,766,603
NET ASSETS:
Beginning of year...................................... 40,725,455 32,958,852
----------- -----------
End of year*........................................... $43,679,356 $40,725,455
=========== ===========
*Including undistributed net investment income of:.......... $ 0 $ 310
=========== ===========
CHANGES IN SHARES OUTSTANDING:
Shares sold............................................ 0 0
Shares issued in connection with payment of dividends
and distributions.................................... 307,125 178,122
Shares redeemed........................................ (1,827) (1,656)
----------- -----------
Net increase...................................... 305,298 176,466
=========== ===========
</TABLE>
See Notes to the Financial Statements.
8
<PAGE> 732
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
June 30, 1999
NOTE 1. ACCOUNTING POLICIES. The Equity Fund for Insurance Companies (the
"Fund") is a series of Hotchkis and Wiley Funds (the "Trust"), an
open-end, management investment company organized as a Massachusetts
business trust on August 22, 1984 and registered under the Investment
Company Act of 1940. The Fund commenced operations on January 29,
1993. The sole shareholder of the Fund is The Prudential Insurance
Company of America. The Fund seeks to provide current income and long-
term growth of income, accompanied by growth of capital. In addition
to the Fund, the Trust also offers the Balanced Fund, the Small Cap
Fund, the Equity Income Fund, the International Fund, the Low Duration
Fund, the Short-Term Investment Fund, the Total Return Bond Fund, the
Mid-Cap Fund, and the Global Equity Fund (collectively, the "Funds").
The assets of each series are invested in separate, independently
managed portfolios. The following is a summary of significant
accounting policies followed by the Fund in the preparation of the
financial statements.
SECURITY VALUATION: Portfolio securities that are listed on a
securities exchange (whether domestic or foreign) or The Nasdaq Stock
Market ("NSM") are valued at the last sale price as of 4:00 p.m.,
Eastern time, or, in the absence of recorded sales, at the average of
readily available closing bid and asked prices on such exchange or
NSM. Unlisted securities that are not included in NSM are valued at
the average of the quoted bid and asked price in the over-the-counter
market. Securities for which market quotations are not otherwise
available are valued at fair value as determined in good faith by
Hotchkis and Wiley (the "Advisor") under procedures established by the
Board of Trustees. Short-term investments which mature in less than 60
days are valued at amortized cost (unless the Board of Trustees
determines that this method does not represent fair value), if their
original maturity was 60 days or less, or by amortizing the values as
of the 61st day prior to maturity, if their original term to maturity
exceeded 60 days. Investments quoted in foreign currency are valued
daily in U.S. dollars on the basis of the foreign currency exchange
rate prevailing at the time of valuation.
FEDERAL INCOME TAXES: It is the Fund's policy to meet the
requirements of the Internal Revenue Code applicable to regulated
investment companies and the Fund intends to distribute substantially
all of its investment company net taxable income and net capital gains
to its shareholders. Therefore, no federal income tax provision is
required.
EXPENSE ALLOCATION: Common expenses incurred by the Trust are
allocated among the Funds based upon (i) relative average net assets,
(ii) as incurred on a specific identification basis, or (iii) evenly
among the Funds, depending on the nature of the expenditure.
9
<PAGE> 733
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS, CONTINUED
June 30, 1999
USE OF ESTIMATES: The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
DISTRIBUTIONS TO SHAREHOLDERS: Dividends from net investment
income are declared and paid quarterly. Distributions of net realized
capital gains, if any, will be declared at least annually.
OTHER: Security and shareholder transactions are recorded on
trade date. Realized gains and losses on sales of investments are
calculated on the identified cost basis. Dividend income and dividends
and distributions to shareholders are recorded on the ex-dividend
date. Interest income is recognized on the accrual basis. Generally
accepted accounting principles require that permanent financial
reporting and tax differences relating to shareholder distributions be
reclassified within the capital accounts.
NOTE 2. INVESTMENT ADVISORY AGREEMENT. The Fund has an investment advisory
agreement with the Advisor. The Advisor receives a fee, computed daily
and payable monthly, at an annual rate of 0.60% of the first $10
million of the Fund's average daily net assets, and 0.50% of the
average daily net assets in excess of $10 million.
The Advisor provides continuous supervision of the investment
portfolio and pays all of the operating expenses relating to the Fund
other than the advisory fee. For the year ended June 30, 1999, the
Advisor paid $51,097 of operating expenses on behalf of the Fund.
As permitted under Rule 10f-3 of the Investment Company Act of
1940, the Board of Trustees of the Trust has adopted procedures which
allow the Fund, under certain conditions described in the Rule, to
acquire newly-issued securities from a member of an underwriting group
in which an affiliated underwriter participates.
NOTE 3. PURCHASES AND SALES OF SECURITIES. Purchases and sales of investment
securities, other than short-term investments, for the year ended June
30, 1999 were $6,568,338 and $5,538,728, respectively. There were no
purchases or sales of long-term U.S. government securities.
At June 30, 1999 (for financial reporting and federal income tax
purposes), net unrealized appreciation aggregated $12,075,615, of
which $13,747,816 related to appreciated securities and $1,672,201
related to depreciated securities. At June 30, 1999, the cost of
investments for book and federal income tax purposes was $31,534,068.
10
<PAGE> 734
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year.......................... $18.55 $16.32 $13.51 $11.53 $ 9.89
------ ------ ------ ------ ------
Income from Investment Operations:
Net investment income................................... 0.41 0.41 0.39 0.34 0.41
Net realized and unrealized gain on investments......... 0.70 3.31 3.30 2.26 1.59
------ ------ ------ ------ ------
Total from investment operations........................ 1.11 3.72 3.69 2.60 2.00
------ ------ ------ ------ ------
Less Distributions:
Dividends (from net investment income).................. (0.41) (0.41) (0.40) (0.40) (0.34)
Distributions (from realized gains)..................... (1.79) (1.08) (0.48) (0.22) (0.02)
------ ------ ------ ------ ------
Total distributions..................................... (2.20) (1.49) (0.88) (0.62) (0.36)
------ ------ ------ ------ ------
Net Asset Value, End of Year................................ $17.46 $18.55 $16.32 $13.51 $11.53
====== ====== ====== ====== ======
Total Return................................................ 7.29% 23.69% 28.20% 22.93% 20.62%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (millions).......................... $43.7 $40.7 $33.0 $24.6 $17.4
Ratio of expenses to average net assets:
Before expense reimbursement............................ 0.65% 0.73% 0.75% 0.76% 1.05%
After expense reimbursement............................. 0.52% 0.52% 0.53% 0.54% 0.58%
Ratio of net investment income to average net assets:
Before expense reimbursement............................ 2.28% 2.06% 2.50% 2.78% 3.58%
After expense reimbursement............................. 2.41% 2.27% 2.72% 3.00% 4.03%
Portfolio turnover.......................................... 14% 21% 22% 21% 29%
</TABLE>
See Notes to the Financial Statements.
11
<PAGE> 735
HOTCHKIS
AND WILEY FUNDS
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Trustees and Shareholders of the Hotchkis and Wiley Equity Fund
for Insurance Companies:
In our opinion, the accompanying statement of assets and liabilities, including
the schedule of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of the Hotchkis and Wiley Equity Fund
for Insurance Companies (one of the ten portfolios of Hotchkis and Wiley Funds,
the "Fund") at June 30, 1999, the results of its operations for the year then
ended, the changes in its net assets for each of the two years in the period
then ended and the financial highlights for each of the five years in the period
then ended, in conformity with generally accepted accounting principles. These
financial statements and financial highlights (hereafter referred to as
"financial statements") are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits, which included confirmation of securities at June
30, 1999 by correspondence with the custodian, provide a reasonable basis for
the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
Milwaukee, WI
August 11, 1999
12
<PAGE> 736
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
EQUITY INCOME FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 97.3% Shares Value
------------------------------------------------------------
<S> <C> <C>
AEROSPACE -- 5.2%
............................................................
Lockheed Martin Corporation 106,400 $ 2,327,500
............................................................
Northrop Grumman Corporation 47,700 2,578,781
............................................................
Rockwell International
Corporation 21,000 1,005,375
..................... ...................... -----------
5,911,656
------------------------------------------------------------
ALUMINUM -- 3.5%
............................................................
Alcoa, Inc. 1,900 157,700
............................................................
Reynolds Metals Company 49,600 3,800,600
..................... ...................... -----------
3,958,300
------------------------------------------------------------
APPAREL & TEXTILES -- 0.6%
............................................................
Russell Corporation 43,000 720,250
------------------------------------------------------------
APPLIANCE & HOUSEHOLD FURNITURE -- 1.3%
............................................................
Whirlpool Corporation 22,200 1,444,388
------------------------------------------------------------
AUTO PARTS -- 4.8%
............................................................
Dana Corporation 55,000 1,646,563
............................................................
Delphi Automotive Systems
Corporation 49,949 786,697
............................................................
Meritor Automotive, Inc. 32,000 620,000
............................................................
Tenneco Automotive, Inc. 26,140 243,429
............................................................
TRW Inc. 41,500 2,155,406
..................... ...................... -----------
5,452,095
------------------------------------------------------------
AUTOS & TRUCKS -- 5.3%
............................................................
Ford Motor Company 60,000 3,206,250
............................................................
General Motors Corporation 38,000 2,762,125
..................... ...................... -----------
5,968,375
------------------------------------------------------------
BEVERAGES -- 0.8%
............................................................
Anheuser-Busch Companies, Inc. 13,000 921,375
------------------------------------------------------------
CHEMICALS -- 2.8%
............................................................
The Dow Chemical Company 14,100 1,884,113
............................................................
Eastman Chemical Company 27,200 1,297,100
..................... ...................... -----------
3,181,213
------------------------------------------------------------
CONTAINERS -- 1.2%
............................................................
Pactiv Corporation # 130,700 1,388,688
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
ELECTRICAL UTILITIES -- 9.7%
............................................................
CMS Energy Corporation 46,700 $ 1,456,456
............................................................
Central & South West
Corporation 40,400 808,000
............................................................
DTE Energy Company 31,500 988,312
............................................................
Edison International 22,500 589,219
............................................................
Entergy Corporation 21,500 553,625
............................................................
GPU, Inc. 19,000 568,813
............................................................
Illinova Corporation 80,800 2,807,800
............................................................
PECO Energy Company 11,300 392,675
............................................................
P P & L Resources, Inc. 20,000 457,500
............................................................
Public Service Enterprises
Group, Inc. 25,400 884,237
............................................................
SCANA Corporation 55,300 1,486,188
..................... ...................... -----------
10,992,825
------------------------------------------------------------
ENGINEERING AND CONSTRUCTION -- 1.2%
............................................................
Harsco Corporation 42,295 1,342,866
------------------------------------------------------------
FOREST PRODUCTS -- 3.2%
............................................................
Georgia-Pacific (Timber Group) 48,200 1,186,925
............................................................
Weyerhaeuser Company 33,500 2,405,719
..................... ...................... -----------
3,592,644
------------------------------------------------------------
INSURANCE: LIFE -- 3.0%
............................................................
American General Corporation 24,900 1,889,286
............................................................
Lincoln National Corporation 37,100 1,484,000
..................... ...................... -----------
3,373,286
------------------------------------------------------------
INSURANCE: PROPERTY CASUALTY -- 4.7%
............................................................
The Allstate Corporation 90,600 2,174,400
............................................................
Safeco Corporation 49,000 1,218,875
............................................................
St. Paul Companies, Inc. 57,000 1,920,187
..................... ...................... -----------
5,313,462
------------------------------------------------------------
LEISURE/TOYS -- 0.7%
............................................................
Fortune Brands, Inc. 23,500 776,969
------------------------------------------------------------
MACHINERY -- 1.7%
............................................................
CNH Global N.V. 142,500 1,897,031
------------------------------------------------------------
METALS: MISC. -- 0.6%
............................................................
Phelps Dodge Corporation 9,700 651,112
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
14
<PAGE> 737
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
EQUITY INCOME FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
OFFICE EQUIPMENT & SUPPLIES -- 1.7%
............................................................
Xerox Corporation 83,600 $ 1,896,675
------------------------------------------------------------
OIL: DOMESTIC -- 7.6%
............................................................
Conoco, Inc. 34,700 863,163
............................................................
Occidental Petroleum
Corporation 113,300 2,450,112
............................................................
Phillips Petroleum Company 49,700 2,335,900
............................................................
Sunoco, Inc. 9,300 218,550
............................................................
USX-Marathon Group, Inc. 69,500 1,715,780
............................................................
Ultramar Diamond Shamrock
Corporation 43,800 993,712
..................... ...................... -----------
8,577,217
------------------------------------------------------------
OIL: INTERNATIONAL -- 0.5%
............................................................
Texaco, Inc. 10,300 559,419
------------------------------------------------------------
PAPER -- 4.6%
............................................................
Georgia-Pacific Group 30,100 1,527,575
............................................................
International Paper Company 65,800 3,713,588
..................... ...................... -----------
5,241,163
------------------------------------------------------------
PHOTOGRAPHY/IMAGING -- 2.3%
............................................................
Eastman Kodak Company 38,800 2,570,500
------------------------------------------------------------
POLLUTION CONTROL -- 0.5%
............................................................
Waste Management, Inc. 36,000 618,750
------------------------------------------------------------
RAILROADS -- 1.5%
............................................................
CSX Corporation 16,000 502,000
............................................................
Norfolk Southern Corporation 59,000 1,209,500
..................... ...................... -----------
1,711,500
------------------------------------------------------------
REGIONAL BANKS -- 5.7%
............................................................
Bank One Corporation 52,600 1,686,488
............................................................
First Security Corporation 35,800 914,019
............................................................
First Union Corporation 42,700 1,401,094
............................................................
FleetBoston Financial
Corporation 23,800 828,538
............................................................
KeyCorp 48,800 1,079,700
............................................................
UnionBanCal Corporation 14,900 587,619
..................... ...................... -----------
6,497,458
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
RETAIL: DEPARTMENT STORES -- 1.2%
............................................................
May Department Stores Company 40,800 $ 1,315,800
------------------------------------------------------------
RETAIL: GENERAL MERCHANDISE -- 2.0%
............................................................
J.C. Penney Company, Inc. 46,000 917,125
............................................................
Sears, Roebuck & Company 46,000 1,400,125
..................... ...................... -----------
2,317,250
------------------------------------------------------------
SAVINGS & LOANS -- 1.9%
............................................................
Washington Mutual, Inc. 85,400 2,220,400
------------------------------------------------------------
SMALL LOANS & FINANCE -- 3.7%
............................................................
Fannie Mae 39,600 2,472,525
............................................................
Household International, Inc. 45,000 1,676,250
..................... ...................... -----------
4,148,775
------------------------------------------------------------
STEEL -- 2.6%
............................................................
USX-U.S. Steel Group, Inc. 90,500 2,986,500
------------------------------------------------------------
TELEPHONE -- 8.4%
............................................................
AT&T Corporation 56,000 2,842,000
............................................................
ALLTEL Corporation 28,800 2,381,400
............................................................
Bell Atlantic Corporation 33,400 2,056,188
............................................................
GTE Corporation 13,700 966,706
............................................................
SBC Communications, Inc. 27,000 1,316,250
..................... ...................... -----------
9,562,544
------------------------------------------------------------
TOBACCO -- 2.4%
............................................................
Philip Morris Companies, Inc. 117,300 2,719,894
------------------------------------------------------------
TRUCKERS/AIR FREIGHT -- 0.4%
............................................................
Ryder System, Inc. 18,200 444,762
------------------------------------------------------------
Total common stock (cost
$102,123,535) 110,275,142
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
15
<PAGE> 738
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
EQUITY INCOME FUND
<TABLE>
<CAPTION>
VARIABLE RATE Principal
DEMAND NOTES* -- 2.4% Amount Value
------------------------------------------------------------
<S> <C> <C>
General Mills, Inc., 6.095% $2,451,178 $ 2,451,178
............................................................
Pitney Bowes, Inc., 6.095% 313,532 313,532
------------------------------------------------------------
Total variable rate demand
notes (cost $2,764,710) 2,764,710
------------------------------------------------------------
Total investments -- 99.7%
(cost $104,888,245) 113,039,852
............................................................
Other assets in excess of
liabilities -- 0.3% 365,706
..................... ...................... -----------
Total net assets -- 100.0% $113,405,558
------------------------------------------------------------
</TABLE>
* -- Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rate listed is as of December 31, 1999.
# -- Non-income producing security.
See Notes to the Financial Statements
16
<PAGE> 739
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
MID-CAP FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 92.8% Shares Value
------------------------------------------------------------
<S> <C> <C>
AEROSPACE/DEFENSE -- 3.1%
............................................................
Northrop Grumman Corporation 4,000 $ 216,250
------------------------------------------------------------
AIRLINES -- 1.7%
............................................................
KLM NV 4,750 118,453
------------------------------------------------------------
ALUMINUM -- 1.1%
............................................................
Reynolds Metals Company 1,000 76,625
------------------------------------------------------------
APPAREL & TEXTILES -- 1.8%
............................................................
Russell Corporation 8,100 135,675
------------------------------------------------------------
APPLIANCE & HOUSEHOLD FURNITURE -- 1.7%
............................................................
Whirlpool Corporation 1,800 117,113
------------------------------------------------------------
AUTO PARTS -- 3.6%
............................................................
Dana Corporation 2,072 62,030
............................................................
Lear Corporation # 2,800 89,600
............................................................
Meritor Automotive, Inc. 5,000 96,875
...................... ....................... ---------
248,505
------------------------------------------------------------
CHEMICALS -- 7.8%
............................................................
Air Products and Chemicals, Inc. 2,800 93,975
............................................................
Cytec Industries, Inc. # 7,300 168,812
............................................................
Eastman Chemical Company 900 42,919
............................................................
Millenium Chemicals, Inc. 4,500 88,875
............................................................
Olin Corporation 7,500 148,594
...................... ....................... ---------
543,175
------------------------------------------------------------
CONTAINERS -- 1.8%
............................................................
Pactiv Corporation # 11,600 123,250
------------------------------------------------------------
ELECTRICAL EQUIPMENT -- 2.5%
............................................................
UCAR International, Inc. # 9,600 171,000
------------------------------------------------------------
ELECTRICAL UTILITIES -- 6.7%
............................................................
CMP Group, Inc. 6,500 179,155
............................................................
Illinova Corporation 3,100 107,725
............................................................
P P & L Resources, Inc. 4,339 99,255
............................................................
SCANA Corporation 3,000 80,625
...................... ....................... ---------
466,760
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
ELECTRONICS -- 1.4%
............................................................
Amphenol Corporation # 1,000 $ 66,563
............................................................
MEMC Electronic Materials, Inc. # 2,700 33,075
...................... ....................... ---------
99,638
------------------------------------------------------------
ENERGY: MISC. -- 0.5%
............................................................
MidAmerican Energy Holdings
Company 1,000 33,688
------------------------------------------------------------
FINANCE: MISC. -- 1.8%
............................................................
Radian Group, Inc. 2,600 124,150
------------------------------------------------------------
FOODS -- 4.4%
............................................................
Dean Foods Company 2,300 91,425
............................................................
Interstate Bakeries Corporation 5,800 105,125
............................................................
Nabisco Group Holdings Corporation 10,400 110,500
...................... ....................... ---------
307,050
------------------------------------------------------------
HEALTHCARE: DRUGS -- 0.2%
............................................................
Bergen Brunswig
Corporation -- Class A 1,600 13,300
------------------------------------------------------------
HEALTHCARE: MISC. -- 0.6%
............................................................
Beverly Enterprises, Inc. # 9,000 39,375
------------------------------------------------------------
HOSPITAL/HEALTHCARE MANAGEMENT -- 2.1%
............................................................
Total Renal Care Holdings, Inc. # 22,100 147,794
------------------------------------------------------------
INSURANCE: LIFE -- 4.1%
............................................................
ESG Re Limited 41,200 285,825
------------------------------------------------------------
INSURANCE: MULTI-LINE -- 1.1%
............................................................
Harleysville Group, Inc. 5,500 78,375
------------------------------------------------------------
INSURANCE: PROPERTY
CASUALTY -- 0.6%
............................................................
IPC Holdings Limited 3,000 44,625
------------------------------------------------------------
INVESTMENT BANKING & BROKERAGE -- 0.8%
............................................................
Countrywide Credit Industries,
Inc. 2,300 58,075
------------------------------------------------------------
MACHINERY -- 2.6%
............................................................
CNH Global N.V. 13,700 182,381
------------------------------------------------------------
MISCELLANEOUS -- 0.5%
............................................................
American Coin Merchandising, Inc.
# 13,000 35,750
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
17
<PAGE> 740
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
MID-CAP FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
OIL: DOMESTIC -- 6.9%
............................................................
Conoco, Inc. 2,900 $ 72,137
............................................................
Occidental Petroleum Corporation 6,300 136,237
............................................................
Sunoco, Inc. 4,000 94,000
............................................................
Ultramar Diamond Shamrock
Corporation 2,600 58,988
............................................................
Valero Energy Corporation 6,100 121,238
...................... ....................... ---------
482,600
------------------------------------------------------------
OIL EXPLORATION & PRODUCTION -- 2.3%
............................................................
Triton Energy Limited # 7,700 158,813
------------------------------------------------------------
PAPER -- 3.3%
............................................................
Bowater Incorporated 600 32,588
............................................................
Chesapeake Corporation 1,800 54,900
............................................................
Consolidated Papers, Inc. 4,500 143,156
...................... ....................... ---------
230,644
------------------------------------------------------------
POLLUTION CONTROL -- 2.1%
............................................................
Waste Management, Inc. 8,400 144,375
------------------------------------------------------------
REAL ESTATE -- 3.6%
............................................................
Brookfield Properties Corporation 6,500 68,250
............................................................
Equity Office Properties 4,500 110,813
............................................................
Kilroy Realty Corporation 1,700 37,400
............................................................
Mack-Cali Realty Corporation 1,400 36,487
...................... ....................... ---------
252,950
------------------------------------------------------------
REGIONAL BANKS -- 2.3%
............................................................
Colonial BancGroup, Inc. 6,500 67,438
............................................................
UnionBanCal Corporation 2,300 90,705
...................... ....................... ---------
158,143
------------------------------------------------------------
SAVINGS & LOANS -- 0.8%
............................................................
Charter One Financial, Inc. 2,756 52,709
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
SHIPPING -- 8.5%
............................................................
Knightsbridge Tankers Ltd. 14,500 $ 195,750
............................................................
OMI Corporation # 40,500 83,531
............................................................
Overseas Shipholding Group, Inc. 5,500 81,468
............................................................
Teekay Shipping Corporation 14,400 229,500
...................... ....................... ---------
590,249
------------------------------------------------------------
SPECIALIZED SERVICES -- 2.5%
............................................................
Pittston Brink's Group 8,000 176,000
------------------------------------------------------------
STEEL -- 6.2%
............................................................
AK Steel Holding Corporation 11,615 219,233
............................................................
USX-U.S. Steel Group, Inc. 6,500 214,500
...................... ....................... ---------
433,733
------------------------------------------------------------
TOBACCO -- 1.8%
............................................................
R.J. Reynolds Tobacco Holdings,
Inc. 4,200 74,025
............................................................
Universal Corporation/VA 2,200 50,188
...................... ....................... ---------
124,213
------------------------------------------------------------
Total common stock
(cost $7,291,691) 6,471,261
------------------------------------------------------------
<CAPTION>
VARIABLE RATE Principal
DEMAND NOTES* -- 7.0% Amount
------------------------------------------------------------
<S> <C> <C>
General Mills, Inc., 6.095% $187,709 187,709
............................................................
Pitney Bowes, Inc., 6.095% 299,559 299,559
------------------------------------------------------------
Total variable rate demand notes
(cost $487,268) 487,268
------------------------------------------------------------
Total investments -- 99.8%
(cost $7,778,959) 6,958,529
............................................................
Other assets in excess of
liabilities -- 0.2% 14,393
...................... ....................... ---------
$6,972,922
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
* -- Variable rate demand notes are considered short-term obligations are
payable and on demand. Interest rates change periodically on specified dates.
The rates listed are as of December 31, 1999.
ADR -- American Depository Receipts.
# -- Non-income producing security.
See Notes to the Financial Statements
18
<PAGE> 741
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
SMALL CAP FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 94.9% Shares Value
-----------------------------------------------------------
<S> <C> <C>
AEROSPACE/DEFENSE -- 3.4%
...........................................................
AVTEAM, Inc. # 227,200 $ 1,221,200
-----------------------------------------------------------
APPAREL & TEXTILES -- 1.0%
...........................................................
Russell Corporation 21,100 353,425
-----------------------------------------------------------
AUTO PARTS -- 4.4%
...........................................................
Stoneridge, Inc. # 39,000 602,063
...........................................................
Titan International, Inc. 145,700 947,050
..................... ...................... ----------
1,549,113
-----------------------------------------------------------
AUTO REPAIR -- 0.1%
...........................................................
Midas, Inc. 1,500 32,813
-----------------------------------------------------------
BROADCAST MEDIA -- 0.6%
...........................................................
Groupe AB SA ADR # 39,200 220,500
-----------------------------------------------------------
CHEMICALS -- 1.9%
...........................................................
The Carbide/Graphite Group, Inc.
# 102,800 668,200
-----------------------------------------------------------
COMPUTER SOFTWARE & SERVICES -- 7.6%
...........................................................
Creative Technology, Ltd. 78,400 1,362,200
...........................................................
THQ Inc. # 56,950 1,320,528
..................... ...................... ----------
2,682,728
-----------------------------------------------------------
COMPUTER SYSTEMS -- 3.4%
...........................................................
Hutchinson Technology, Inc. # 15,800 335,750
...........................................................
Radisys Corporation # 7,500 382,500
...........................................................
Tech Data Corporation # 18,300 496,388
..................... ...................... ----------
1,214,638
-----------------------------------------------------------
DIVERSIFIED COMPANIES -- 2.7%
...........................................................
Playboy Enterprises, Inc. Class A
# 31,900 653,950
...........................................................
Playboy Enterprises, Inc. # 12,100 294,181
..................... ...................... ----------
948,131
-----------------------------------------------------------
</TABLE>
<TABLE>
-----------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
ELECTRICAL UTILITY -- 5.5%
...........................................................
CH Energy Group, Inc. 2,000 $ 66,000
...........................................................
CMP Group, Inc. 56,800 1,565,550
...........................................................
Cleco Corporation 2,600 83,362
...........................................................
Public Service Company of New
Mexico 4,200 68,250
...........................................................
RGS Energy Group, Inc. 3,300 67,856
...........................................................
The United Illuminating Company 2,000 102,750
..................... ...................... ----------
1,953,768
-----------------------------------------------------------
ENGINEERING AND CONSTRUCTION -- 1.1%
...........................................................
Stone & Webster, Inc. 23,900 401,819
-----------------------------------------------------------
FOODS -- 7.8%
...........................................................
The Earthgrains Company 18,200 293,475
...........................................................
Interstate Bakeries Corporation 59,400 1,076,625
...........................................................
J & J Snack Foods Corporation # 67,900 1,391,950
..................... ...................... ----------
2,762,050
-----------------------------------------------------------
HEALTHCARE: MISC. -- 1.6%
...........................................................
Beverly Enterprises, Inc. # 132,500 579,688
-----------------------------------------------------------
HOME BUILDING/MANUFACTURED
HOUSING -- 3.1%
...........................................................
Centex Corporation 7,200 177,750
...........................................................
Lennar Corporation 25,200 409,500
...........................................................
Pulte Corporation 6,600 148,500
...........................................................
Toll Brothers, Inc. # 19,500 363,188
..................... ...................... ----------
1,098,938
-----------------------------------------------------------
HOSPITAL/HEALTHCARE MANAGEMENT -- 5.7%
...........................................................
Total Renal Care Holdings, Inc. # 197,900 1,323,456
...........................................................
Ventas, Inc. 165,000 690,938
..................... ...................... ----------
2,014,394
-----------------------------------------------------------
INSURANCE: LIFE -- 4.9%
...........................................................
ESG Re Limited 251,000 1,741,313
-----------------------------------------------------------
INSURANCE: MULTI-LINE -- 2.9%
...........................................................
Enhance Financial Services Group,
Inc. 11,300 183,625
...........................................................
Horace Mann Educators Corporation 43,600 855,650
..................... ...................... ----------
1,039,275
-----------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
19
<PAGE> 742
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
SMALL CAP FUND
<TABLE>
<CAPTION>
Shares Value
-----------------------------------------------------------
<S> <C> <C>
INSURANCE: PROPERTY CASUALTY -- 0.5%
...........................................................
Stirling Cooke Brown Holdings
Limited 95,100 $ 184,256
-----------------------------------------------------------
INVESTMENT BANKING & BROKERAGE -- 2.1%
...........................................................
PIMCO Advisors Holdings LP 19,500 734,906
-----------------------------------------------------------
MACHINERY -- 8.4%
...........................................................
CNH Global NV 80,100 1,066,330
...........................................................
Denison International PLC ADR # 130,700 1,339,675
...........................................................
Hawk Corporation Class A # 96,300 559,744
..................... ...................... ----------
2,965,749
-----------------------------------------------------------
MISCELLANEOUS -- 4.6%
...........................................................
American Coin Merchandising, Inc.
# 282,000 775,500
...........................................................
Mac-Gray Corporation # 40,300 153,644
...........................................................
Ralcorp Holdings, Inc. # 35,200 701,800
..................... ...................... ----------
1,630,944
-----------------------------------------------------------
NATURAL GAS -- 0.5%
...........................................................
MDU Resources Group, Inc. 4,000 80,000
...........................................................
UGI Corporation 4,400 89,924
..................... ...................... ----------
169,924
-----------------------------------------------------------
OIL EXPLORATION & PRODUCTION -- 2.3%
...........................................................
Triton Energy Limited # 39,400 812,625
-----------------------------------------------------------
PROFESSIONAL SERVICES -- 0.8%
...........................................................
FirstService Corporation # 16,100 220,369
...........................................................
Strayer Education, Inc. 2,600 51,350
..................... ...................... ----------
271,719
-----------------------------------------------------------
RESTAURANTS -- 1.6%
...........................................................
IHOP Corp. # 33,900 565,706
-----------------------------------------------------------
RETAIL: SPECIALTY -- 3.4%
...........................................................
Friedman's, Inc. 159,000 1,192,500
-----------------------------------------------------------
SHIPPING -- 1.1%
...........................................................
Knightsbridge Tankers Ltd. 6,000 81,000
...........................................................
Omi Corporation # 104,500 215,531
...........................................................
Teekay Shipping Corporation 5,400 86,063
..................... ...................... ----------
382,594
-----------------------------------------------------------
</TABLE>
<TABLE>
-----------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
SHOES -- 3.9%
...........................................................
Payless ShoeSource, Inc. # 29,200 $ 1,372,400
-----------------------------------------------------------
SPECIALIZED SERVICES -- 4.8%
...........................................................
Pittston Brink's Group 77,500 1,705,000
-----------------------------------------------------------
STEEL -- 1.4%
...........................................................
AK Steel Holding Corporation 26,879 507,341
-----------------------------------------------------------
TRUCKER/AIR FREIGHT -- 1.8%
...........................................................
AirNet Systems, Inc. # 91,600 652,650
-----------------------------------------------------------
Total common stock (cost
$48,770,349) 33,630,307
-----------------------------------------------------------
<CAPTION>
VARIABLE RATEPrincipal
DEMAND NOTES* -- 2.5% -- Amount
------------------------------------------------------------
<S> <C> <C>
General Mills, Inc., 6.095% $890,785 890,785
------------------------------------------------------------
Total variable rate demand notes
(cost $890,785) 890,785
------------------------------------------------------------
Total investments -- 97.4% (cost
$49,661,134) 34,521,092
............................................................
Other assets in excess of liabilities -- 2.6% 922,686
...................... ...................... ----------
$35,443,778
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
* -- Variable rate demand notes are considered short-term obligations are
payable and on demand. Interest rates change periodically on specified dates.
The rates listed are as of December 31, 1999.
ADR -- American Depository Receipts.
# -- Non-income producing security.
See Notes to the Financial Statements
20
<PAGE> 743
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
INTERNATIONAL FUND
<TABLE>
<CAPTION>
COMMON
STOCKS -- 95.5% Shares Value
------------------------------------------------------------
<S> <C> <C>
AUSTRALIA -- 1.5%
------------------------------------------------------------
REGIONAL BANKS -- 1.5%
............................................................
Australia and New Zealand
Banking Group, Ltd. 2,881,895 $ 20,956,870
.................... ..................... -------------
20,956,870
Total Australia
------------------------------------------------------------
AUSTRIA -- 0.4%
------------------------------------------------------------
STEEL -- 0.4%
............................................................
Boehler -- Uddeholm AG 135,350 6,243,043
.................... ..................... -------------
6,243,043
Total Austria
------------------------------------------------------------
CANADA -- 3.0%
------------------------------------------------------------
INSURANCE: MULTI-LINE -- 2.0%
............................................................
Clarica Life Insurance Co. 559,318 10,079,246
............................................................
Manulife Financial
Corporation # 1,497,147 19,145,059
.................... ..................... -------------
29,224,305
------------------------------------------------------------
METALS: MISC. -- 1.0%
............................................................
Noranda, Inc. 1,034,729 13,913,111
.................... ..................... -------------
43,137,416
Total Canada
------------------------------------------------------------
FINLAND -- 2.1%
------------------------------------------------------------
PAPER -- 2.1%
............................................................
UPM-Kymmene OYJ 754,385 30,389,653
.................... ..................... -------------
30,389,653
Total Finland
------------------------------------------------------------
FRANCE -- 9.1%
------------------------------------------------------------
BEVERAGES -- 1.2%
............................................................
Pernod Ricard SA 309,223 17,688,570
------------------------------------------------------------
BUILDING MATERIALS -- 1.3%
............................................................
Lafarge SA 156,767 18,250,933
------------------------------------------------------------
OFFICE EQUIPMENT & SUPPLIES -- 1.1%
............................................................
BIC 324,259 14,754,037
------------------------------------------------------------
OIL: INTERNATIONAL -- 3.0%
............................................................
Elf Aquitaine SA 12 1,849
............................................................
Total Fina SA 321,891 42,953,376
.................... ..................... -------------
42,955,225
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
REGIONAL BANKS -- 2.5%
............................................................
Banque Nationale de Paris 388,160 $ 35,807,900
.................... ..................... -------------
129,456,665
Total France
------------------------------------------------------------
GERMANY -- 6.5%
------------------------------------------------------------
CHEMICALS -- 2.9%
............................................................
Aventis SA 487,860 28,251,102
............................................................
SGL Carbon AG # 192,820 12,816,475
.................... ..................... -------------
41,067,577
------------------------------------------------------------
CONSUMER DURABLES: MISC. -- 1.0%
............................................................
Buderus AG 831,975 14,076,418
------------------------------------------------------------
REGIONAL BANKS -- 1.1%
............................................................
Commerzbank AG 442,455 16,241,990
------------------------------------------------------------
UTILITIES: MISC. -- 1.5%
............................................................
VEBA AG 442,690 21,511,447
.................... ..................... -------------
92,897,432
Total Germany
------------------------------------------------------------
HONG KONG -- 3.0%
------------------------------------------------------------
ELECTRICAL UTILITIES -- 0.7%
............................................................
Shandong International Power
Development Company Limited 67,810,000 9,595,386
------------------------------------------------------------
METALS: MISC. -- 0.3%
............................................................
Yanzhou Coal Mining Co., Ltd. 14,414,000 3,986,566
------------------------------------------------------------
PUBLISHING -- 1.4%
............................................................
South China Morning Post
(Holdings), Ltd. 23,057,000 19,872,552
------------------------------------------------------------
REAL ESTATE -- 0.6%
............................................................
Hang Lung Development Company 8,046,000 9,108,329
.................... ..................... -------------
42,562,833
Total Hong Kong
------------------------------------------------------------
IRELAND -- 4.3%
------------------------------------------------------------
FOODS -- 1.1%
............................................................
Greencore Group PLC 4,885,960 15,007,983
------------------------------------------------------------
PAPER -- 1.7%
............................................................
Jefferson Smurfit Group PLC 8,121,995 24,538,984
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
21
<PAGE> 744
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
INTERNATIONAL FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
REGIONAL BANKS -- 1.5%
............................................................
Allied Irish Banks PLC 1,916,455 $ 21,848,300
.................... ..................... -------------
61,395,267
Total Ireland
------------------------------------------------------------
ITALY -- 3.9%
------------------------------------------------------------
OIL: INTERNATIONAL -- 1.3%
............................................................
ENI SPA 3,496,624 19,227,117
------------------------------------------------------------
TELECOMMUNICATIONS -- 2.6%
............................................................
Telecom Italia SPA 2,589,200 36,506,167
.................... ..................... -------------
55,733,284
Total Italy
------------------------------------------------------------
JAPAN -- 7.1%
------------------------------------------------------------
ELECTRONICS -- 3.8%
............................................................
Nintendo Co., Ltd. 329,500 54,779,764
------------------------------------------------------------
OFFICE EQUIPMENT & SUPPLIES -- 1.3%
............................................................
Canon, Inc. 483,000 19,199,955
------------------------------------------------------------
SMALL LOANS & FINANCE -- 2.0%
............................................................
Promise Company, Ltd. 261,300 13,303,619
............................................................
Sanyo Shinpan Finance Co.,
Ltd. 431,100 14,773,150
.................... ..................... -------------
28,076,769
.................... ..................... -------------
102,056,488
Total Japan
------------------------------------------------------------
NETHERLANDS -- 10.6%
------------------------------------------------------------
CHEMICALS -- 1.6%
............................................................
Akzo Nobel N.V. 457,606 22,950,579
------------------------------------------------------------
DISTRIBUTORS -- 0.5%
............................................................
Buhrmann N.V. 439,620 6,618,982
------------------------------------------------------------
ELECTRONICS -- 2.5%
............................................................
Philips Electronics N.V. 267,371 36,351,360
------------------------------------------------------------
INSURANCE: MULTI-LINE -- 2.9%
............................................................
Fortis (NL) N.V. 474,592 17,087,128
............................................................
ING Groep N.V. 400,916 24,201,524
.................... ..................... -------------
41,288,652
------------------------------------------------------------
REGIONAL BANKS -- 1.1%
............................................................
ABN AMRO Holding N.V. 627,300 15,667,495
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
TELECOMMUNICATIONS -- 2.0%
............................................................
Koninklijke KPN N.V. 288,275 $ 28,132,178
.................... ..................... -------------
151,009,246
Total Netherlands
------------------------------------------------------------
NEW ZEALAND -- 2.2%
------------------------------------------------------------
TELECOMMUNICATIONS -- 2.2%
............................................................
Telecom Corporation of New
Zealand 6,746,390 31,652,038
.................... ..................... -------------
31,652,038
Total New Zealand
------------------------------------------------------------
NORWAY -- 0.6%
------------------------------------------------------------
ENGINEERING & CONSTRUCTION -- 0.6%
............................................................
Kvaerner PLC -- Class A # 400,043 8,394,118
.................... ..................... -------------
8,394,118
Total Norway
------------------------------------------------------------
PORTUGAL -- 1.9%
------------------------------------------------------------
TELEPHONE -- 1.9%
............................................................
Portugal Telecom SA 2,517,961 27,615,282
.................... ..................... -------------
27,615,282
Total Portugal
------------------------------------------------------------
SINGAPORE -- 5.0%
------------------------------------------------------------
COMPUTER SOFTWARE & SERVICES -- 2.5%
............................................................
Creative Technology, Ltd. 2,037,162 35,395,690
------------------------------------------------------------
DIVERSIFIED COMPANIES -- 0.7%
............................................................
Jardine Matheson Holdings,
Ltd. 2,450,200 9,653,788
------------------------------------------------------------
MONEY CENTER BANKS -- 1.8%
............................................................
United Overseas Bank 3,006,432 26,527,337
.................... ..................... -------------
71,576,815
Total Singapore
------------------------------------------------------------
SPAIN -- 2.1%
------------------------------------------------------------
TELECOMMUNICATIONS -- 2.1%
............................................................
Telefonica S.A. 1,197,999 29,921,319
.................... ..................... -------------
29,921,319
Total Spain
------------------------------------------------------------
SWEDEN -- 1.7%
------------------------------------------------------------
ELECTRICAL EQUIPMENT -- 1.7%
............................................................
Electrolux AB -- Class B 952,940 23,977,991
.................... ..................... -------------
23,977,991
Total Sweden
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
22
<PAGE> 745
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
INTERNATIONAL FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
SWITZERLAND -- 5.8%
------------------------------------------------------------
BUILDING MATERIALS -- 1.9%
............................................................
Geberit International AG 76,704 $ 26,243,932
------------------------------------------------------------
MACHINERY -- 2.1%
............................................................
SIG Schweizerische Industrie-
Gesellschaft Holding "registered" 19,682 11,738,355
............................................................
Sulzer AG "registered" # 28,456 18,489,646
.................... ..................... -------------
30,228,001
------------------------------------------------------------
MEDICAL PRODUCTS & SUPPLIES -- 1.8%
............................................................
Novartis AG "registered" 17,873 26,233,507
.................... ..................... -------------
82,705,440
Total Switzerland
------------------------------------------------------------
UNITED KINGDOM -- 24.7%
------------------------------------------------------------
AIRLINES -- 1.4%
............................................................
BAA PLC 2,868,182 20,153,439
------------------------------------------------------------
AUTO -- 0.8%
............................................................
Lex Service PLC 1,865,410 11,209,092
------------------------------------------------------------
BEVERAGES -- 0.8%
............................................................
Allied Domecq PLC 2,351,684 11,623,946
------------------------------------------------------------
BUILDING MATERIALS -- 1.5%
............................................................
Hanson PLC 2,562,907 21,485,893
------------------------------------------------------------
DIVERSIFIED COMPANIES -- 7.2%
............................................................
Cookson Group PLC 6,446,390 26,032,134
............................................................
Invensys PLC 1,199,107 6,527,412
............................................................
TI Group PLC 3,433,020 26,340,447
............................................................
Tomkins PLC 7,986,267 25,800,434
............................................................
Williams PLC 4,015,430 18,274,655
.................... ..................... -------------
102,975,082
------------------------------------------------------------
FOODS -- 0.8%
............................................................
Unilever PLC 1,535,910 11,300,752
------------------------------------------------------------
HOUSEHOLD PRODUCTS -- 1.2%
............................................................
Reckitt Benckiser PLC 1,812,521 16,995,677
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
INSURANCE: MULTI-LINE -- 2.4%
............................................................
Allied Zurich AG PLC 1,260,884 $ 14,857,770
............................................................
CGU PLC 1,243,995 20,044,016
.................... ..................... -------------
34,901,786
------------------------------------------------------------
MEDICAL PRODUCTS & SUPPLIES -- 0.9%
............................................................
Medeva PLC 4,473,240 12,572,587
------------------------------------------------------------
PUBLISHING -- 2.6%
............................................................
Reed International PLC 1,983,090 14,847,227
............................................................
United News & Media PLC 1,730,665 22,056,836
.................... ..................... -------------
36,904,063
------------------------------------------------------------
REGIONAL BANKS -- 2.7%
............................................................
Lloyds TSB Group PLC 1,461,987 18,290,186
............................................................
National Westminster Bank PLC 953,681 20,488,396
.................... ..................... -------------
38,778,582
------------------------------------------------------------
TELECOMMUNICATIONS -- 1.4%
............................................................
British Telecommunications
PLC 809,573 19,785,550
------------------------------------------------------------
TOBACCO -- 1.0%
............................................................
B.A.T. Industries PLC 2,435,894 13,840,306
.................... ..................... -------------
352,526,755
Total United Kingdom
------------------------------------------------------------
Total common stocks
(cost $1,133,162,788) 1,364,207,955
------------------------------------------------------------
PREFERRED STOCKS -- 0.9%
------------------------------------------------------------
GERMANY -- 0.9%
------------------------------------------------------------
BUILDING MATERIALS -- 0.9%
............................................................
Dyokerhoff AG 396,320 12,133,670
.................... ..................... -------------
12,133,670
Total Germany
------------------------------------------------------------
Total preferred stocks
(cost $13,182,487) 12,133,670
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
23
<PAGE> 746
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
INTERNATIONAL FUND
<TABLE>
<CAPTION>
SHORT-TERM Principal
INVESTMENTS -- 3.9% Amount Value
------------------------------------------------------------
<S> <C> <C>
COMMERCIAL PAPER -- 3.9%
............................................................
Armstrong World Industries,
Inc., 6.90%, 1/04/2000 4(2) $1,100,000 $ 1,099,367
............................................................
BMW U.S. Capital Corporation,
6.50%, 1/04/2000 300,000 299,837
............................................................
Countrywide Funding, 6.60%,
1/04/2000 4,850,000 4,847,333
............................................................
Edison International, 6.55%,
1/10/2000 4(2) 7,000,000 6,988,538
............................................................
Exxon Credit Corporation,
5.50%, 1/04/2000 4(2) 250,000 249,885
............................................................
Ford Motor Credit Company,
6.49%, 1/04/2000 9,700,000 9,694,754
............................................................
Safeway, Inc., 7.21%,
1/04/2000 4(2) 9,650,000 9,644,205
............................................................
Tyco International, Inc.,
6.25%, 1/10/2000 4(2) 1,900,000 1,897,031
............................................................
Union Carbide Corporation,
5.05%, 1/03/2000 4(2) 14,807,000 14,802,845
............................................................
Union Carbide Corporation,
5.25%, 1/05/2000 4(2) 6,200,000 6,196,383
------------------------------------------------------------
Total short-term investments
(cost $55,720,178) 55,720,178
------------------------------------------------------------
Total investments -- 100.3%
(cost $1,202,065,453) 1,432,061,803
............................................................
Liabilities in excess of
other assets -- (0.3)% (4,444,772)
.................... ..................... -------------
$1,427,617,031
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
# -- Non-income producing security.
4(2) -- Restricted security requiring resale to institutional investors.
See Notes to the Financial Statements
24
<PAGE> 747
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
GLOBAL EQUITY FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 97.1% Shares Value
------------------------------------------------------------
<S> <C> <C>
AUSTRALIA -- 1.8%
------------------------------------------------------------
DIVERSIFIED COMPANIES -- 0.2%
............................................................
Reinsurance Australia Corporation,
Ltd. 39,233 $ 13,646
------------------------------------------------------------
REGIONAL BANKS -- 1.6%
............................................................
Australia and New Zealand Banking
Group, Ltd. 16,940 123,186
...................... ....................... ---------
136,832
Total Australia
------------------------------------------------------------
CANADA -- 3.2%
------------------------------------------------------------
INSURANCE: MULTI-LINE -- 2.0%
............................................................
Clarica Life Insurance Co. 2,685 48,385
............................................................
Manulife Financial Corporation # 8,921 101,174
...................... ....................... ---------
149,559
------------------------------------------------------------
METALS: MISC. -- 1.2%
............................................................
Noranda, Inc. 6,385 85,854
...................... ....................... ---------
235,413
Total Canada
------------------------------------------------------------
FRANCE -- 4.6%
------------------------------------------------------------
OFFICE EQUIPMENT &
SUPPLIES -- 1.3%
............................................................
BIC 2,135 97,144
------------------------------------------------------------
OIL: INTERNATIONAL -- 0.9%
............................................................
Total Fina SA 514 68,589
------------------------------------------------------------
REGIONAL BANKS -- 2.4%
............................................................
Banque Nationale de Paris 1,955 180,349
...................... ....................... ---------
346,082
Total France
------------------------------------------------------------
GERMANY -- 4.2%
------------------------------------------------------------
CHEMICALS -- 1.6%
............................................................
Aventis SA 2,070 119,857
------------------------------------------------------------
REGIONAL BANKS -- 1.3%
............................................................
Commerzbank AG 2,500 91,772
------------------------------------------------------------
UTILITIES: MISC. -- 1.3%
............................................................
VEBA AG 2,014 97,865
...................... ....................... ---------
309,494
Total Germany
------------------------------------------------------------
HONG KONG -- 4.9%
------------------------------------------------------------
METALS: MISC. -- 1.1%
............................................................
Yanzhou Coal Mining Co., Ltd. 284,000 78,548
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
REAL ESTATE -- 1.0%
............................................................
New World Development Co., Ltd. 33,000 $ 74,290
------------------------------------------------------------
REGIONAL BANKS -- 1.6%
............................................................
Dao Heng Bank Group, Ltd. 23,500 121,224
------------------------------------------------------------
RETAIL: GENERAL
MERCHANDISE -- 1.2%
............................................................
Dickson Concepts International,
Ltd. 73,500 92,659
...................... ....................... ---------
366,721
Total Hong Kong
------------------------------------------------------------
IRELAND -- 4.1%
------------------------------------------------------------
FOODS -- 0.9%
............................................................
Greencore Group PLC 21,160 64,996
------------------------------------------------------------
PAPER -- 2.1%
............................................................
Jefferson Smurfit Group PLC 53,130 160,522
------------------------------------------------------------
REGIONAL BANKS -- 1.1%
............................................................
Allied Irish Banks PLC 7,073 80,635
...................... ....................... ---------
306,153
Total Ireland
------------------------------------------------------------
ITALY -- 3.7%
------------------------------------------------------------
OIL: INTERNATIONAL -- 1.4%
............................................................
ENI SPA 19,100 105,026
------------------------------------------------------------
TELECOMMUNICATIONS -- 2.3%
............................................................
Telecom Italia SPA 11,900 167,783
...................... ....................... ---------
272,809
Total Italy
------------------------------------------------------------
JAPAN -- 5.8%
------------------------------------------------------------
ELECTRONICS -- 3.8%
............................................................
Nintendo Co., Ltd. 1,700 282,644
------------------------------------------------------------
SMALL LOANS & FINANCE -- 2.0%
............................................................
Promise Company, Ltd. 1,400 71,278
............................................................
Sanyo Shinpan Finance Co., Ltd. 2,400 82,244
...................... ....................... ---------
153,522
...................... ....................... ---------
436,166
Total Japan
------------------------------------------------------------
NETHERLANDS -- 8.8%
------------------------------------------------------------
CHEMICALS -- 1.6%
............................................................
Akzo Nobel N.V. 2,420 121,372
------------------------------------------------------------
ELECTRONICS -- 2.5%
............................................................
Philips Electronics N.V. 1,343 182,592
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
25
<PAGE> 748
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
GLOBAL EQUITY FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
INSURANCE: MULTI-LINE -- 1.8%
............................................................
ING Groep N.V. 2,255 $ 136,124
------------------------------------------------------------
REGIONAL HOLDINGS -- 1.2%
............................................................
ABN AMRO Holding N.V. 3,585 89,539
------------------------------------------------------------
TELECOMMUNICATIONS -- 1.7%
............................................................
Koninklijke KPN N.V. 1,300 126,864
...................... ....................... ---------
656,491
Total Netherlands
------------------------------------------------------------
NEW ZEALAND -- 3.0%
------------------------------------------------------------
BUILDING MATERIALS -- 0.9%
............................................................
Fletcher Challenge Building 45,514 66,909
------------------------------------------------------------
TELECOMMUNICATIONS -- 2.1%
............................................................
Telecom Corporation of New Zealand 32,767 153,733
...................... ....................... ---------
220,642
Total New Zealand
------------------------------------------------------------
PORTUGAL -- 1.7%
------------------------------------------------------------
TELECOMMUNICATIONS -- 1.7%
............................................................
Portugal Telecom SA 11,551 126,684
...................... ....................... ---------
126,684
Total Portugal
------------------------------------------------------------
SINGAPORE -- 3.1%
------------------------------------------------------------
COMPUTER SOFTWARE & SERVICES -- 2.4%
............................................................
Creative Technology, Ltd. 10,260 178,268
------------------------------------------------------------
DIVERSIFIED COMPANIES -- 0.7%
............................................................
Jardine Matheson Holdings, Ltd. 14,000 55,160
...................... ....................... ---------
233,428
Total Singapore
------------------------------------------------------------
SPAIN -- 2.1%
------------------------------------------------------------
TELECOMMUNICATIONS -- 2.1%
............................................................
Telefonica S.A. 6,296 157,249
...................... ....................... ---------
157,249
Total Spain
------------------------------------------------------------
SWEDEN -- 1.9%
------------------------------------------------------------
ELECTRICAL EQUIPMENT -- 1.9%
............................................................
Electrolux AB -- Class B 5,525 139,021
...................... ....................... ---------
139,021
Total Sweden
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
SWITZERLAND -- 3.9%
------------------------------------------------------------
MACHINERY -- 1.9%
............................................................
Saurer AG "registered" 141 $ 68,071
............................................................
SIG Schweizerische Industrie-
Gesellschaft Holding
"registered" 126 75,146
...................... ....................... ---------
143,217
------------------------------------------------------------
MEDICAL PRODUCTS &
SUPPLIES -- 2.0%
............................................................
Novartis AG "registered" 99 145,310
...................... ....................... ---------
288,527
Total Switzerland
------------------------------------------------------------
UNITED KINGDOM -- 18.0%
------------------------------------------------------------
AIRLINES -- 1.1%
............................................................
BAA PLC 11,880 83,475
------------------------------------------------------------
BEVERAGES -- 0.8%
............................................................
Allied Domecq PLC 12,690 62,724
------------------------------------------------------------
BUILDING MATERIALS -- 1.6%
............................................................
Hanson PLC 14,080 118,038
------------------------------------------------------------
CHEMICALS -- 1.0%
............................................................
Elementis PLC 55,010 71,975
------------------------------------------------------------
DIVERSIFIED COMPANIES -- 3.2%
............................................................
Cookson Group PLC 19,870 80,240
............................................................
Invensys PLC 11,106 60,457
............................................................
Tomkins PLC 29,832 96,375
...................... ....................... ---------
237,072
------------------------------------------------------------
ENGINEERING & CONSTRUCTION -- 1.8%
............................................................
TI Group PLC 17,640 135,346
------------------------------------------------------------
HOUSEHOLD PRODUCTS -- 1.0%
............................................................
Reckitt Benckiser PLC 7,790 73,045
------------------------------------------------------------
INSURANCE: MULTI-LINE -- 2.3%
............................................................
Allied Zurich AG PLC 5,870 69,170
............................................................
CGU PLC 6,340 102,154
...................... ....................... ---------
171,324
------------------------------------------------------------
MEDICAL PRODUCTS &
SUPPLIES -- 1.0%
............................................................
Medeva PLC 25,878 72,733
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
26
<PAGE> 749
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
GLOBAL EQUITY FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
PUBLISHING -- 2.3%
............................................................
Reed International PLC 8,700 $ 65,136
............................................................
United News & Media PLC 8,276 105,475
...................... ....................... ---------
170,611
------------------------------------------------------------
REGIONAL BANKS -- 1.4%
............................................................
Lloyds TSB Group PLC 8,337 104,300
------------------------------------------------------------
TOBACCO -- 0.5%
............................................................
B.A.T. Industries PLC 7,230 41,080
...................... ....................... ---------
1,341,723
Total United Kingdom
------------------------------------------------------------
UNITED STATES -- 22.3%
------------------------------------------------------------
AEROSPACE/DEFENSE -- 0.8%
............................................................
Northrop Grumman Corporation 1,100 59,469
------------------------------------------------------------
AUTO PARTS -- 1.0%
............................................................
Dana Corporation 2,400 71,850
------------------------------------------------------------
AUTOS & TRUCKS -- 0.9%
............................................................
Ford Motor Company 1,260 67,331
------------------------------------------------------------
CONTAINERS -- 0.9%
............................................................
Pactiv Corporation # 6,600 70,125
------------------------------------------------------------
ELECTRICAL UTILITIES -- 0.6%
............................................................
GPU, Inc. 1,590 47,601
------------------------------------------------------------
FOREST PRODUCTS -- 1.4%
............................................................
Weyerhaeuser Company 1,450 104,128
------------------------------------------------------------
INSURANCE: PROPERTY
CASUALTY -- 0.6%
............................................................
Safeco Corporation 1,800 44,775
------------------------------------------------------------
MACHINERY -- 1.8%
............................................................
CNH Global N.V. 9,750 129,797
------------------------------------------------------------
OFFICE EQUIPMENT &
SUPPLIES -- 0.9%
............................................................
Xerox Corporation 3,000 68,063
------------------------------------------------------------
OIL: DOMESTIC -- 2.3%
............................................................
Conoco, Inc. -- Class B 4,000 99,500
............................................................
Occidental Petroleum Corporation 3,400 73,525
...................... ....................... ---------
173,025
------------------------------------------------------------
PHOTOGRAPHY/IMAGING -- 1.2%
............................................................
Eastman Kodak Company 1,400 92,750
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
RAILROADS -- 1.1%
............................................................
Norfolk Southern Company 4,000 $ 82,000
------------------------------------------------------------
RETAIL: GENERAL
MERCHANDISE -- 0.5%
............................................................
J.C. Penney Company, Inc. 1,700 33,894
------------------------------------------------------------
SAVINGS & LOANS -- 0.9%
............................................................
Washington Mutual, Inc. 2,500 65,000
------------------------------------------------------------
SMALL LOANS & FINANCE -- 2.0%
............................................................
Fannie Mae 1,050 65,559
............................................................
Household International, Inc. 2,210 82,323
...................... ....................... ---------
147,882
------------------------------------------------------------
TELEPHONE -- 4.5%
............................................................
AT&T Corporation 1,950 98,963
............................................................
ALLTEL Corporation 1,800 148,838
............................................................
GTE Corporation 1,200 84,675
...................... ....................... ---------
332,476
------------------------------------------------------------
TOBACCO -- 0.9%
............................................................
Philip Morris Companies, Inc. 2,905 67,360
...................... ....................... ---------
1,657,526
Total United States
------------------------------------------------------------
Total common stock
(cost $6,926,229) 7,230,961
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
SHORT-TERM Principal
INVESTMENTS -- 2.2% Amount
------------------------------------------------------------
<S> <C> <C>
VARIABLE RATE
DEMAND NOTES* -- 2.2%
------------------------------------------------------------
Chase Manhattan Bank, 3.9062% $164,944 164,944
------------------------------------------------------------
CASH EQUIVALENTS -- 0.0%
------------------------------------------------------------
Chase Bank Domestic Liquidity Fund 689 689
------------------------------------------------------------
Total short-term investments (cost
$165,633) 165,633
------------------------------------------------------------
Total investments -- 99.3%
(cost $7,091,173) 7,396,594
............................................................
Other assets in excess of
liabilities -- 0.7% 50,873
...................... ....................... ---------
$7,447,467
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
# -- Non-income producing security.
* -- Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rate listed is as of December 31, 1999.
See Notes to the Financial Statements
27
<PAGE> 750
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
BALANCED FUND
<TABLE>
<CAPTION>
COMMON STOCKS -- 47.1% Shares Value
------------------------------------------------------------
<S> <C> <C>
AEROSPACE -- 2.4%
............................................................
Lockheed Martin Corporation 34,800 $ 761,250
............................................................
Northrop Grumman Corporation 16,200 875,812
............................................................
Rockwell International
Corporation 6,100 292,038
...................... ...................... ----------
1,929,100
------------------------------------------------------------
ALUMINUM -- 1.7%
............................................................
Alcoa, Inc. 400 33,200
............................................................
Reynolds Metals Company 17,700 1,356,262
...................... ...................... ----------
1,389,462
------------------------------------------------------------
APPAREL & TEXTILES -- 0.3%
............................................................
Russell Corporation 15,000 251,250
------------------------------------------------------------
APPLIANCE & HOUSEHOLD FURNITURE -- 0.6%
............................................................
Whirlpool Corporation 7,300 474,956
------------------------------------------------------------
AUTO PARTS -- 2.3%
............................................................
Dana Corporation 19,900 595,756
............................................................
Delphi Automotive Systems
Corporation 18,094 284,980
............................................................
Meritor Automotive, Inc. 10,700 207,313
............................................................
Tenneco Automotive Inc. 9,860 91,821
............................................................
TRW Inc. 11,700 607,669
...................... ...................... ----------
1,787,539
------------------------------------------------------------
AUTOS & TRUCKS -- 2.4%
............................................................
Ford Motor Company 15,000 801,563
............................................................
General Motors Corporation 15,100 1,097,581
...................... ...................... ----------
1,899,144
------------------------------------------------------------
BEVERAGES -- 0.4%
............................................................
Anheuser-Busch Companies, Inc. 5,000 354,375
------------------------------------------------------------
CHEMICALS -- 1.6%
............................................................
The Dow Chemical Company 5,200 694,850
............................................................
Eastman Chemical Company 10,700 510,256
............................................................
Millennium Chemicals, Inc. 4,442 87,730
...................... ...................... ----------
1,292,836
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
CONTAINERS -- 0.7%
............................................................
Pactiv Corporation ## 49,300 $ 523,813
------------------------------------------------------------
ELECTRICAL UTILITIES -- 5.1%
............................................................
CMS Energy Corporation 10,000 311,875
............................................................
DTE Energy Company 12,700 398,462
............................................................
Edison International 5,000 130,937
............................................................
Entergy Corporation 8,100 208,575
............................................................
GPU, Inc. 6,100 182,619
............................................................
Illinova Corporation 20,000 695,000
............................................................
PECO Energy Company 14,800 514,300
............................................................
P P & L Resources, Inc. 10,600 242,475
............................................................
Public Service Enterprises
Group, Inc. 7,400 257,612
............................................................
SCANA Corporation 25,800 693,375
............................................................
Scottish Power PLC ADR 7,366 206,248
............................................................
Texas Utilities Company 6,600 234,713
...................... ...................... ----------
4,076,191
------------------------------------------------------------
ENGINEERING & CONSTRUCTION -- 0.4%
............................................................
Harsco Corporation 9,200 292,100
------------------------------------------------------------
FOREST PRODUCTS -- 1.6%
............................................................
Georgia-Pacific (Timber Group) 13,000 320,125
............................................................
Weyerhaeuser Company 13,000 933,563
...................... ...................... ----------
1,253,688
------------------------------------------------------------
HEALTHCARE: DRUGS -- 0.0%
............................................................
American Home Products
Corporation 600 23,662
------------------------------------------------------------
HEALTHCARE: MEDICAL PRODUCTS & SUPPLIES -- 0.2%
............................................................
Baxter International, Inc. 2,200 138,187
------------------------------------------------------------
INSURANCE: LIFE -- 1.3%
............................................................
American General Corporation 8,000 607,000
............................................................
Lincoln National Corporation 11,600 464,000
...................... ...................... ----------
1,071,000
------------------------------------------------------------
INSURANCE: MULTI-LINE -- 0.3%
............................................................
Harleysville Group, Inc. 14,500 206,625
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
28
<PAGE> 751
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
BALANCED FUND
<TABLE>
<CAPTION>
Shares Value
------------------------------------------------------------
<S> <C> <C>
INSURANCE: PROPERTY CASUALTY -- 2.6%
............................................................
The Allstate Corporation 36,000 $ 864,000
............................................................
Safeco Corporation 19,500 485,063
............................................................
St. Paul Companies, Inc. 21,900 737,756
...................... ...................... ----------
2,086,819
------------------------------------------------------------
LEISURE/TOYS -- 0.5%
............................................................
Fortune Brands, Inc. 11,000 363,687
------------------------------------------------------------
MACHINERY -- 1.0%
............................................................
CNH Global N.V 60,300 802,744
------------------------------------------------------------
METALS: MISC. -- 0.5%
............................................................
Phelps Dodge Corporation 6,400 429,600
------------------------------------------------------------
OFFICE EQUIPMENT & SUPPLIES -- 0.8%
............................................................
Xerox Corporation 27,220 617,554
------------------------------------------------------------
OIL: DOMESTIC -- 3.4%
............................................................
Conoco Inc. -- Class B 11,800 293,525
............................................................
Occidental Petroleum
Corporation 27,100 586,037
............................................................
Phillips Petroleum Company 14,400 676,800
............................................................
Sunoco Inc. 4,200 98,700
............................................................
Ultramar Diamond Shamrock
Corporation 16,300 369,806
............................................................
USX-Marathon Group, Inc. 26,600 656,688
...................... ...................... ----------
2,681,556
------------------------------------------------------------
OIL: INTERNATIONAL -- 0.3%
............................................................
Texaco Inc. 3,700 200,956
------------------------------------------------------------
PAPER -- 2.4%
............................................................
Georgia-Pacific Group 10,600 537,950
............................................................
International Paper Company 24,100 1,360,144
...................... ...................... ----------
1,898,094
------------------------------------------------------------
PHOTOGRAPHY/IMAGING -- 1.0%
............................................................
Eastman Kodak Company 12,500 828,125
------------------------------------------------------------
POLLUTION CONTROL -- 0.2%
............................................................
Waste Management, Inc. 10,000 171,875
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Shares Value
<S> <C> <C>
RAILROADS -- 1.0%
............................................................
CSX Corporation 10,200 $ 320,025
............................................................
Norfolk Southern Corporation 23,200 475,600
...................... ...................... ----------
795,625
------------------------------------------------------------
REGIONAL BANKS -- 2.0%
............................................................
Bank One Corporation 18,300 586,744
............................................................
First Security Corporation 8,200 209,356
............................................................
First Union Corporation 15,800 518,437
............................................................
KeyCorp 9,100 201,338
...................... ...................... ----------
1,515,875
------------------------------------------------------------
RETAIL: DEPARTMENT STORES -- 0.6%
............................................................
May Department Stores Company 14,900 480,525
------------------------------------------------------------
RETAIL: GENERAL MERCHANDISE -- 1.2%
............................................................
J.C. Penney Company, Inc. 20,200 402,738
............................................................
Sears, Roebuck & Company 18,000 547,875
...................... ...................... ----------
950,613
------------------------------------------------------------
SAVINGS & LOANS -- 0.9%
............................................................
Washington Mutual, Inc. 29,000 754,000
------------------------------------------------------------
SMALL LOANS & FINANCE -- 1.6%
............................................................
Associates First Capital
Corporation -- Class A 2,400 65,850
............................................................
Fannie Mae 13,200 824,175
............................................................
Household International, Inc. 11,200 417,200
...................... ...................... ----------
1,307,225
------------------------------------------------------------
STEEL -- 1.3%
............................................................
USX-U.S. Steel Group, Inc. 30,600 1,009,800
------------------------------------------------------------
TELEPHONE -- 3.1%
............................................................
AT&T Corporation 16,700 847,525
............................................................
ALLTEL Corporation 9,400 777,262
............................................................
GTE Corporation 4,200 296,363
............................................................
SBC Communications, Inc. 10,400 507,000
...................... ...................... ----------
2,428,150
------------------------------------------------------------
TOBACCO -- 1.4%
............................................................
Philip Morris Companies, Inc. 47,400 1,099,088
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
29
<PAGE> 752
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
BALANCED FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
Total common stocks (cost
$38,759,552) $37,385,839
------------------------------------------------------------
CORPORATE BONDS -- 23.1%
------------------------------------------------------------
AIRLINES -- 1.4%
............................................................
NWA Trust, CLB, 11.30%,
12/21/2012 $ 1,034,769 1,145,300
------------------------------------------------------------
BANKS -- 3.7%
............................................................
Korea Development Bank,
(Acquired 9/23/1999, cost
$747,570), 7.625%, 10/01/2002
r 750,000 747,772
............................................................
MBNA Corporation, 6.49%,
6/17/2002 # 1,500,000 1,492,881
............................................................
Wells Fargo Company, 6.625%,
7/15/2004 750,000 734,269
...................... ...................... ----------
2,974,922
------------------------------------------------------------
EUROBANKS -- 7.5%
............................................................
Foreningsbanken Kredit AB, CLB
12/18/2001, 6.89%, 12/29/2049
# 2,500,000 2,495,472
............................................................
Nordbanken, CLB 10/25/2001,
6.8025%, 10/29/2049 # 2,000,000 1,975,340
............................................................
Okobank, CLB 9/09/2002, 6.62%,
9/29/2049 # 1,500,000 1,477,550
...................... ...................... ----------
5,948,362
------------------------------------------------------------
FINANCIAL SERVICES -- 6.3%
............................................................
Countrywide Home Loans, Inc.,
6.655%, 3/16/2005 # 2,500,000 2,498,007
............................................................
Dana Credit Corporation,
(Acquired 12/10/1999, cost
$749,798), 7.25%, 12/16/2002
r 750,000 745,057
............................................................
Ford Motor Credit Company,
7.375%, 10/28/2009 900,000 890,300
............................................................
Lehman Brothers Holdings,
6.56%, 6/01/2001 # 900,000 899,658
...................... ...................... ----------
5,033,022
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
RETAIL -- 1.2%
............................................................
Rite Aid Corp.:
(Acquired 12/16/1998, cost
$747,645), 6.00%, 12/15/2005
r $ 750,000 $ 562,500
............................................................
7.125%, 1/15/2007 475,000 361,000
...................... ...................... ----------
923,500
------------------------------------------------------------
STEEL -- 0.9%
............................................................
Pohang Iron & Steel, 7.50%,
8/01/2002 700,000 691,624
------------------------------------------------------------
TRANSPORTATION -- 1.3%
............................................................
Delta Air Lines ETC:
9.90%, 1/02/2002 150,000 155,979
............................................................
10.50%, 4/30/2016 750,000 872,066
...................... ...................... ----------
1,028,045
------------------------------------------------------------
UTILITIES -- 0.8%
............................................................
TXU Eastern Funding, CLB,
6.45%, 5/15/2005 700,000 660,050
------------------------------------------------------------
Total corporate bonds (cost
$19,028,635) 18,404,825
------------------------------------------------------------
GOVERNMENT AGENCY
MORTGAGE-BACKED
SECURITIES -- 8.2%
------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 8.1%
............................................................
Federal Home Loan Mortgage
Corporation:
8.00%, 1/15/2030' 2,900,000 2,928,991
............................................................
1588 SA, 7.05099%, 9/15/2023
# 700,000 483,992
............................................................
Federal National Mortgage
Association:
1993-175 SD, 8.6319%,
9/25/2008 # 900,000 885,706
............................................................
Pool #323977, 6.077%,
9/01/2039 2,221,005 2,129,011
...................... ...................... ----------
6,427,700
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
30
<PAGE> 753
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
BALANCED FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
STRIPPED MORTGAGE-BACKED SECURITIES -- 0.1%
............................................................
Federal National Mortgage
Association, 1994-53 E (PO),
0.00%, 11/25/2023 $ 98,051 $ 81,281
------------------------------------------------------------
Total government agency
mortgage-backed securities
(cost $5,336,602) 6,508,981
------------------------------------------------------------
<CAPTION>
NON-AGENCY
MORTGAGE-BACKED
SECURITIES -- 14.9%
------------------------------------------------------------
<S> <C> <C>
ASSET-BACKED
SECURITIES -- 7.1%
............................................................
DiTech Home Loan Owner Trust,
CLB, 1997-1 A3, 6.71%,
8/15/2018 1,750,000 1,735,694
............................................................
Commercial Mortgage Asset
Trust, CLB, 7.546%,
12/17/2010 1,150,000 1,142,416
............................................................
GREAT, (Acquired 7/02/1998,
cost $1,104,141), 1998-1 A1,
7.33%, 9/15/2007 r+ 1,104,141 331,242
............................................................
Heilig-Meyers Master Trust,
(Acquired 2/20/1998, cost
$1,399,872), CLB, 1998-1A A,
6.125%, 1/20/2007 r 1,400,000 1,345,631
............................................................
Nomura Asset Securities
Corporation, CLB, 1995-MD3
A1B, 8.15%, 3/04/2020 1,000,000 1,025,075
...................... ...................... ----------
5,580,058
------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 2.8%
............................................................
PNC Mortgage Securities
Corporation, CLB, 1996-1 A11,
7.50%, 6/25/2026 2,062,666 1,920,023
............................................................
Prudential Home Mortgage
Securities, CLB, 1993-54 A17,
6.44486%, 1/25/2024 # 500,000 355,000
...................... ...................... ----------
2,275,023
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
STRIPPED MORTGAGE-BACKED SECURITIES -- 5.0%
............................................................
Chase Commercial Mortgage
Securities Corporation, CLB,
1997-1 X (IO), 1.43733%,
4/19/2015 # $21,795,156 $ 1,430,307
............................................................
Commercial Mortgage Asset
Trust, (Acquired 7/22/1999,
cost $2,546,254) CLB, 1999-C1
X (IO), 1.56583%, 6/17/2000 #
r 39,770,016 2,524,402
...................... ...................... ----------
3,954,709
------------------------------------------------------------
Total non-agency
mortgage-backed securities
(cost $14,257,327) 11,809,790
------------------------------------------------------------
<CAPTION>
PREFERRED STOCKS -- 1.0%
Shares
------------------------------------------------------------
<S> <C> <C>
Home Ownership Funding 2,
(Acquired 2/20/1997,
cost $1,000,000) r 1,000 790,000
------------------------------------------------------------
U.S. TREASURY Principal
OBLIGATIONS -- 3.9% Amount
------------------------------------------------------------
U.S. Treasury Notes:
6.375%, 3/31/2001 ' ' $ 1,650,000 1,654,125
............................................................
10.75%, 2/15/2003 ' ' 1,250,000 1,400,781
------------------------------------------------------------
Total U.S. Treasury obligations
(cost $3,060,741) 3,054,906
------------------------------------------------------------
SHORT-TERM INVESTMENTS -- 5.0%
------------------------------------------------------------
COMMERCIAL PAPER -- 1.7%
............................................................
Norfolk Southern Corporation,
6.50%, 1/14/2000 4(2) 957,000 954,754
............................................................
Tyco International Group SA,
6.25%, 1/10/2000 4(2) 400,000 399,375
...................... ...................... ----------
1,354,129
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
31
<PAGE> 754
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
BALANCED FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
VARIABLE DEMAND NOTES* -- 3.3%
............................................................
General Mills, Inc., 6.095% $ 1,220,041 $ 1,220,041
............................................................
Pitney Bowes, Inc., 6.095% 869,656 869,656
............................................................
Sara Lee Corporation, 6.09% 500,000 500,000
...................... ...................... ----------
2,589,697
------------------------------------------------------------
Total short-term investments
(cost $3,943,826) 3,943,826
------------------------------------------------------------
Total investments -- 103.2%
(cost $85,386,683) 81,898,167
............................................................
Liabilities in excess of other
assets -- (3.2)% (2,501,462)
...................... ...................... ----------
$79,396,705
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
# -- Variable rate security. The rate listed is as of December 31, 1999.
* -- Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rates listed are as of December 31, 1999.
IO -- Interest Only.
PO -- Principal Only.
CLB -- Callable.
r -- Restricted Security. Purchased in a private placement transaction; resale
to the public may require registration or may extend only to qualified
institutional buyers.
4(2) -- Restricted Security requiring resale to institutional investors.
+ -- Security Fair Valued under procedures established by the Board of Trustees
(See Note 1).
ADR -- American Depository Receipts.
## --Non-income producing security.
' -- When-issued security.
" -- Security segregated as collateral to cover when-issued security.
See Notes to the Financial Statements
32
<PAGE> 755
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
TOTAL RETURN BOND FUND
<TABLE>
<CAPTION>
CORPORATE BONDS Principal
AND NOTES -- 45.0% Amount Value
------------------------------------------------------------
<S> <C> <C>
BANKS -- 3.9%
............................................................
MBNA Corporation:
6.42%, 3/09/2000 # $1,000,000 $ 1,000,019
............................................................
6.49%, 6/17/2002 # 1,100,000 1,094,779
............................................................
Sovereign Bancorp, 6.625%,
3/15/2001 2,500,000 2,437,743
............................................................
Unibanco Grand Cayman,
(Acquired 11/15/1999, cost
$1,044,308), 7.75%, 8/14/2000
r 1,050,000 1,044,750
..................... ...................... ----------
5,577,291
------------------------------------------------------------
BEVERAGES -- 0.8%
............................................................
Coca-Cola Femsa SA, 8.95%,
11/01/2006 1,110,000 1,115,550
------------------------------------------------------------
BROADCAST SERVICE/PROGRAMS -- 1.7%
............................................................
Liberty Media Group, (Acquired
12/06/1999, cost $1,588,743),
7.875%, 7/15/2009 r 1,575,000 1,570,456
............................................................
News America Holdings, 8.625%,
2/1/2003 907,000 938,014
..................... ...................... ----------
2,508,470
------------------------------------------------------------
CABLE -- 4.6%
............................................................
Charter Communication Holdings
LLC, (Acquired 10/01/1999,
cost $2,592,070), CLB
4/01/2004, 8.625%, 4/01/2009
r 2,600,000 2,414,750
............................................................
CSC Holdings Inc., 7.25%,
7/15/2008 2,200,000 2,095,500
............................................................
Jones Intercable Inc., 9.625%,
03/15/2002 2,000,000 2,088,632
..................... ...................... ----------
6,598,882
------------------------------------------------------------
EUROBANKS -- 2.4%
............................................................
Nordbanken, CLB 9/27/2001,
6.88125%, 9/29/2049 # 1,300,000 1,286,103
............................................................
Okobank, CLB 10/25/2001, 6.62%,
9/29/2049 # 2,150,000 2,117,821
..................... ...................... ----------
3,403,924
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
<S> <C> <C>
FINANCIAL SERVICES -- 9.1%
............................................................
Countrywide Home Loans, Inc.:
6.56125%, 3/19/2003 # $ 500,000 $ 500,630
............................................................
6.655%, 3/16/2005 # 1,700,000 1,698,645
............................................................
Dana Credit Corporation,
(Acquired 12/10/99, cost
$1,499,609), 7.25%,
12/16/2002 r 1,450,000 1,440,443
............................................................
Finova Capital Corp. 7.125%,
5/17/2004 2,000,000 1,970,964
............................................................
Fuji Finance Grand Cayman:
7.30%, 3/29/2049 # 1,200,000 1,155,000
............................................................
6.5737%, 8/29/2049 # 1,000,000 955,000
............................................................
Golden State Holdings, CLB
8/01/2000, 7.205%, 8/01/2003
# 3,000,000 2,859,555
............................................................
U.S. West Capital Funding,
CLB, 6.375%, 7/15/2008 2,250,000 2,066,900
............................................................
Western Financial Savings,
8.50%, 7/01/2003 500,000 453,036
..................... ...................... ----------
13,100,173
------------------------------------------------------------
FOOD -- 1.3%
............................................................
Gruma S.A., 7.625%, 10/15/2007 2,215,000 1,932,588
------------------------------------------------------------
INDUSTRIAL -- 1.7%
............................................................
Lennar Corp., 7.625%, 3/01/2009 2,750,000 2,453,393
------------------------------------------------------------
MISCELLANEOUS -- 1.6%
............................................................
Republic of Brazil, 11.625%,
4/15/2004 750,000 751,875
............................................................
Republic of Philippines,
8.875%, 4/15/2008 1,600,000 1,568,000
..................... ...................... ----------
2,319,875
------------------------------------------------------------
OIL: INTEGRATED -- 2.1%
............................................................
YPF Sociedad Anonima, 8.00%,
2/15/2004 3,000,000 2,964,681
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
33
<PAGE> 756
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
TOTAL RETURN BOND FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
RETAIL -- 3.7%
............................................................
Great Atlantic & Pacific Tea,
7.70%, 1/15/2004 $2,500,000 $ 2,386,290
............................................................
Rite Aid Corp.:
(Acquired 12/15/1999, cost
$662,850), 6.00%, 12/15/2000
r 750,000 648,750
............................................................
(Acquired 12/16/1998, cost
$2,213,026), 6.00%,
12/15/2005 r 2,250,000 1,687,500
............................................................
7.125%, 1/15/2007 850,000 646,000
..................... ...................... ----------
5,368,540
------------------------------------------------------------
STEEL -- 1.0%
............................................................
Pohang Iron & Steel, 7.50%,
8/01/2002 1,500,000 1,482,053
------------------------------------------------------------
TELECOMMUNICATIONS -- 2.5%
............................................................
AT&T Corporation, 6.00%,
3/15/2009 1,950,000 1,779,240
............................................................
MCI Worldcom, Inc., CLB,
8.875%, 1/15/2006 775,000 810,715
............................................................
Telecom Argentina Stet. Fran.,
(Acquired 6/25/1999, cost
$998,750), 9.75%, 7/12/2001 r 1,000,000 1,001,250
..................... ...................... ----------
3,591,205
------------------------------------------------------------
TRANSPORTATION -- 3.0%
............................................................
Bombardier Capital, Inc.:
(Acquired 1/22/1999, cost
$1,496,910), 6.00%, 1/15/2002
r 1,500,000 1,462,697
............................................................
(Acquired 8/18/1999, cost
$1,994,020), 7.50%,
8/15/2004 r 2,000,000 1,970,896
............................................................
Delta Air Lines ETC:
CLB, 9.90%, 1/02/2002 250,000 259,966
............................................................
10.50%, 4/30/2016 500,000 581,378
..................... ...................... ----------
4,274,937
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
<S> <C> <C>
UTILITIES -- 5.6%
............................................................
CMS Energy Corp., CLB, 8.00%,
7/01/2001 # $2,000,000 $ 1,977,404
............................................................
Korea Electric Power, 6.375%,
12/1/2003 2,200,000 2,082,573
............................................................
Niagara Mohawk Power, 8.50%,
7/01/2010 2,500,000 1,890,263
............................................................
TXU Eastern Funding, CLB,
6.45%, 5/15/2005 2,200,000 2,074,442
..................... ...................... ----------
8,024,682
------------------------------------------------------------
Total corporate bonds and notes
(cost $66,584,161) 64,716,244
------------------------------------------------------------
<CAPTION>
GOVERNMENT AGENCY
MORTGAGE-BACKED
SECURITIES -- 17.3%
------------------------------------------------------------
<S> <C> <C>
COLLATERALIZED MORTGAGE OBLIGATIONS -- 17.2%
............................................................
Federal Home Loan Mortgage
Corporation:
1564 SE, CLB, 8.74033%,
8/15/2008 # 79,934 80,399
............................................................
1565 OC, CLB, 6.36544%,
8/15/2008 # 1,827,135 1,637,813
............................................................
1261 J, CLB, 8.00%, 7/15/2021 732,247 744,140
............................................................
1573 GC, CLB, 10.70421%,
1/15/2023 # 389,364 345,109
............................................................
2118 Z, CLB, 6.50%,
12/15/2028 140,278 111,288
............................................................
8.00%, 1/15/2030' 4,500,000 4,544,987
............................................................
1588 SA, 7.05099%, 9/15/2023
# 1,625,000 1,123,552
............................................................
</TABLE>
See Notes to the Financial Statements
34
<PAGE> 757
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
TOTAL RETURN BOND FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
Federal National Mortgage
Association:
G93-27 SB, 7.2048%, 8/25/2023
# $ 36,426 $ 24,243
............................................................
5.125%, 2/13/2004 2,400,000 2,253,910
............................................................
1993-170 SE, 8.38949%,
9/25/2008 # 2,000,000 1,877,801
............................................................
1993-175 SD, 8.6319%,
9/25/2008 # 4,600,000 4,526,940
............................................................
1994-27 SD, 6.47014%,
3/25/2023 2,435,785 1,894,373
............................................................
Pool #323977, 6.077%,
9/01/2039 4,935,566 4,731,135
............................................................
Government National Mortgage
Association, 1999-28 ZA,
6.50%, 11/20/2005 924,618 821,014
..................... ...................... ----------
24,716,704
------------------------------------------------------------
STRIPPED MORTGAGE-BACKED SECURITIES -- 0.1%
............................................................
Federal National Mortgage
Association:
G93-32 E (PO), 0.00%,
9/25/2023 157,030 147,829
............................................................
1998-48 CI (IO), 6.50%,
8/25/2028 152,947 31,626
..................... ...................... ----------
179,455
------------------------------------------------------------
Total government agency
mortgage-backed securities
(cost $25,722,083) 24,896,159
------------------------------------------------------------
<CAPTION>
NON-AGENCY
MORTGAGE-BACKED
SECURITIES -- 17.6%
------------------------------------------------------------
<S> <C> <C>
ASSET-BACKED SECURITIES --
12.0%
............................................................
Associates Manufactured Housing
Pass-Through Certificates,
CLB, 1996-2 A4, 6.60%,
6/15/2027 500,000 494,483
............................................................
CIT Marine Trust, CLB, 1999-A
A2, 5.80%, 4/15/2010 2,000,000 1,928,550
............................................................
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
Commercial Financial Services
Securitized Multiple Asset
Rated Trust, (Acquired
9/24/1997, cost $360,974),
1997-5 A1, 7.72%, 6/15/2005 r
+ $ 360,974 $ 108,292
............................................................
Commercial Mortgage Acceptance
Corporation, (Acquired
3/13/1998, cost $274,144),
CLB, 1996-C2 A2, 7.0341%,
9/15/2023 # r 271,136 268,556
............................................................
Commercial Mortgage Asset
Trust: (Acquired 7/22/1999,
cost $3,182,582), CLB,
1999-C1, 1.156583%, 6/17/2000
r 49,712,520 3,155,502
............................................................
CLB, 7.546%, 01/17/2010 2,600,000 2,582,853
............................................................
Commercial Resecuritization
Trust, (Acquired 2/10/1999,
cost $871,348), CLB,
1999-ABC1 A, 6.74%, 1/27/2009
r 880,566 836,538
............................................................
CPS Auto Trust, CLB, 1998-1 A,
6.00%, 8/15/2003 253,265 250,705
............................................................
The C.S. First Boston Mortgage
Securities Corp. Commercial
Mortgage Pass-Through
Certificates, 1998-C1 A1B,
6.48%, 5/17/2008 750,000 699,926
............................................................
Delta Funding Home Equity Loan
Trust, CLB, 1999-1 A2F,
5.98%, 2/15/2023 2,000,000 1,966,670
............................................................
DiTech Home Loan Owner Trust,
CLB, 1997-1 A3, 6.71%,
8/15/2018 600,000 595,095
............................................................
GREAT, (Acquired 7/02/1998,
cost $157,734), 1998-1 A1,
7.33%, 9/15/2007 r + 157,734 47,320
............................................................
Green Tree Financial
Corporation, 1995-4 A4, CLB,
6.75%, 6/15/2025 265,112 264,667
............................................................
Green Tree Recreational,
Equipment & Consumer Trust,
CLB, 1996-B CTFS, 7.70%,
7/15/2018 450,000 432,079
............................................................
</TABLE>
See Notes to the Financial Statements
35
<PAGE> 758
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
TOTAL RETURN BOND FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
Heilig-Meyers Master Trust,
(Acquired 2/20/1998, cost
$499,954), CLB, 1998-1A A,
6.125%, 1/20/2007 r $ 500,000 $ 480,583
............................................................
Nomura Asset Securities
Corporation, 1995-MD3 A1B,
CLB, 8.15%, 3/04/2020 750,000 768,806
............................................................
Resolution Trust Corporation:
1994-C2 G, CLB, 8.00%,
4/25/2025 504,608 481,151
............................................................
1994-C1 E, CLB, 8.00%,
6/25/2026 1,969,440 1,941,436
..................... ...................... ----------
17,303,212
------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 5.6%
............................................................
Blackrock Capital Finance LP,
(Acquired 6/23/1997, cost
$146,244), CLB, 1997-R2 (AP),
8.15%, 12/25/2035 # r 147,141 151,997
............................................................
CMC Securities Corporation IV,
CLB, 1994-G A4, 7.00%,
9/25/2024 200,000 183,565
............................................................
Citicorp Mortgage Securities,
Inc., CLB, 1997-3 A2, 6.92%,
8/25/2027 28,611 28,542
............................................................
Collateralized Mortgage
Obligations Trust, CLB, 57 D,
9.90%, 2/01/2019 216,515 228,617
............................................................
GE Capital Mortgage Services,
Inc., 1994-24 A4, 7.00%,
7/25/2024 169,843 156,533
............................................................
Housing Securities, Inc., CLB,
1994-1 AB2, 6.50%, 3/25/2009 412,141 298,287
............................................................
CLB, 1994-2 B1, 6.50%,
7/25/2009 219,542 167,675
............................................................
Independent National Mortgage
Corporation, CLB, 1995-F A5,
8.25%, 5/25/2010 620,666 629,004
............................................................
Nomura Depositor Trust,
(Acquired 6/28/1999, cost
$486,914), 1998-ST1 A3, CLB,
7.0125%, 1/15/2003 r # 500,000 490,782
............................................................
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
<S> <C> <C>
Nomura Depositor Trust,
(Acquired 9/03/1999, cost
$1,699,528), 1998-ST1A A3A,
7.0125%, 1/15/2003 # $1,700,000 $ 1,667,062
............................................................
Ocwen Residential MBS Corp.,
(Acquired 6/18/1998, cost
$470,892), CLB, 1998-R2 AP,
6.4416%, 11/25/2034 r # 471,481 467,066
............................................................
Prudential Home Mortgage
Securities: CLB, 1993-54 A17,
6.44486%, 1/25/2024 # 1,150,000 816,500
............................................................
CLB, 1993-50 A11, 8.75%,
11/25/2023 3,312,928 2,791,142
..................... ...................... ----------
8,076,772
------------------------------------------------------------
Total non-agency
mortgage-backed securities
(cost $26,674,640) 25,379,984
------------------------------------------------------------
<CAPTION>
PREFERRED STOCK -- 0.3% Shares
------------------------------------------------------------
<S> <C> <C>
Home Ownership Funding 2,
(Acquired 2/20/1997, cost
$500,000) r 500 395,000
------------------------------------------------------------
<CAPTION>
U.S. TREASURY Principal
OBLIGATIONS -- 16.4% Amount
------------------------------------------------------------
<S> <C> <C>
U.S. Treasury Bonds:
6.50%, 11/15/2026 $1,700,000 1,657,500
............................................................
6.375%, 8/15/2027 375,000 360,117
............................................................
6.00%, 8/15/2009 3,675,000 9,084,966
............................................................
5.875%, 11/15/2004 7,000,000 6,866,566
............................................................
U.S. Treasury Note, 6.50%,
10/15/2006 " 5,000,000 4,987,500
............................................................
U.S. Treasury Strips, 0.00%,
2/15/2009 1,200,000 653,411
------------------------------------------------------------
Total U.S. Treasury obligations
(cost $24,242,944) 23,610,060
------------------------------------------------------------
<CAPTION>
SHORT-TERM
INVESTMENTS -- 5.6%
------------------------------------------------------------
<S> <C> <C>
COMMERCIAL PAPER -- 2.4%
............................................................
Norfolk Southern Corporation,
6.50%, 1/14/2000 4(2) 3,500,000 3,491,785
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
36
<PAGE> 759
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
TOTAL RETURN BOND FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
VARIABLE DEMAND NOTES* -- 3.2%
............................................................
General Mills, Inc., 6.095% $1,856,109 $ 1,856,109
............................................................
Pitney Bowes, Inc., 6.095% 1,378,481 1,378,481
............................................................
Sara Lee Corporation, 6.09% 1,312,572 1,312,572
............................................................
Warner Lambert, 6.044% 96,144 96,144
..................... ...................... ----------
4,643,306
------------------------------------------------------------
Total short-term investments
(cost $8,135,091) 8,135,091
------------------------------------------------------------
Total investments -- 102.2%
(cost $151,858,919) 147,132,538
............................................................
Liabilities in excess of other
assets -- (2.2)% (3,191,844)
..................... ...................... ----------
$143,940,694
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
# -- Variable rate security. The rate listed is as of December 31, 1999.
* -- Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rates listed are as of December 31, 1999.
IO -- Interest Only.
PO -- Principal Only.
CLB -- Callable.
r -- Restricted Security. Purchased in a private placement transaction; resale
to the public may require registration or be limited to qualified institutional
buyers.
4(2) -- Restricted Security requiring resale to institutional investors.
+ -- Security Fair Valued under procedures established by the Board of Trustees
(See Note 1).
' -- When-issued security.
" -- Security marked as segregated to cover when-issued security.
See Notes to the Financial Statements
37
<PAGE> 760
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
CORPORATE BONDS Principal
AND NOTES -- 41.5% Amount Value
------------------------------------------------------------
<S> <C> <C>
BANKS -- 5.8%
............................................................
Capital One Bank, 7.35%,
6/20/2000 $ 1,800,000 $ 1,806,520
............................................................
Korea Development Bank,
9.60%, 12/01/2000 4,220,000 4,303,400
............................................................
Korea Development Bank,
(Acquired 9/23/1999, cost
$747,570), 7.625%,
10/01/2002 r 750,000 747,772
............................................................
MBNA Corporation,
6.49%, 6/17/2002 # 2,125,000 2,114,915
............................................................
MBNA Global Capital
Securities,
CLB 2/01/2007, 7.005%,
2/01/2027 # 2,000,000 1,648,456
............................................................
Sovereign Bancorp,
6.625%, 3/15/2001 7,150,000 6,971,943
............................................................
Unibanco Grand Cayman,
(Acquired 11/15/1999, cost
$3,978,316), 7.75%,
8/14/2000 r 4,000,000 3,980,000
..................... ...................... -----------
21,573,006
------------------------------------------------------------
BEVERAGES -- 0.8%
............................................................
Coca-Cola Femsa SA,
8.95%, 11/01/2006 2,875,000 2,889,375
------------------------------------------------------------
EUROBANKS -- 7.4%
............................................................
Foreningsbanken Kredit AB,
CLB 12/18/2001, 6.89%,
12/29/2049 # 5,750,000 5,739,587
............................................................
Nordbanken, CLB 10/25/2001,
6.8025%, 10/29/2049 # 6,680,000 6,597,636
............................................................
Okobank, CLB 10/25/2001, 6.62%,
9/29/2049 # 8,750,000 8,619,039
............................................................
Skandinavinska Enskilda
Banken,
CLB 6/28/2003, 7.1812%,
6/29/2049 # 3,700,000 3,601,950
............................................................
Svenska Hndls Banken,
CLB 3/03/2002, 6.6212%,
3/29/2049 # 3,250,000 3,206,489
..................... ...................... -----------
27,764,701
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
<S> <C> <C>
FINANCIAL SERVICES -- 12.8%
............................................................
AT & T Capital Corp.,
6.28%, 10/24/2000 # $ 2,750,000 $ 2,752,296
............................................................
Bear Stearns Co., Inc.,
6.45%, 8/01/2002 3,150,000 3,093,265
............................................................
Case Credit Corporation,
6.15%, 3/01/2002 4,000,000 3,914,432
............................................................
Countrywide Home Loans, Inc.,
6.655%, 3/16/2005 # 5,000,000 4,996,015
............................................................
Fuji Finance Grand Cayman:
7.30%, 3/29/2049 # 6,600,000 6,352,500
............................................................
6.5737%, 8/29/2049 # 2,400,000 2,292,000
............................................................
Golden State Holdings,
CLB 8/01/2000, 7.205%,
8/01/2003 # 9,900,000 9,436,531
............................................................
Lehman Brothers Holdings:
6.56%, 6/01/2001 # 800,000 799,696
............................................................
7.000%, 10/01/2002 5,000,000 4,954,650
............................................................
Providian National Bank,
CLB 4/10/2000, 6.7762%,
4/10/2001 # 4,000,000 3,996,560
............................................................
U.S. West Capital Funding:
(Acquired 6/03/1999, cost
$5,000,000), CLB 6/15/2000,
6.5712%, 6/15/2000 # r 5,000,000 4,998,970
............................................................
(Acquired 6/14/1999, cost
$249,985), CLB 6/15/2000,
6.5712%, 6/15/2000 # r 250,000 249,949
..................... ...................... -----------
47,836,864
------------------------------------------------------------
MISCELLANEOUS -- 0.7%
............................................................
Republic of Brazil,
11.625%, 4/15/2004 2,700,000 2,706,750
------------------------------------------------------------
OIL: INTEGRATED -- 2.0%
............................................................
YPF Sociedad Anonima,
8.00%, 2/15/2004 7,450,000 7,362,291
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
38
<PAGE> 761
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
RETAIL -- 4.3%
............................................................
Great Atlantic & Pacific Tea,
7.70%, 1/15/2004 $ 6,433,000 $ 6,140,401
............................................................
Rite Aid Corp.:
(Acquired 12/16/1998, cost
$3,943,167), 6.00%,
12/15/2000 r 3,950,000 3,416,750
............................................................
(Acquired 10/29/1999, cost
$1,705,229), 6.00%,
12/15/2000 r 2,000,000 1,730,000
............................................................
6.70%, 12/15/2001 5,650,000 4,774,250
..................... ...................... -----------
16,061,401
------------------------------------------------------------
STEEL -- 2.3%
............................................................
Pohang Iron & Steel,
6.625%, 7/01/2003 9,225,000 8,794,312
------------------------------------------------------------
TELECOMMUNICATIONS -- 1.9%
............................................................
Sprint Spectrum L.P.,
CLB 8/15/2001, 11.00%,
8/15/2006 3,000,000 3,316,920
............................................................
Telecom Argentina Stet. Fran.,
(Acquired 6/25/1999, cost
$3,995,000), 9.75%,
7/12/2001 r 4,000,000 4,005,000
..................... ...................... -----------
7,321,920
------------------------------------------------------------
TRANSPORTATION -- 1.7%
............................................................
Bombardier Capital, Inc.,
(Acquired 1/22/1999, cost
$6,711,147), 6.00%,
1/15/2002 r 6,725,000 6,557,756
------------------------------------------------------------
UTILITIES -- 1.8%
............................................................
CMS Energy Corp.,
CLB, 8.00%, 7/01/2001 # 5,000,000 4,943,510
............................................................
Korea Electric Power,
6.375%, 12/01/2003 1,050,000 993,955
............................................................
TXU Eastern Funding,
CLB, 6.45%, 5/15/2005 800,000 754,342
..................... ...................... -----------
6,691,807
------------------------------------------------------------
Total corporate bonds and
notes
(cost $158,244,967) 155,560,183
------------------------------------------------------------
<CAPTION>
GOVERNMENT AGENCY
MORTGAGE-BACKED Principal
SECURITIES 11.0% Amount Value
------------------------------------------------------------
<S> <C> <C>
COLLATERALIZED MORTGAGE OBLIGATIONS -- 10.8%
............................................................
Federal Home Loan Mortgage Corporation:
1564 SB, 7.6699%, 8/15/2008
# $ 512,496 $ 491,984
............................................................
1336 H, 7.75%, 1/15/2021 106,443 107,150
............................................................
1617 D, 6.50%, 11/15/2023 71,000 62,959
............................................................
2118 Z, CLB, 6.50%,
12/15/2028 685,957 544,195
............................................................
8.00%, 1/15/2030' 13,300,000 13,432,960
............................................................
Federal National Mortgage
Association:
1991-153 N, 7.50%, 2/25/2007 150,047 150,345
............................................................
1993-6 S, 6.72%, 1/25/2008 # 869,827 812,281
............................................................
1993-175 SD, 8.6319%,
9/25/2008 # 1,714,500 1,687,269
............................................................
1988-26 C, 7.50%, 7/25/2018 17,024 17,028
............................................................
1991-147 K, 7.00%, 1/25/2021 746 745
............................................................
1992-138 O, 7.50%, 7/25/2022 2,569 2,560
............................................................
1993-45 SB, 9.468%,
4/25/2023 # 406,833 349,357
............................................................
1997-59 SU, 8.3069%,
9/25/2023 # 706,053 672,349
............................................................
1994-60 D, 7.00%, 4/25/2024 30,000 28,295
............................................................
1997-76 FT, 6.8687%,
9/17/2027 # 870,528 810,760
............................................................
Pool #489814, 6.338%,
4/01/2029 9,994,883 9,714,829
............................................................
Pool #514230, 6.281%,
9/01/2029 1,884,540 1,818,260
............................................................
Pool #323977, 6.077%,
9/01/2039 10,265,977 9,840,762
..................... ...................... -----------
40,544,088
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
39
<PAGE> 762
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
STRIPPED MORTGAGE-BACKED SECURITIES -- 0.2%
Federal National Mortgage
Association:
1993-72 J (IO), 6.50%,
12/25/2006 $ 344,413 $ 12,650
............................................................
1993-97 L (IO), 7.50%,
5/25/2023 252,487 5,597
............................................................
1994-53 E (PO), 0.00%,
11/25/2023 517,217 428,760
............................................................
1998-48 CI (IO), 6.50%,
8/25/2028 606,039 125,315
..................... ...................... -----------
572,322
------------------------------------------------------------
Total government agency
mortgage-backed securities
(cost $41,574,482) 41,116,410
------------------------------------------------------------
NON-AGENCY MORTGAGE-BACKED
SECURITIES -- 27.3%
------------------------------------------------------------
ASSET-BACKED SECURITIES -- 18.0%
............................................................
ACC Automobile Receivables
Trust, (Acquired 6/24/1999,
cost $1,946,792), CLB,
1997-C A, 6.40%, 3/17/2004 r 1,942,543 1,937,482
............................................................
Asset Backed Funding
Certificates, CLB, 1999-1
A2F, 7.641%, 10/25/2030 4,104,095 4,095,120
............................................................
BankBoston Home Equity Loan
Trust, CLB, 1998-1 A1,
6.46%, 4/25/2012 628,022 625,576
............................................................
Champion Auto Grantor Trust,
(Acquired 3/18/1998, cost
$530,529), CLB, 1998-A A,
6.11%, 10/15/2002 r 530,538 529,874
............................................................
CIT Marine Trust, CLB, 1999-A A2,
5.80%, 4/15/2010 4,200,000 4,049,955
............................................................
Cityscape Home Equity Loan
Trust, (Acquired 9/09/1998, cost
$2,810,850) CLB, 1996-4 A10,
7.40%, 9/25/2027 r 2,769,310 2,689,261
............................................................
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
<S> <C> <C>
Commercial Financial Services
Securitized Multiple Asset
Rated Trust, (Acquired 9/24/1997,
cost $2,256,088), 1997-5 A1,
7.72%, 6/15/2005 r + $ 2,256,088 $ 676,827
............................................................
Commercial Mortgage Acceptance
Corporation, (Acquired 3/13/1998,
cost $1,174,904), CLB,
1996-C2 A2, 7.0341%,
9/15/2023 # r 1,162,012 1,150,956
............................................................
Commercial Resecuritization
Trust, (Acquired 2/10/1999,
cost $3,485,390), CLB,
1999-ABC1 A, 6.74%,
1/27/2009 r 3,522,264 3,346,151
............................................................
Countrywide Home Equity Loan
Trust, CLB, 1999-A CTFS,
6.7825%, 4/15/2025 # 1,144,827 1,148,908
............................................................
CPS Auto Trust, CLB, 1998-1 A,
6.00%, 8/15/2003 1,013,058 1,002,821
............................................................
DiTech Home Loan Owner Trust:
CLB, 1997-1 A2, 6.59%,
4/15/2013 477,360 476,450
............................................................
CLB, 1997-1 A3, 6.71%,
8/15/2018 3,280,000 3,253,186
............................................................
Firstplus Home Loan Trust,
CLB, 1998-4 A4, 6.32%,
3/10/2017 5,000,000 4,926,575
............................................................
First Tennessee Auto Grantor
Trust, (Acquired 4/17/1998,
cost $847,150), CLB, 1998-A
A, 6.134%, 4/15/2003 r 847,150 847,679
............................................................
GREAT, (Acquired 7/02/1998,
cost $2,704,018), 1998-1 A1,
7.33%, 9/15/2007 r + 2,704,018 811,205
............................................................
Green Tree Recreational,
Equipment & Consumer Trust:
CLB, 1996-C A1, 6.7025%,
10/15/2017 5,501,988 5,505,317
............................................................
CLB, 1996-B CTFS, 7.70%,
7/15/2018 2,250,000 2,160,394
............................................................
</TABLE>
See Notes to the Financial Statements
40
<PAGE> 763
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
Heilig-Meyers Master Trust,
(Acquired 2/20/1998, cost
$4,099,626), CLB, 1998-1A A,
6.125%, 1/20/2007 r $ 4,100,000 $ 3,940,777
............................................................
The Money Store Residential
Trust, CLB, 1998-I A2, 6.20%,
3/15/2008 501,128 500,153
............................................................
Nationslink Funding
Corporation:
CLB, 1999-SL A2, 6.096%,
12/10/2001 2,050,000 2,019,896
............................................................
CLB, 1999-2 A3, 7.181%,
12/20/2006 2,000,000 1,979,650
............................................................
CLB, 1999-SL A1V, 6.8187%,
4/10/2007 # 2,395,743 2,396,569
............................................................
CLB, 1999-2 A1C, 7.03%,
1/20/2008 596,990 589,286
............................................................
Nomura Asset Securities
Corporation:
CLB, 1995-MD3 A1A, 8.17%,
3/04/2020 1,873,101 1,900,589
............................................................
CLB, 1995-MD3 A1B,
8.15%, 3/04/2020 2,750,000 2,818,956
............................................................
Resolution Trust Corporation:
CLB, 1992-C8 A2, 7.85%,
12/25/2023 # 274,651 275,122
............................................................
CLB, 1994-C2 G, 8.00%,
4/25/2025 3,653,362 3,483,536
............................................................
CLB, 1994-C1 E, 8.00%,
6/25/2026 6,716,394 6,620,893
............................................................
CLB, 1994-C1 F, 8.00%,
6/25/2026 1,885,071 1,760,571
..................... ...................... -----------
67,519,735
------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 8.1%
............................................................
Blackrock Capital Finance L.P.,
(Acquired 6/23/1997, cost
$804,342), CLB, 1997-R2 AP,
8.15%, 12/25/2035 # r 809,273 835,982
............................................................
Citicorp Mortgage Securities,
Inc.,
CLB, 1997-3 A2, 6.92%,
8/25/2027 243,194 242,604
............................................................
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
<S> <C> <C>
Countrywide Funding Corporation,
CLB, 1994-17 A9, 8.00%,
7/25/2024 $ 4,000 $ 3,986
............................................................
First Union-Lehman Brothers
Commercial Mortgage Trust,
CLB, 1997-C1 A1, 7.15%,
2/18/2004 5,214,115 5,182,648
............................................................
Housing Securities, Inc.,
CLB, 1994-2 B1, 6.50%,
7/25/2009 196,538 150,106
............................................................
Independent National Mortgage
Corporation, CLB, 1995-A A4,
8.75%, 3/25/2025 4,155 4,162
............................................................
Morgan Stanley Mortgage Trust,
CLB, 34 6, 8.9712%,
6/22/2018 832,788 832,359
............................................................
Nomura Depositor Trust,
(Acquired 6/28/1999, cost
$12,405,588), CLB, 1998-ST1
A3, 7.0425%, 1/15/2003 # r 12,738,992 12,504,123
............................................................
Ocwen Residential MBS Corp.,
(Acquired 6/18/1998, cost
$2,943,073), CLB, 1998-R2
AP, 6.50056%,
11/25/2034 # r 2,946,756 2,919,163
............................................................
PNC Mortgage Securities Corp.,
CLB, 1997-3 1A5, 7.00%,
5/25/2027 4,820,291 4,786,428
............................................................
Prudential Home Mortgage
Securities, Co., CLB,
1993-36 A10, 7.25%,
10/25/2023 311,648 310,637
............................................................
Residential Funding Mortgage
Securities, Inc.:
CLB, 1993-S9 A8, 6.4167%,
2/25/2008 # 46,510 41,168
............................................................
CLB, 1998-S17 A6, 6.75%,
8/25/2028 1,285,607 1,281,474
............................................................
Salomon Brothers Mortgage
Securities VII,
CLB, 1994-6 A1, 6.95018%,
5/25/2024 # 524,293 523,111
............................................................
</TABLE>
See Notes to the Financial Statements
41
<PAGE> 764
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
Structured Mortgage Asset
Residential Trust:
CLB, 1992-3A AA, 8.00%,
10/25/2007 $ 99,711 $ 100,885
............................................................
CLB, 1991-1 H, 8.25%,
6/25/2022 63,085 63,793
............................................................
CLB, 1993-5A AA, 6.575%,
6/25/2024 # 35,613 33,722
............................................................
Walsh Acceptance,
(Acquired 3/06/1997, cost
$857,620), CLB, 1997-2 A,
6.625%, 3/01/2027 # r 850,972 711,625
..................... ...................... -----------
30,527,976
------------------------------------------------------------
PASS-THROUGH
SECURITIES -- 0.1%
............................................................
Citicorp Mortgage Securities,
Inc.:
CLB, 1988-16 A1, 10.00%,
11/25/2018 23,014 23,964
............................................................
CLB, 1989-8 A1, 10.50%,
6/25/2019 249,799 262,986
..................... ...................... -----------
286,950
------------------------------------------------------------
STRIPPED MORTGAGE-BACKED SECURITIES -- 1.1%
............................................................
Asset Securitization
Corporation,
1997-D5 ACS1 (IO), 2.09033%,
2/14/2041 # 67,887,788 2,045,458
............................................................
Chase Commercial Mortgage
Securities Corporation,
CLB, 1997-1 X (IO),
1.43733%, 4/19/2015 # 24,118,780 1,582,795
............................................................
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
<S> <C> <C>
CS First Boston Mortgage
Securities Corporation,
(Acquired 8/14/1997, cost
$949,235), CLB, 1995-WF1 AX
(IO), 1.35362%, 12/21/2027 #
r $15,041,831 $ 564,069
..................... ...................... -----------
4,192,322
------------------------------------------------------------
Total non-agency mortgage-
backed securities (cost
$108,447,135) 102,526,983
------------------------------------------------------------
<CAPTION>
PREFERRED
STOCK -- 0.3% Shares
------------------------------------------------------------
<S> <C> <C>
Home Ownership Funding 2,
(Acquired 2/20/1997, cost
$1,500,000) r 1,500 1,185,000
------------------------------------------------------------
<CAPTION>
U.S. TREASURY Principal
OBLIGATIONS -- 14.7% Amount
------------------------------------------------------------
<S> <C> <C>
U.S. Treasury Notes:
5.50%, 3/31/2000 " $19,000,000 19,005,947
............................................................
6.375%, 3/31/2001 34,150,000 34,235,375
............................................................
5.75%, 10/31/2002 2,000,000 1,972,500
------------------------------------------------------------
Total U.S. Treasury
obligations (cost
$55,296,764) 55,213,822
------------------------------------------------------------
SHORT-TERM INVESTMENTS -- 8.1%
------------------------------------------------------------
COMMERCIAL PAPER -- 6.2%
............................................................
MCI Communications Corporation,
5.78%, 1/27/2000 4(2) 8,000,000 7,966,604
............................................................
Norfolk Southern Corporation,
6.50%, 1/14/2000 4(2) 9,350,000 9,328,054
............................................................
Safeway Inc., 7.20%,
1/4/2000 4(2) 3,400,000 3,397,960
............................................................
Union Carbide Corp., 5.25%,
1/5/2000 4(2) 2,600,000 2,598,483
..................... ...................... -----------
23,291,101
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
42
<PAGE> 765
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
LOW DURATION FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
VARIABLE DEMAND NOTES* -- 1.9%
............................................................
General Mills, Inc., 6.095% $ 4,149,914 $ 4,149,914
............................................................
Pitney Bowes, Inc., 6.095% 1,735,989 1,735,989
............................................................
Sara Lee Corporation, 6.09% 1,032,454 1,032,454
..................... ...................... -----------
6,918,357
------------------------------------------------------------
Total short-term investments
(cost $30,209,458) 30,209,458
------------------------------------------------------------
Total investments -- 102.9%
(cost $395,272,806) 385,811,856
............................................................
Liabilities in excess of other
assets -- (2.9)% (10,855,228)
..................... ...................... -----------
$374,956,628
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
# -- Variable rate security. The rate listed is as of December 31, 1999.
* -- Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rates listed are as of December 31, 1999.
IO -- Interest Only.
PO -- Principal Only.
CLB -- Callable.
r -- Restricted Security. Purchased in a private placement transaction; resale
to the public may require registration or be limited to qualified institutional
buyers.
4(2) -- Restricted Security requiring resale to institutional investors.
+ -- Security Fair Valued under procedures established by the Board of Trustees
(See Note 1).
' -- When-issued security.
" -- Security marked as segregated to cover when-issued security.
See Notes to the Financial Statements
43
<PAGE> 766
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
SHORT-TERM INVESTMENT FUND
<TABLE>
<CAPTION>
CORPORATE BONDS Principal
AND NOTES -- 40.5% Amount Value
------------------------------------------------------------
<S> <C> <C>
AUTO -- 1.7%
............................................................
TRW Inc. (Acquired 6/18/1999,
cost $1,000,000), 6.6012%,
6/28/2000 # r $1,000,000 $ 1,000,114
------------------------------------------------------------
BANKS -- 5.0%
............................................................
Capital One Bank, 7.35%,
6/20/2000 800,000 802,898
............................................................
Korea Development Bank, 9.60%,
12/01/2000 675,000 688,340
............................................................
MBNA Corporation:
6.42%, 3/09/2000 # 500,000 500,010
............................................................
6.49%, 6/17/2002 # 500,000 497,627
............................................................
Unibanco Grand Cayman, (Acquired
11/15/99, cost $447,561),
7.75%, 8/14/2000 r 450,000 447,750
...................... ...................... ----------
2,936,625
------------------------------------------------------------
CABLE TELEVISION -- 1.7%
............................................................
Cox Communications Inc., CLB
2/28/2000, 6.04%, 8/15/2000 # 1,000,000 999,877
------------------------------------------------------------
BUILDING PRODUCTS: WOOD -- 1.5%
............................................................
Rayonier Inc., 6.4012%,
2/23/2001 # 900,000 899,855
------------------------------------------------------------
EUROBANKS -- 6.5%
............................................................
Foreningsbanken Kredit AB, CLB
12/18/2001, 6.89%, 12/29/2049
# 750,000 748,642
............................................................
Nordbanken, CLB 10/25/2001,
6.8025%, 10/29/2049 # 550,000 543,219
............................................................
Okobank, CLB 10/25/2001, 6.62%,
9/29/2049 # 1,050,000 1,034,285
............................................................
Skandinavinska Enskilda Banken,
CLB 6/28/2003, 7.1812%,
6/29/2049 # 800,000 778,800
............................................................
Svenska Hndls Banken, CLB
3/03/2002, 6.6212%, 3/29/2049
# 750,000 739,959
...................... ...................... ----------
3,844,905
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
<S> <C> <C>
FINANCIAL SERVICES -- 18.8%
............................................................
AT & T Capital Corp., 6.28%,
10/24/2000 # $ 500,000 $ 500,417
............................................................
Associates Corp. NA, 6.19%,
5/17/2002 # 1,000,000 999,723
............................................................
Bear Stearns Co. Inc., 6.39%,
3/15/2002 # 1,500,000 1,499,584
............................................................
Countrywide Home Loans, Inc.:
6.5612%, 3/19/2003 # 250,000 250,315
............................................................
6.655%, 3/16/2005 # 750,000 749,402
............................................................
Fuji Finance Grand Cayman,
6.5737%, 8/29/2049 # 750,000 716,250
............................................................
Golden State Holdings, CLB
8/01/2000, 7.205%, 8/01/2003 # 1,900,000 1,811,051
............................................................
Lehman Brothers Holdings, 6.56%,
6/01/2001 # 900,000 899,658
............................................................
National Westminster BK, 6.62%,
9/16/2002 # 1,000,000 1,001,662
............................................................
Orix Credit Alliance, (Acquired
4/6/99, cost $750,000), 6.40%,
1/31/2000 r 750,000 750,104
............................................................
Providian National Bank, CLB
4/10/2000, 6.7762%, 4/10/2001
# 1,000,000 999,140
............................................................
U.S. West Capital Funding,
(Acquired 6/03/1999, cost
$1,000,000), CLB 6/15/2000,
6.5712%, 6/15/2000 # r 1,000,000 999,794
...................... ...................... ----------
11,177,100
------------------------------------------------------------
OIL: INTEGRATED -- 0.8%
............................................................
Occidental Petroleum, 6.24%,
11/24/2000 450,000 446,951
------------------------------------------------------------
RETAIL -- 2.5%
............................................................
Rite Aid Corp.:
(Acquired 12/07/1999,
cost $1,124,263), 5.50%,
12/15/2000 r 1,250,000 1,081,250
............................................................
6.70%, 12/15/2001 500,000 422,500
...................... ...................... ----------
1,503,750
------------------------------------------------------------
</TABLE>
See Notes to the Financial Statements
44
<PAGE> 767
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
SHORT-TERM INVESTMENT FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
TELECOMMUNICATIONS -- 1.2%
............................................................
Sprint Spectrum L.P., CLB
8/15/2001, 11.00%, 8/15/2006 $ 650,000 $ 718,666
------------------------------------------------------------
UTILITIES -- 0.8%
............................................................
CMS Energy Corp., CLB, 8.00%,
7/01/2001 # 500,000 494,351
------------------------------------------------------------
Total corporate bonds and notes
(cost $24,158,718) 24,022,194
------------------------------------------------------------
GOVERNMENT AGENCY
MORTGAGE-BACKED
SECURITIES -- 2.1%
------------------------------------------------------------
COLLATERALIZED MORTGAGE
OBLIGATIONS -- 0.3%
............................................................
Federal Home Loan Mortgage
Corporation, CLB, 2118 Z,
6.50%, 12/15/2028 85,745 68,024
............................................................
Federal National Mortgage
Association, 1993-142 SA,
8.957%, 10/25/2022 # 109,939 102,272
...................... ...................... ----------
170,296
------------------------------------------------------------
PASS-THROUGH SECURITIES -- 1.7%
............................................................
Federal Housing Authority
Project, 7.43%, 2/01/2023 131,521 126,520
............................................................
Government National Mortgage
Association:
8570, 6.125%, 10/20/2019 # 197,551 199,377
............................................................
8346, 6.125%, 12/20/2023 # 704,265 708,431
...................... ...................... ----------
1,034,328
------------------------------------------------------------
STRIPPED MORTGAGE-BACKED
SECURITIES -- 0.1%
............................................................
Federal National Mortgage
Association:
1993-129 J (IO), 6.50%, 2/25/2007 465,424 29,493
............................................................
1993-97L (IO), 7.50%,
5/25/2023 93,118 2,064
...................... ...................... ----------
31,557
------------------------------------------------------------
Total government agency
mortgage-backed securities
(cost $1,278,113) 1,236,181
------------------------------------------------------------
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
<S> <C> <C>
NON-AGENCY MORTGAGE-
BACKED SECURITIES -- 22.7%
------------------------------------------------------------
ASSET-BACKED SECURITIES -- 18.7%
............................................................
ACC Automobile Receivables
Trust, (Acquired 6/24/1999,
cost $741,635), CLB, 1997-C A,
6.40%, 3/17/2004 r $ 740,016 $ 738,088
............................................................
Americredit Automobile
Receivables Trust, CLB, 1998-A
A2, 6.59875%, 11/05/2001 # 392,829 393,015
............................................................
Americredit Automobile
Receivables Trust, CLB, 1999-A
A2, 5.383%, 4/05/2002 754,608 752,711
............................................................
Associates Manufactured Housing
Pass-Through Certificates,
CLB, 1996-2 A4, 6.60%,
6/15/2027 500,000 494,482
............................................................
BankBoston Home Equity Loan
Trust, CLB, 1998-1 A1, 6.46%,
4/25/2012 216,559 215,716
............................................................
Champion Auto Grantor Trust,
(Acquired 10/28/97, cost
$27,721), CLB, 1997-D A,
6.27%, 9/15/2002 r 27,721 27,712
............................................................
CIT Marine Trust, CLB, 1999-A
A1, 5.45%, 9/15/2006 660,712 655,476
............................................................
Commercial Financial Services
Securitized Multiple Asset
Rated Trust, (Acquired
9/24/97, cost $360,974),
1997-5 A1, 7.72%, 6/15/2005 r
+ 360,974 108,292
............................................................
Countrywide Home Equity Loan
Trust, CLB, 1999-A CTFS,
6.7825%, 4/15/2025 # 915,862 919,127
............................................................
DiTech Home Loan Owner Trust,
CLB, 1997-1 A2, 6.59%,
4/15/2013 190,494 190,580
............................................................
Duck Auto Grantor Trust,
(Acquired 4/21/99, cost
$320,258), CLB, 1999-A A1,
5.65%, 3/15/2004 r 320,308 316,569
............................................................
</TABLE>
See Notes to the Financial Statements
45
<PAGE> 768
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
SHORT-TERM INVESTMENT FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
First Tennessee Auto Grantor
Trust, (Acquired 4/17/98, cost
$228,959), CLB, 1998A-A,
6.134%, 4/15/2003 r $ 228,959 $ 229,103
............................................................
Green Tree Home Improvement Loan
Trust, CLB, 1997-A, 7.21%,
3/15/2028 # 432,688 433,999
............................................................
Green Tree Recreational,
Equipment & Consumer Trust,
CLB, 1996-C, 6.7025%,
10/15/2017 # 640,231 640,619
............................................................
Harley-Davidson Eaglemark
Motorcycle Trust, CLB, 1999-A
A1, 5.25%, 7/15/2003 640,611 630,611
............................................................
Nationslink Funding Corporation,
CLB, 1999-SL A1V, 6.8187%,
4/10/2007 # 647,498 647,721
............................................................
Navistar Financial Corporation
Owner Trust, CLB, 1996-B A3,
6.33%, 4/21/2003 259,991 260,042
............................................................
Peco Energy Transition Trust,
CLB, 1999-A A3, 6.020%,
3/01/2006 # 1,000,000 997,365
............................................................
PNC Mortgage Securities Corp.,
CLB, 1997-3 1A5, 7.00%,
5/25/2027 1,500,000 1,489,463
............................................................
Resolution Trust Corporation:
1992- C8 A2, CLB, 7.85%,
12/25/2023 # 336,405 320,767
............................................................
1994-C2G A3, CLB, 8.00%,
4/25/2025 372,914 373,553
............................................................
Union Acceptance Corporation,
CLB, 1998-C A2, 5.44%,
10/09/2001 279,240 279,132
...................... ...................... ----------
11,114,143
------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS -- 4.0%
............................................................
Nomura Asset Securities
Corporation, CLB, 1995-MD3
A1A, 8.17%, 3/04/2020 787,467 799,023
............................................................
Nomura Depositor Trust,
(Acquired 9/03/1999, cost
$1,080,283), 1998-ST1 A3A,
7.0125%, 1/15/2003 # r 1,100,000 1,078,688
............................................................
</TABLE>
<TABLE>
------------------------------------------------------------
<CAPTION>
Principal
Amount Value
<S> <C> <C>
Residential Funding Mortgage
Securities, Inc., CLB,
1998-S17 A6, 6.75%, 8/25/2028 $ 128,561 $ 128,147
............................................................
Salomon Brothers Mortgage
Securities VI, CLB, 1986-1 A,
6.00%, 12/25/2011 244,232 239,115
............................................................
Walsh Acceptance, (Acquired
3/06/1997, cost $142,937),
CLB, 1997-2 A, 6.625%,
3/01/2027 # r 141,829 118,604
...................... ...................... ----------
2,363,577
------------------------------------------------------------
Total non-agency mortgage-backed
securities (cost $13,833,724) 13,477,720
------------------------------------------------------------
U.S. TREASURY
OBLIGATIONS -- 7.6%
------------------------------------------------------------
U.S. Treasury Notes:
5.75%, 10/31/2000 2,600,000 2,595,125
............................................................
6.25%, 6/30/2002 1,925,000 1,924,399
------------------------------------------------------------
Total U.S. Treasury obligations
(cost $4,574,121) 4,519,524
------------------------------------------------------------
SHORT-TERM INVESTMENTS -- 26.6%
------------------------------------------------------------
COMMERCIAL PAPER -- 5.7%
............................................................
Alpine Securitization, 5.25%,
1/11/2000 4(2) 1,100,000 1,098,396
............................................................
Armstrong World Industries,
Inc., 6.90%, 1/04/2000 4(2) 700,000 699,598
............................................................
MCI Communications Corporation,
5.78%, 1/27/2000 4(2) 1,100,000 1,095,408
............................................................
Tyco International Group SA,
6.25%, 1/10/2000 4(2) 500,000 499,219
...................... ...................... ----------
3,392,621
------------------------------------------------------------
VARIABLE DEMAND NOTES* -- 20.9%
............................................................
General Mills, Inc., 6.095% 2,900,000 2,900,000
............................................................
Pitney Bowes, Inc., 6.095% 2,899,485 2,899,485
............................................................
Sara Lee, Corp., 6.09% 2,900,000 2,900,000
............................................................
</TABLE>
See Notes to the Financial Statements
46
<PAGE> 769
SCHEDULE OF INVESTMENTS -- DECEMBER 31, 1999 (UNAUDITED)
--------------------------------------------------------------------------------
SHORT-TERM INVESTMENT FUND
<TABLE>
<CAPTION>
Principal
Amount Value
------------------------------------------------------------
<S> <C> <C>
Warner-Lambert Co., 6.044% $2,909,808 $ 2,909,808
............................................................
Wisconsin Electric, 6.0432% 790,794 790,794
...................... ...................... ----------
12,400,087
------------------------------------------------------------
Total short-term investments
(cost $15,792,708) 15,792,708
------------------------------------------------------------
Total investments -- 99.5% (cost
$59,637,384) 59,048,327
............................................................
Other assets in excess of
liabilities -- 0.5% 300,058
...................... ...................... ----------
$59,348,385
Total net assets -- 100.0%
------------------------------------------------------------
</TABLE>
# -- Variable rate security. The rate listed is as of December 31, 1999.
* -- Variable rate demand notes are considered short-term obligations and are
payable on demand. Interest rates change periodically on specified dates. The
rates listed are as of December 31, 1999.
IO -- Interest only.
CLB -- Callable.
r -- Restricted Security. Purchased in a private placement transaction; resale
to the public may require registration or be limited to qualified institutional
buyers.
+ -- Security Fair Valued under procedures established by the Board of Trustees
(See Note 1).
4(2) -- Restricted Security requiring resale to institutional investors.
See Notes to the Financial Statements
47
<PAGE> 770
STATEMENT OF ASSETS AND LIABILITIES
--------------------------------------------------------------------------------
DECEMBER 31, 1999 (UNAUDITED)
<TABLE>
<CAPTION>
Equity
Income Mid-Cap Small
Fund Fund Cap Fund
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ASSETS:
Investments, at value*.................................... $113,039,852 $6,958,529 $34,521,092
Cash...................................................... 161,496 -- --
Dividends and interest receivable......................... 330,080 14,503 26,936
Receivable for investments sold........................... -- -- 1,086,507
Receivable for Fund shares sold........................... 32 -- 591,717
Receivable for forward currency exchange contracts........ -- -- --
Prepaid expenses.......................................... 20,739 11,994 24,839
------------ ---------- -----------
Total assets.......................................... 113,552,199 6,985,026 36,251,091
------------ ---------- -----------
LIABILITIES:
Payable to Advisor........................................ 63,530 -- 22,018
Payable to Custodian...................................... -- -- --
Payable for investments purchased......................... -- -- --
Payable for Fund shares repurchased....................... 24,378 -- 738,387
Dividends payable......................................... -- -- --
Accrued expenses and other liabilities.................... 58,733 12,104 46,908
------------ ---------- -----------
Total liabilities..................................... 146,641 12,104 807,313
------------ ---------- -----------
Net assets............................................ $113,405,558 $6,972,922 $35,443,778
============ ========== ===========
NET ASSETS CONSIST OF:
Paid in capital........................................... $104,316,394 $7,677,008 $61,308,901
Undistributed (distributions in excess of) net investment
income.................................................. (10,118) 64,703 (35,979)
Undistributed net realized gain (loss) on securities...... 947,675 51,641 (10,689,102)
Net unrealized appreciation (depreciation) of securities
and foreign currency.................................... 8,151,607 (820,430) (15,140,042)
------------ ---------- -----------
Net assets............................................ $113,405,558 $6,972,922 $35,443,778
============ ========== ===========
CALCULATION OF NET ASSET VALUE PER SHARE -- INVESTOR CLASS:
Net assets................................................ $113,405,558 $6,972,922 $35,443,778
Shares outstanding (unlimited shares of no par value
authorized)............................................. 7,774,585 630,201 2,079,866
Net asset value per share (offering and redemption
price).................................................. $ 14.59 $ 11.06 $ 17.04
============ ========== ===========
CALCULATION OF NET ASSET VALUE PER SHARE -- DISTRIBUTOR
CLASS:
Net assets................................................
Shares outstanding (unlimited shares of no par value
authorized).............................................
Net asset value per share (offering and redemption
price)..................................................
*Cost of Investments........................................ $104,888,245 $7,778,959 $49,661,134
============ ========== ===========
</TABLE>
See Notes to the Financial Statements
48
<PAGE> 771
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Total Low Short-Term
International Global Equity Balanced Return Bond Duration Investment
Fund Fund Fund Fund Fund Fund
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$1,432,061,803 $7,396,594 $ 81,898,167 $147,132,538 $385,811,856 $59,048,327
-- 16,791 16 33 10,012 --
3,056,272 21,190 541,761 2,101,118 4,798,793 398,739
-- -- 14,542 33 67,365 2,342
1,869,038 -- 13,353 479,200 816,204 103,463
-- 1,732 -- -- -- --
64,774 14,965 23,780 23,797 28,157 18,854
-------------- ---------- ------------ ------------ ------------ -----------
1,437,051,887 7,451,272 82,491,619 149,736,719 391,532,387 59,571,725
-------------- ---------- ------------ ------------ ------------ -----------
893,475 -- 36,331 40,714 126,593 6,957
757,093 -- -- -- -- --
-- -- 2,948,031 4,574,531 13,520,281 --
6,724,882 -- 33,516 755,621 2,523,131 148,789
-- -- -- 312,639 156,595 44,053
1,059,406 3,805 77,036 112,520 249,159 23,541
-------------- ---------- ------------ ------------ ------------ -----------
9,434,856 3,805 3,094,914 5,796,025 16,575,759 223,340
-------------- ---------- ------------ ------------ ------------ -----------
$1,427,617,031 $7,447,467 $ 79,396,705 $143,940,694 $374,956,628 $59,348,385
============== ========== ============ ============ ============ ===========
$1,173,807,538 $7,063,345 $ 82,319,321 $152,069,770 $388,622,724 $60,051,011
(17,778,620) (31,983) (10,000) (49,648) 278,199 25,135
41,689,333 109,295 575,900 (3,353,047) (4,483,345) (138,704)
229,898,780 306,810 (3,488,516) (4,726,381) (9,460,950) (589,057)
-------------- ---------- ------------ ------------ ------------ -----------
$1,427,617,031 $7,447,467 $ 79,396,705 $143,940,694 $374,956,628 $59,348,385
============== ========== ============ ============ ============ ===========
$1,424,256,548 $7,447,467 $ 79,373,670 $110,465,166 $370,116,868 $59,348,385
53,954,161 664,977 4,812,775 8,864,722 37,689,120 5,919,974
$ 26.40 $ 11.20 $ 16.49 $ 12.46 $ 9.82 $ 10.03
============== ========== ============ ============ ============ ===========
$ 3,360,483 $ 23,035 $ 33,475,528 $ 4,839,760
127,411 1,401 2,686,095 492,815
$ 26.38 $ 16.44 $ 12.46 $ 9.82
============== ============ ============ ============
$1,202,065,453 $7,091,173 $ 85,386,683 $151,858,919 $395,272,806 $59,637,384
============== ========== ============ ============ ============ ===========
</TABLE>
See Notes to the Financial Statements
49
<PAGE> 772
STATEMENT OF OPERATIONS
--------------------------------------------------------------------------------
SIX MONTHS ENDED DECEMBER 31, 1999 (UNAUDITED)
<TABLE>
<CAPTION>
Equity Small
Income Mid-Cap Cap
Fund Fund Fund
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INVESTMENT INCOME:
Income*
Dividends.............................................. $ 1,876,960 $ 92,457 $ 200,900
Interest............................................... 86,414 11,400 31,190
------------ --------- ------------
Total income....................................... 1,963,374 103,857 232,090
------------ --------- ------------
Expenses
Advisory fee........................................... 476,836 25,499 157,383
Legal and auditing fees................................ 9,856 461 2,940
Custodian fees and expenses............................ 20,257 3,120 13,124
Accounting and transfer agent fees and expenses........ 62,987 22,964 59,894
Administration fee..................................... 25,522 1,341 7,920
Trustees' fees and expenses............................ 4,960 328 2,576
Reports to shareholders................................ 9,978 696 5,128
Registration fees...................................... 11,049 9,217 18,184
Distribution fees -- Distributor Class................. -- -- --
Other expenses......................................... 1,427 186 920
------------ --------- ------------
Total expenses..................................... 622,872 63,812 268,069
Less, expense reimbursement............................ (22,449) (24,713) --
------------ --------- ------------
Net expenses....................................... 600,423 39,099 268,069
------------ --------- ------------
Net investment income (loss)........................... 1,362,951 64,758 (35,979)
------------ --------- ------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain (loss) on securities and foreign
currency............................................. 5,223,752 422,331 (3,020,670)
Net change in unrealized appreciation (depreciation) of
securities and foreign currency...................... (24,026,333) (768,995) (6,462,941)
------------ --------- ------------
Net gain (loss) on investments........................... (18,802,581) (346,664) (9,483,611)
------------ --------- ------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM
OPERATIONS............................................... $(17,439,630) $(281,906) $ (9,519,590)
============ ========= ============
*Net of Foreign Taxes Withheld............................. $ -- $ -- $ --
============ ========= ============
</TABLE>
See Notes to the Financial Statements
50
<PAGE> 773
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Global Total Low Short-Term
International Equity Balanced Return Bond Duration Investment
Fund Fund Fund Fund Fund Fund
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$ 12,884,768 $ 83,122 $ 719,053 $ 31,845 $ 95,535 $ --
1,497,313 7,595 1,623,410 4,512,261 13,597,760 1,698,637
------------ -------- ----------- ----------- ------------ ----------
14,382,081 90,717 2,342,463 4,544,106 13,693,295 1,698,637
------------ -------- ----------- ----------- ------------ ----------
5,162,908 27,925 338,763 352,370 942,765 111,700
72,252 454 5,189 9,652 39,859 3,664
336,296 3,168 13,510 14,548 50,046 6,080
1,040,354 22,338 102,572 142,702 251,809 42,611
125,632 1,200 18,241 23,440 82,066 9,652
54,074 492 5,144 8,080 25,499 2,491
128,225 312 9,767 10,364 42,721 3,935
26,868 7,560 13,703 21,736 26,861 10,513
2,029 -- 6 7,866 3,809 --
16,884 264 1,792 1,228 5,205 684
------------ -------- ----------- ----------- ------------ ----------
6,965,522 63,713 508,687 591,986 1,470,640 191,330
-- (17,241) (77,996) (167,683) (278,127) (57,290)
------------ -------- ----------- ----------- ------------ ----------
6,965,522 46,472 430,691 424,303 1,192,513 134,040
------------ -------- ----------- ----------- ------------ ----------
7,416,559 44,245 1,911,772 4,119,803 12,500,782 1,564,597
------------ -------- ----------- ----------- ------------ ----------
71,438,690 356,120 1,119,593 (1,980,260) (2,461,971) 35,299
78,723,220 (294,700) (8,809,819) (1,867,033) (963,818) (220,531)
------------ -------- ----------- ----------- ------------ ----------
150,161,910 61,420 (7,690,226) (3,847,293) (3,425,789) (185,232)
------------ -------- ----------- ----------- ------------ ----------
$157,578,469 $105,665 $(5,778,454) $ 272,510 $ 9,074,993 $1,379,365
============ ======== =========== =========== ============ ==========
$ 1,475,105 $ 5,955 $ -- $ -- $ -- $ --
============ ======== =========== =========== ============ ==========
</TABLE>
See Notes to the Financial Statements
51
<PAGE> 774
STATEMENT OF CHANGES IN NET ASSETS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Equity Income Fund Mid-Cap Fund
--------------------------------- ---------------------------------
Six Months Ended Six Months Ended
December 31, 1999 Year Ended December 31, 1999 Year Ended
(Unaudited) June 30, 1999 (Unaudited) June 30, 1999
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OPERATIONS:
Net investment income (loss).......................... $ 1,362,951 $ 3,276,393 $ 64,758 $ 88,195
Net realized gain (loss) on securities and foreign
currency transactions............................... 5,223,752 18,492,251 422,331 (192,150)
Net change in unrealized appreciation (depreciation)
of securities and foreign currency.................. (24,026,333) (11,950,809) (768,995) 309,930
------------ ------------ ---------- ----------
Net increase (decrease) in net assets resulting
from operations................................. (17,439,630) 9,817,835 (281,906) 205,975
------------ ------------ ---------- ----------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- INVESTOR
CLASS:
Net investment income................................. (1,417,022) (3,285,265) (87,019) --
Net realized gain on securities transactions.......... (19,101,253) (24,468,165) (177,368) (807,762)
------------ ------------ ---------- ----------
Total dividends and distributions................. (20,518,275) (27,753,430) (264,387) (807,762)
------------ ------------ ---------- ----------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- DISTRIBUTOR
CLASS:
Net investment income.................................
Net realized gain on securities transactions..........
Total dividends and distributions.................
FUND SHARE TRANSACTIONS -- INVESTOR CLASS:
Net proceeds from shares sold......................... 32,498,358 45,268,422 1,648,646 3,117,822
Shares issued in connection with payment of dividends
and distributions................................... 19,320,808 25,424,531 122,027 806,204
Cost of shares redeemed............................... (49,190,022) (79,277,624) (1,122,138) (3,990,739)
------------ ------------ ---------- ----------
Net increase (decrease) in net assets from Fund
share transactions.............................. 2,629,144 (8,584,671) 648,535 (66,713)
------------ ------------ ---------- ----------
FUND SHARE TRANSACTIONS -- DISTRIBUTOR CLASS:
Net proceeds from shares sold.........................
Shares issued in connection with payment of dividends
and distributions...................................
Cost of shares redeemed...............................
Net increase (decrease) in net assets from Fund
share transactions..............................
Total increase (decrease) in net assets................... (35,328,761) (26,520,266) 102,242 (668,500)
NET ASSETS:
Beginning of period................................... 148,734,319 175,254,585 6,870,680 7,539,180
------------ ------------ ---------- ----------
End of period*........................................ $113,405,558 $148,734,319 $6,972,922 $6,870,680
============ ============ ========== ==========
* Including undistributed (distributions in excess of) net
investment income of:................................... $ (10,118) $ 43,953 $ 64,703 $ 86,963
============ ============ ========== ==========
CHANGES IN SHARES OUTSTANDING -- INVESTOR CLASS:
Shares sold........................................... 1,840,572 2,249,985 146,855 290,589
Shares issued in connection with payment of dividends
and distributions................................... 1,355,280 1,400,456 11,644 83,631
Shares redeemed....................................... (2,872,284) (4,157,729) (99,636) (386,607)
------------ ------------ ---------- ----------
Net increase (decrease)........................... 323,568 (507,288) 58,863 (12,387)
============ ============ ========== ==========
CHANGES IN SHARES OUTSTANDING -- DISTRIBUTOR CLASS:
Shares sold...........................................
Shares issued in connection with payment of dividends
and distributions...................................
Shares redeemed.......................................
Net increase......................................
</TABLE>
See Notes to the Financial Statements
52
<PAGE> 775
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Small Cap Fund International Fund Global Equity Fund
--------------------------------- ---------------------------------- ---------------------------------
Six Months Ended Six Months Ended Six Months Ended
December 31, 1999 Year Ended December 31, 1999 Year Ended December 31, 1999 Year Ended
(Unaudited) June 30, 1999 (Unaudited) June 30, 1999 (Unaudited) June 30, 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$ (35,979) $ (152,432) $ 7,416,559 $ 26,606,581 $ 44,245 $ 191,999
(3,020,670) (7,393,487) 71,438,690 70,779,798 356,120 80,356
(6,462,941) (9,556,411) 78,723,220 (42,099,206) (294,700) 75,740
------------ ------------ -------------- -------------- ---------- ----------
(9,519,590) (17,102,330) 157,578,469 55,287,173 105,665 348,095
------------ ------------ -------------- -------------- ---------- ----------
-- -- (37,662,544) (14,481,803) (202,208) (76,144)
-- (4,099,720) (75,054,381) (19,626,614) (290,200) (15,242)
------------ ------------ -------------- -------------- ---------- ----------
-- (4,099,720) (112,716,925) (34,108,417) (492,408) (91,386)
------------ ------------ -------------- -------------- ---------- ----------
(85,103)
(172,601)
--------------
(257,704)
--------------
15,348,532 92,751,659 1,131,365,232 2,002,009,131 256,135 857,258
-- 3,981,064 89,209,624 29,138,880 367,920 90,117
(23,761,932) (117,067,181) (1,219,837,170) (2,150,212,412) (351,741) (987,473)
------------ ------------ -------------- -------------- ---------- ----------
(8,413,400) (20,334,458) 737,686 (119,064,401) 272,314 (40,098)
------------ ------------ -------------- -------------- ---------- ----------
2,742,783 1,126,235
-- --
(513,252) --
-------------- --------------
2,229,531 1,126,235
-------------- --------------
(17,932,990) (41,536,508) 47,571,057 (96,759,410) (114,429) 216,611
53,376,768 94,913,276 1,380,045,974 1,476,805,384 7,561,896 7,345,285
------------ ------------ -------------- -------------- ---------- ----------
$ 35,443,778 $ 53,376,768 $1,427,617,031 $1,380,045,974 $7,447,467 $7,561,896
============ ============ ============== ============== ========== ==========
$ (35,979) $ -- $ (17,778,620) $ 12,552,468 $ (31,983) $ 125,981
============ ============ ============== ============== ========== ==========
866,113 4,577,685 42,550,297 85,591,643 22,553 79,898
-- 208,433 3,484,751 1,297,951 33,692 8,656
(1,325,277) (5,831,667) (45,676,362) (91,604,448) (30,195) (95,127)
------------ ------------ -------------- -------------- ---------- ----------
(459,164) (1,045,549) 358,686 (4,714,854) 26,050 (6,573)
============ ============ ============== ============== ========== ==========
102,165 44,593
-- --
(19,347) --
-------------- --------------
82,818 44,593
============== ==============
</TABLE>
See Notes to the Financial Statements
53
<PAGE> 776
STATEMENT OF CHANGES IN NET ASSETS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Balanced Fund
-----------------------------------------
Six Months Ended
December 31, 1999 Year Ended
(Unaudited) June 30, 1999
-------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS:
Net investment income................................... $ 1,911,772 $ 4,153,455
Net realized gain (loss) on securities and foreign
currency transactions.................................. 1,119,593 3,908,674
Net change in unrealized depreciation of securities and
foreign currency....................................... (8,809,819) (3,677,845)
------------ ------------
Net increase (decrease) in net assets resulting from
operations.......................................... (5,778,454) 4,384,284
------------ ------------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- INVESTOR
CLASS:
Net investment income................................... (1,994,250) (4,073,380)
Net realized gain on securities transactions............ (4,255,092) (4,515,885)
------------ ------------
Total dividends and distributions................... (6,249,342) (8,589,265)
------------ ------------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- DISTRIBUTOR
CLASS:
Net investment income................................... (277)
Net realized gain on securities transactions............ (1,189)
------------
Total dividends and distributions................... (1,466)
------------
FUND SHARE TRANSACTIONS -- INVESTOR CLASS:
Net proceeds from shares sold........................... 5,108,135 28,758,855
Shares issued in connection with payment of dividends
and distributions...................................... 6,058,710 8,305,107
Cost of shares redeemed................................. (17,663,362) (39,556,292)
------------ ------------
Net increase in net assets from Fund share
transactions........................................ (6,496,517) (2,492,330)
------------ ------------
FUND SHARE TRANSACTIONS -- DISTRIBUTOR CLASS:
Net proceeds from shares sold........................... 25,506
Shares issued in connection with payment of dividends
and distributions...................................... --
Cost of shares redeemed................................. (1,124)
------------
Net increase in net assets from Fund share
transactions........................................ 24,382
------------
Total increase (decrease) in net assets..................... (18,501,397) (6,697,311)
NET ASSETS:
Beginning of period..................................... 97,898,102 104,595,413
------------ ------------
End of period*.......................................... $ 79,396,705 $ 97,898,102
============ ============
* Including undistributed (distributions in excess of) net
investment income of:..................................... $ (10,000) $ 72,755
============ ============
CHANGES IN SHARES OUTSTANDING -- INVESTOR CLASS:
Shares sold............................................. 281,295 1,518,693
Shares issued in connection with payment of dividends
and distributions...................................... 367,750 445,955
Shares redeemed......................................... (989,551) (2,083,905)
------------ ------------
Net increase (decrease)............................. (340,506) (119,257)
============ ============
CHANGES IN SHARES OUTSTANDING -- DISTRIBUTOR CLASS:
Shares sold............................................. 1,465
Shares issued in connection with payment of dividends
and distributions...................................... --
Shares redeemed......................................... (64)
------------
Net increase........................................ 1,401
============
</TABLE>
See Notes to the Financial Statements
54
<PAGE> 777
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Total Return Bond Fund Low Duration Fund Short-Term Investment Fund
--------------------------------- --------------------------------- ---------------------------------
Six Months Ended Six Months Ended Six Months Ended
December 31, 1999 Year Ended December 31, 1999 Year Ended December 31, 1999 Year Ended
(Unaudited) June 30, 1999 (Unaudited) June 30, 1999 (Unaudited) June 30, 1999
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$ 4,119,803 $ 4,939,996 $ 12,500,782 $ 21,127,218 $ 1,564,597 $ 2,350,298
(1,980,260) (572,730) (2,461,971) (737,715) 35,299 (50,623)
(1,867,033) (3,760,047) (963,818) (9,809,554) (220,531) (407,341)
------------ ------------ ------------- ------------- ------------- ------------
272,510 607,219 9,074,993 10,579,949 1,379,365 1,892,334
------------ ------------ ------------- ------------- ------------- ------------
(3,864,492) (5,340,145) (12,695,145) (21,925,763) (1,520,861) (2,307,426)
-- (611,925) -- (642,509) -- --
------------ ------------ ------------- ------------- ------------- ------------
(3,864,492) (5,952,070) (12,695,145) (22,568,272) (1,520,861) (2,307,426)
------------ ------------ ------------- ------------- ------------- ------------
(225,322) (1,610) (124,350)
-- -- --
------------ ------------ -------------
(225,322) (1,610) (124,350)
------------ ------------ -------------
19,764,028 125,105,923 134,461,641 535,272,087 42,702,591 121,678,835
2,918,489 5,441,888 11,986,184 22,210,113 1,252,928 1,750,451
(32,873,034) (46,130,262) (182,650,402) (388,657,005) (35,321,983) (100,196,327)
------------ ------------ ------------- ------------- ------------- ------------
(10,190,517) 84,417,549 (36,202,577) 168,825,195 8,633,536 23,232,959
------------ ------------ ------------- ------------- ------------- ------------
35,167,878 349,125 6,872,268
-- 1,610 --
(1,888,987) -- (1,955,968)
------------ ------------ -------------
33,278,891 350,735 4,916,300
------------ ------------ -------------
19,271,070 79,421,823 (35,030,779) 156,836,872 8,492,040 22,817,867
124,669,624 45,247,801 409,987,407 253,150,535 50,856,345 28,038,478
------------ ------------ ------------- ------------- ------------- ------------
$143,940,694 $124,669,624 $ 374,956,628 $ 409,987,407 $ 59,348,385 $ 50,856,345
============ ============ ============= ============= ============= ============
$ (49,648) $ (79,367) $ 278,199 $ 596,912 $ 25,135 $ (18,601)
============ ============ ============= ============= ============= ============
1,555,942 9,353,948 13,574,729 52,973,512 4,245,644 12,032,563
231,351 408,076 1,217,099 2,201,641 124,980 173,571
(2,595,952) (3,450,832) (18,466,309) (38,637,818) (3,513,471) (9,911,294)
------------ ------------ ------------- ------------- ------------- ------------
(808,659) 6,311,192 (3,674,481) 16,537,335 857,153 2,294,840
============ ============ ============= ============= ============= ============
2,809,132 27,108 691,565
-- 125 --
(150,270) -- (198,751)
------------ ------------ -------------
2,658,862 27,233 492,814
============ ============ =============
</TABLE>
See Notes to the Financial Statements
55
<PAGE> 778
NOTES TO THE FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
DECEMBER 31, 1999 (UNAUDITED)
NOTE 1.
ACCOUNTING POLICIES. Hotchkis and Wiley Funds (the "Trust") is registered under
the Investment Company Act of 1940 as a diversified, open-end, management
investment company. The Trust was organized as a Massachusetts business trust on
August 22, 1984 and consists of ten series of shares comprising the Balanced
Fund, the Small Cap Fund, the Equity Income Fund, the International Fund, the
Total Return Bond Fund, the Low Duration Fund, the Short-Term Investment Fund,
the Mid-Cap Fund, the Global Equity Fund and the Equity Fund for Insurance
Companies (collectively, the "Funds"), the assets of which are invested in
separate, independently managed portfolios. The accompanying financial
statements exclude financial information for the Equity Fund for Insurance
Companies; financial statements for that Fund are reported on separately.
Investment operations of the Funds began on August 13, 1985 (the Balanced Fund),
September 20, 1985 (the Small Cap Fund), June 24, 1987 (the Equity Income Fund),
October 1, 1990 (the International Fund), January 29, 1993 (the Equity Fund for
Insurance Companies), May 18, 1993 (the Low Duration Fund and the Short-Term
Investment Fund), December 6, 1994 (the Total Return Bond Fund), and January 2,
1997 (the Mid-Cap Fund and the Global Equity Fund).
The Balanced Fund seeks to preserve capital while producing a high total return.
The Small Cap Fund seeks capital appreciation. The Equity Income Fund seeks
current income and long-term growth of income, accompanied by growth of capital.
The International Fund seeks current income and long-term growth of income,
accompanied by growth of capital. The Total Return Bond Fund seeks to maximize
long-term total return. The Low Duration Fund seeks to maximize total return,
consistent with preservation of capital. The Short-Term Investment Fund seeks to
maximize total return, consistent with preservation of capital. The Mid-Cap Fund
seeks current income and long-term growth of income, accompanied by growth of
capital. The Global Equity Fund seeks current income and long-term growth of
income, accompanied by growth of capital. The following is a summary of
significant accounting policies followed by the Funds in the preparation of the
financial statements.
Effective April 1, 1999, the Balanced, Small Cap, International, Total Return
Bond and Low Duration Funds have issued two classes of shares: Investor Class
and Distributor Class. Distributor Class shares are subject to an annual Rule
12b-1 fee of 0.25% of average net assets of the Distributor Class shares.
Investor Class shares do not pay a 12b-1 fee. Each class of shares for each Fund
has identical rights and privileges except with respect to Rule 12b-1 fees paid
by the Distributor Class, voting rights on any other matters pertaining to a
single class of shares and the exchange privileges of each class of shares. As
of December 31, 1999, the Small Cap Fund had no Distributor Class activity
except for the purchase of one share by Hotchkis and Wiley (the "Advisor")
representing net assets of $17.
SECURITY VALUATION: Portfolio securities that are listed on a securities
exchange (whether domestic or foreign) or The Nasdaq Stock Market ("NSM") are
valued at the last sale price as of 4:00 p.m., Eastern Time, or, in the absence
of recorded sales, at the average of readily available closing bid and asked
prices on such exchange or NSM. Unlisted securities that are not included in NSM
are valued at the average of the quoted bid and asked price in the
over-the-counter market. Fixed-income securities are normally valued on the
basis of quotes obtained from broker/dealers or pricing services. Certain
fixed-income securities for which daily market quotations are not readily
available may be valued pursuant to guidelines established by the Board of
Trustees, with reference to
56
<PAGE> 779
fixed-income securities whose prices are more readily obtainable or an
appropriate matrix utilizing similar factors. As a broader market does not
exist, the proceeds received upon the disposal of such securities may differ
from quoted values previously furnished by such market makers. Securities for
which market quotations are not otherwise available are valued at fair value as
determined in good faith by the Advisor under procedures established by the
Board of Trustees. Short-term investments which mature in less than 60 days are
valued at amortized cost (unless the Board of Trustees determines that this
method does not represent fair value), if their original maturity was 60 days or
less, or by amortizing the values as of the 61st day prior to maturity, if their
original term to maturity exceeded 60 days. Investments quoted in foreign
currency are valued daily in U.S. dollars on the basis of the foreign currency
exchange rate prevailing at the time of valuation.
FOREIGN CURRENCY TRANSLATIONS: The books and records of the Funds are maintained
in U.S. dollars. For the International Fund and the Global Equity Fund, foreign
currency transactions are translated into U.S. dollars on the following basis:
(i) market value of investment securities, assets and liabilities at the daily
rates of exchange, and (ii) purchases and sales of investment securities,
dividend and interest income and certain expenses at the rates of exchange
prevailing on the respective dates of such transactions. The International Fund
and the Global Equity Fund do not isolate and treat as ordinary income that
portion of the results of operations arising as a result of changes in the
exchange rate from the fluctuations arising from changes in the market prices of
securities held during the period. However, for federal income tax purposes, the
International Fund and the Global Equity Fund do isolate and treat as ordinary
income the effect of changes in foreign exchange rates arising from actual
foreign currency transactions and the effect of changes in foreign exchange
rates arising from trade date and settlement date differences.
FORWARD CURRENCY EXCHANGE CONTRACTS: The International Fund and the Global
Equity Fund utilize forward currency exchange contracts for the purpose of
hedging foreign currency risk. Under these contracts, they are obligated to
exchange currencies at specific future dates. Risks arise from the possible
inability of counter-parties to meet the terms of their contracts and from
movements in currency values.
FEDERAL INCOME TAXES: It is each Fund's policy to meet the requirements of the
Internal Revenue Code applicable to regulated investment companies and each Fund
intends to distribute substantially all of its investment company net taxable
income and net capital gains to shareholders. Therefore, no federal income tax
provision is required.
INCOME AND EXPENSE ALLOCATION: Common expenses incurred by the Funds are
allocated among the Funds based upon (i) relative average net assets, (ii) as
incurred on a specific identification basis, or (iii) evenly among the Funds,
depending on the nature of the expenditure. Net investment income, other than
class-specific expenses, and realized and unrealized gains and losses are
allocated daily to each class of shares based upon the relative net asset value
of outstanding shares of each class of shares at the beginning of the day (after
adjusting for the current day's capital share activity of the respective class).
RESTRICTED SECURITIES: The Balanced, Total Return Bond, Low Duration and
Short-Term Investment Funds own investment securities which are unregistered and
thus restricted as to resale. Resales of such securities may require
registration or be limited to qualified institutional buyers. At December 31,
1999, the Balanced, Total Return Bond, Low Duration and Short-Term Investment
Funds had restricted securities with an aggregate market value of $7,046,604,
$19,643,128, $60,336,371 and $6,896,068, respectively, representing 9%, 14%, 16%
and 12% of the net assets of each Fund, respectively. Of these amounts, the
Balanced, Total Return Bond, Low Duration and Short-Term Investment Funds had
restricted securities that were determined to be illiquid pursuant
57
<PAGE> 780
to guidelines adopted by the Board of Trustees with an aggregate market value of
$331,242, $155,613, $2,913,831 and $353,416, respectively, representing .4%,
.1%, .8% and .6% of the net assets of each Fund, respectively.
WHEN-ISSUED SECURITIES: The Funds may purchase securities on a when-issued or
delayed delivery basis. Although the payment and interest terms of these
securities are established at the time the purchaser enters into the agreement,
these securities may be delivered and paid for at a future date, generally
within 45 days. The Funds record purchases of when-issued securities and reflect
the values of such securities in determining net asset value in the same manner
as other portfolio securities. The Funds maintain at all times cash or other
liquid assets in an amount at least equal to the amount of outstanding
commitments for when-issued securities.
USE OF ESTIMATES: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
DISTRIBUTIONS TO SHAREHOLDERS: Dividends from net investment income are declared
and paid monthly for the Total Return Bond, Low Duration and Short-Term
Investment Funds, declared and paid quarterly for the Balanced and Equity Income
Funds and declared and paid annually for the Mid-Cap, Small Cap, International
and Global Equity Funds. Distributions of net realized capital gains, if any,
will be declared and paid at least annually. The Funds may utilize earnings and
profits distributed to shareholders on redemption of shares as part of the
dividends paid deduction.
OTHER: Security and shareholder transactions are recorded on trade date.
Realized gains and losses on sales of investments are calculated on the
identified cost basis. Dividend income and dividends and distributions to
shareholders are recorded on the ex-dividend date. Interest income is recognized
on the accrual basis. Generally accepted accounting principles require that
permanent financial reporting and tax differences relating to shareholder
distributions be reclassified within the capital accounts.
NOTE 2.
INVESTMENT ADVISORY AGREEMENTS. Each Fund has an investment advisory agreement
with the Advisor with whom certain officers and Trustees of the Trust are
affiliated. The Advisor is a division of Merrill Lynch Asset Management, L.P.,
an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. The Advisor
receives a fee, computed daily and payable monthly, at the annual rates
presented below as applied to each Fund's daily net assets. For certain of the
Funds, the Advisor has voluntarily agreed to pay all operating expenses in
excess of the
58
<PAGE> 781
annual rates presented below as applied to such Fund's daily net assets. For the
six months ended December 31, 1999, the Advisor reimbursed the following
expenses:
<TABLE>
<CAPTION>
International International Balanced Balanced
Fund -- Fund -- Fund -- Fund --
Equity Income Mid-Cap Small Cap Investor Distributor Global Equity Investor Distributor
Fund Fund Fund Class Class Fund Class Class
----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Annual Advisory
Rate............... 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75%
Annual Cap on
Expenses........... 0.95% 1.15% -- -- -- 1.25% 0.95% 1.20%
Expenses
Reimbursed......... $22,449 $24,713 $0 $0 $0 $17,241 $77,991 $5
</TABLE>
<TABLE>
<CAPTION>
Total Return Total Return Low Duration Low Duration
Bond Fund -- Bond Fund -- Fund -- Fund -- Short-Term
Investor Class Distributor Class Investor Class Distributor Class Investment Fund
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Annual Advisory Rate......... 0.55% 0.55% 0.46% 0.46% 0.40%
Annual Cap on Expenses....... 0.65% 0.90% 0.58% 0.83% 0.48%
Expenses Reimbursed.......... $159,483 $8,200 $276,361 $1,766 $57,290
</TABLE>
The Trust has adopted a plan pursuant to Rule 12b-1 under the Investment Company
Act of 1940 (the "12b-1 Plan") that allows the Distributor Class of the Small
Cap, International, Balanced, Total Return Bond and Low Duration Funds to make
payments to administrators, broker/dealers or other institutions that provide
accounting, recordkeeping or other services to investors and that have an
administrative services agreement with the Trust or the Advisor to make
Distributor Class shares available to their clients ("Recipients"). Recipients
are paid an annual rate of 0.25% of the average net assets of the Distributor
Class shares invested through the Recipient as compensation for providing
distribution-related services such as advertising, printing and mailing
prospectuses to potential investors and training sales personnel regarding the
Funds. During the period ended December 31, 1999, the Distributor Class of the
International, Balanced, Total Return Bond and Low Duration Funds incurred
expenses of $2,029, $6, $7,866 and $3,809, respectively, pursuant to the 12b-1
Plan.
Certain authorized agents of the Funds charge a fee for accounting and
shareholder services that they provide to the Funds on behalf of certain
shareholders; the portion of this fee paid by the Funds is included within
Accounting and transfer agent fees and expenses in the Statement of Operations.
The Advisor has entered into subadvisory agreements with Mercury Asset
Management International Limited and Merrill Lynch Asset Management U.K.
Limited, affiliated investment advisors that are indirect subsidiaries of
Merrill Lynch & Co., Inc. The subadvisory arrangements are for investment
research, recommendations, and other investment-related services to be provided
to the International and Global Equity Funds. There is no increase in the
aggregate fees paid by the Funds for these services.
The International and Global Equity Funds paid commissions on Fund transactions
to an affiliated broker in the amounts of $212,433 and $69, respectively, during
the six months ended December 31, 1999.
As permitted under Rule 10f-3 of the Investment Company Act of 1940, the Board
of Trustees of the Trust has adopted procedures which allow the Funds, under
certain conditions described in the Rule, to acquire newly-issued securities
from a member of an underwriting group in which an affiliated underwriter
participates.
59
<PAGE> 782
NOTE 3.
CREDIT FACILITY. Effective December 3, 1999, the Funds entered into a one year
Credit Agreement with a syndicate of bank lenders led by Bank of America
intended to provide the Funds with a source of cash to be used to meet
redemption requests from the Funds' shareholders. The Funds together with
certain other open-end investment companies advised by Merrill Lynch Asset
Management, L.P. and/or its affiliates may borrow in the aggregate up to
$1,000,000,000, except that in no event may the borrowing by the Funds or any
participating fund be in excess of that permitted by its prospectus and
Statement of Additional Information or by applicable law. The Funds had no
borrowings under the Credit Agreement for the six months ended December 31,
1999.
NOTE 4.
SECURITIES TRANSACTIONS. Purchases and sales of investment securities, other
than short-term investments, for the six months ended December 31, 1999 were as
follows:
<TABLE>
<CAPTION>
Purchases Sales
------------------------------ ------------------------------
Fund U.S. Government Other U.S. Government Other
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Equity Income Fund............................. -- $ 31,795,407 -- $ 49,595,474
Mid-Cap Fund................................... -- 4,391,764 -- 4,093,863
Small Cap Fund................................. -- 15,169,413 -- 23,691,837
International Fund............................. -- 345,820,287 -- 402,438,351
Global Equity Fund............................. -- 1,966,164 -- 2,209,205
Balanced Fund.................................. $ 26,647,233 17,080,790 $ 39,633,021 18,364,549
Total Return Bond Fund......................... 120,023,490 61,212,550 112,625,756 48,150,924
Low Duration Fund.............................. 154,380,521 108,162,272 177,958,267 134,190,831
Short-Term Investment Fund..................... 2,571,695 9,560,986 1,514,992 12,776,103
</TABLE>
As of December 31, 1999, unrealized appreciation (depreciation) for federal
income tax purposes was as follows:
<TABLE>
<CAPTION>
Net Appreciation Appreciated Depreciated
Fund (Depreciation) Securities Securities
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Equity Income Fund.......................................... $ 8,151,607 $ 21,226,901 $(13,075,294)
Mid-Cap Fund................................................ (820,430) 539,253 (1,359,683)
Small Cap Fund.............................................. (15,140,042) 2,647,821 (17,787,863)
International Fund.......................................... 229,898,780 303,500,865 (73,602,085)
Global Equity Fund.......................................... 306,810 1,342,689 (1,035,879)
Balanced Fund............................................... (3,488,516) 5,960,436 (9,448,952)
Total Return Bond Fund...................................... (4,726,381) 350,873 (5,077,254)
Low Duration Fund........................................... (9,460,950) 922,805 (10,383,755)
Short-Term Investment Fund.................................. (589,057) 64,294 (653,351)
</TABLE>
At December 31, 1999, the cost of investments for federal income tax purposes
was $104,888,245, $7,778,959, $49,661,134, $1,202,065,453, $7,091,173,
$85,386,683, $151,858,919, $395,272,806 and $59,637,384 for the Equity Income,
Mid-Cap, Small Cap, International, Global Equity, Balanced, Total Return Bond,
Low Duration and Short-Term Investment Funds, respectively. Any differences
between book and tax are due primarily to wash sale losses.
60
<PAGE> 783
At December 31, 1999, the following Funds deferred, on a tax basis, post-October
losses of:
<TABLE>
<CAPTION>
Fund Post-October Losses
-----------------------------------------------------------------------------------
<S> <C>
Mid-Cap Fund................................................ $ 339,647
Small Cap Fund.............................................. 4,058,500
Total Return Bond Fund...................................... 1,372,787
Low Duration Fund........................................... 1,293,682
Short-Term Investment Fund.................................. 73,268
</TABLE>
Such amounts may be used to offset future capital gains.
At December 31, 1999, the Small Cap Fund had accumulated net realized capital
loss carryovers of $1,842,953 expiring in 2007. The Low Duration Fund had
accumulated net realized capital loss carryovers of $723,707 expiring in 2007.
The Short-Term Investment Fund had accumulated net realized capital loss
carryovers of $61,761 expiring in 2004 and $38,974 expiring in 2005. To the
extent that the Funds realize future net capital gains, those gains will be
offset by any unused capital loss carryover.
NOTE 5.
FORWARD CURRENCY EXCHANGE CONTRACT. At December 31, 1999, the Global Equity Fund
had entered into a "portfolio hedge" forward currency exchange contract that
obligates the Fund to deliver and receive currency at a specified future date.
The net unrealized appreciation of $1,732 is included in the net unrealized
appreciation (depreciation) section of the accompanying financial statements.
The terms of the open contract are as follows:
<TABLE>
<CAPTION>
Settlement Currency to U.S. $ Value at Currency to U.S. $ Value at
Date be Delivered December 31, 1999 be Received December 31, 1999
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
2/29/2000............ 28,277,000 Japanese Yen $279,575 28,277,000 Japanese Yen $281,307
</TABLE>
61
<PAGE> 784
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
Six Months Ended ------------------------------------------
December 31, 1999 1999 1998 1997 1996
EQUITY INCOME FUND (Unaudited) 1995
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period.............. $ 19.96 $22.02 $21.25 $18.91 $17.24 $15.07
------- ------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income......................... 0.19 0.41 0.46 0.49 0.45 (1) 0.49
Net realized and unrealized gain (loss) on
investments................................. (2.56) 0.82 4.02 4.15 2.89 2.48
------- ------ ------ ------ ------ ------
Total from investment operations.............. (2.37) 1.23 4.48 4.64 3.34 2.97
------- ------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income)........ (0.20) (0.41) (0.46) (0.48) (0.57) (0.44)
Distributions (from realized gains)........... (2.80) (2.88) (3.25) (1.82) (1.10) (0.36)
------- ------ ------ ------ ------ ------
Total distributions........................... (3.00) (3.29) (3.71) (2.30) (1.67) (0.80)
------- ------ ------ ------ ------ ------
Net Asset Value, End of Period.................... $ 14.59 $19.96 $22.02 $21.25 $18.91 $17.24
======= ====== ====== ====== ====== ======
TOTAL RETURN...................................... (11.40)%++ 7.32% 22.60% 26.15% 20.04% 20.49%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions).............. $ 113.4 $148.7 $175.3 $185.9 $182.5 $127.1
Ratio of expenses to average net assets:
Before expense reimbursement.................. 0.98%+ 0.91% 0.87% 0.88% 0.98% 1.02%
After expense reimbursement................... 0.95%+ 0.91% 0.87% 0.88% 0.98% 1.00%
Ratio of net investment income to average net
assets:
Before expense reimbursement.................. 2.11%+ 2.09% 1.99% 2.49% 2.56% 3.11%
After expense reimbursement................... 2.14%+ 2.09% 1.99% 2.49% 2.56% 3.14%
Portfolio turnover rate........................... 25%++ 18% 23% 44% 24% 50%
</TABLE>
(1) Net investment income per share is calculated using ending balances prior to
consideration of adjustments for permanent book and tax differences.
+ Annualized.
++ Not Annualized.
See Notes to the Financial Statements
62
<PAGE> 785
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
Six Months Ended -------------------- January 2, 1997*
December 31, 1999 1999 1998 through
MID-CAP FUND (Unaudited) June 30, 1997
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period.................. $12.03 $12.92 $11.65 $10.00
------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income............................. 0.09 0.16 0.13 0.07
Net realized and unrealized gain (loss) on
investments..................................... (0.63) 0.46 1.60 1.64
------ ------ ------ ------
Total from investment operations.................. (0.54) 0.62 1.73 1.71
------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income)............ (0.14) -- (0.14) (0.06)
Distributions (from realized gains)............... (0.29) (1.51) (0.32) --
------ ------ ------ ------
Total distributions............................... (0.43) (1.51) (0.46) (0.06)
------ ------ ------ ------
Net Asset Value, End of Period........................ $11.06 $12.03 $12.92 $11.65
====== ====== ====== ======
TOTAL RETURN.......................................... (4.22)%++ 7.66% 15.00% 17.15%++
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions).................. $ 7.0 $6.9 $7.5 $2.0
Ratio of expenses to average net assets:
Before expense reimbursement...................... 1.88%+ 2.02% 2.72% 8.26%+
After expense reimbursement....................... 1.15%+ 1.05% 1.00% 1.00%+
Ratio of net investment income (loss) to average net
assets:
Before expense reimbursement...................... 1.17%+ 0.46% (0.52)% (5.39)%+
After expense reimbursement....................... 1.90%+ 1.43% 1.20% 1.87%+
Portfolio turnover rate............................... 65%++ 113% 71% 23%++
</TABLE>
* Commencement of operations.
+ Annualized.
++ Not Annualized.
See Notes to the Financial Statements
63
<PAGE> 786
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
Six Months Ended ------------------------------------------
December 31, 1999 1999 1998 1997 1996
SMALL CAP FUND (Unaudited) 1995
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period.............. $ 21.02 $26.48 $23.83 $21.33 $21.53 $19.53
------- ------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss).................. (0.02) (0.05)(2) (0.06)(1) 0.03 0.05(1) (0.06)
Net realized and unrealized gain (loss) on
investments................................. (3.96) (3.88) 5.13 5.62 2.80 2.84
------- ------ ------ ------ ------ ------
Total from investment operations.............. (3.98) (3.93) 5.07 5.65 2.85 2.78
------- ------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income)........ -- -- (0.05) (0.09) -- --
Distributions (from realized gains)........... -- (1.53) (2.37) (3.06) (3.05) (0.78)
------- ------ ------ ------ ------ ------
Total distributions........................... -- (1.53) (2.42) (3.15) (3.05) (0.78)
------- ------ ------ ------ ------ ------
Net Asset Value, End of Period.................... $ 17.04 $21.02 $26.48 $23.83 $21.33 $21.53
======= ====== ====== ====== ====== ======
TOTAL RETURN...................................... (18.94)%++ (14.26)% 22.24% 29.74% 14.24% 14.79%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions).............. $35.4 $53.4 $94.9 $27.5 $16.5 $20.5
Ratio of expenses to average net assets:
Before expense reimbursement.................. 1.28%+ 1.19% 0.94% 1.30% 1.21% 1.49%
After expense reimbursement................... 1.28%+ 1.05% 0.94% 1.00% 1.00% 1.00%
Ratio of net investment income (loss) to average
net assets:
Before expense reimbursement.................. (0.17)%+ (0.40)% (0.23)% (0.20)% 0.03% (0.82)%
After expense reimbursement................... (0.17)%+ (0.26)% (0.23)% 0.10% 0.24% (0.34)%
Portfolio turnover rate........................... 37%++ 105% 85% 88% 119% 81%
</TABLE>
(1) Net investment income per share represents net investment income divided by
the average shares outstanding throughout the year.
(2) Net investment income per share is calculated using ending balances prior to
consideration of adjustments for permanent book and tax differences.
+ Annualized.
++ Not Annualized.
See Notes to the Financial Statements
64
<PAGE> 787
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Investor Class Distributor Class Distributor Class
Six Months Ended Six Months Ended Investor Class June 2, 1999*
INTERNATIONAL December 31, 1999 December 31, 1999 Year Ended through
FUND (Unaudited) (Unaudited) June 30, 1999 June 30, 1999
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period......................... $ 25.73 $25.72 $ 25.33 $25.20
-------- ------ -------- ------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income........ 0.20 0.17 0.59 0.05
Net realized and unrealized
gain on investments........ 2.74 2.74 0.40 0.47
-------- ------ -------- ------
Total from investment
operations................. 2.94 2.91 0.99 0.52
-------- ------ -------- ------
LESS DISTRIBUTIONS:
Dividends (from net
investment income)......... (0.76) (0.74) (0.25) --
Distributions (from realized
gains)..................... (1.51) (1.51) (0.34) --
-------- ------ -------- ------
Total distributions.......... (2.27) (2.25) (0.59) --
-------- ------ -------- ------
Net Asset Value, End of Period... $ 26.40 $26.38 $ 25.73 $25.72
======== ====== ======== ======
TOTAL RETURN..................... 11.67%++ 11.58%++ 4.22% 2.06%++
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period
(millions)..................... $1,424.2 $3.4 $1,378.9 $1.1
Ratio of expenses to average net
assets:
Before expense
reimbursement.............. 1.01%+ 1.26%+ 0.95% 1.30%+
After expense
reimbursement.............. 1.01%+ 1.26%+ 0.95% 1.30%+
Ratio of net investment income to
average net assets:
Before expense
reimbursement.............. 1.08%+ 0.83%+ 1.98% 2.77%+
After expense
reimbursement.............. 1.08%+ 0.83%+ 1.98% 2.77%+
Portfolio turnover rate.......... 27%++,+++ 27%++,+++ 41%+++ 41%++,+++
<CAPTION>
Investor Class
Year Ended June 30,
INTERNATIONAL -------------------------------------
FUND 1998 1997 1996 1995
--------------------------------- -------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period......................... $ 24.17 $20.44 $17.70 $16.79
-------- ------ ------ ------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income........ 0.59 0.59(1) 0.56(1) 0.28
Net realized and unrealized
gain on investments........ 1.23 3.78 2.51 1.52
-------- ------ ------ ------
Total from investment
operations................. 1.82 4.37 3.07 1.80
-------- ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net
investment income)......... (0.66) (0.48) (0.14) (0.44)
Distributions (from realized
gains)..................... -- (0.16) (0.19) (0.45)
-------- ------ ------ ------
Total distributions.......... (0.66) (0.64) (0.33) (0.89)
-------- ------ ------ ------
Net Asset Value, End of Period... $ 25.33 $24.17 $20.44 $17.70
======== ====== ====== ======
TOTAL RETURN..................... 7.77% 21.59% 18.61% 11.08%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period
(millions)..................... $1,476.8 $888.5 $331.0 $51.5
Ratio of expenses to average net
assets:
Before expense
reimbursement.............. 0.89% 1.07% 1.11% 1.39%
After expense
reimbursement.............. 0.89% 1.00% 1.00% 1.00%
Ratio of net investment income to
average net assets:
Before expense
reimbursement.............. 2.32% 2.59% 2.67% 2.45%
After expense
reimbursement.............. 2.32% 2.66% 2.78% 2.83%
Portfolio turnover rate.......... 20% 18% 12% 24%
</TABLE>
(1) Net investment income per share represents net investment income divided by
the average shares outstanding throughout the year.
* Commencement of operations.
+ Annualized.
++ Not Annualized.
+++ Portfolio turnover is calculated on the basis of the Fund as a whole without
distinguishing between the classes of shares issued.
See Notes to the Financial Statements
65
<PAGE> 788
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
Six Months Ended ------------------------------ January 2, 1997*
December 31, 1999 1999 1998 through
GLOBAL EQUITY FUND (Unaudited) June 30, 1997
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period................... $11.84 $11.38 $11.09 $10.00
------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income.............................. 0.08 0.35 0.28 0.14
Net realized and unrealized gain on investments.... 0.07 0.24 0.51 1.09
------ ------ ------ ------
Total from investment operations................... 0.15 0.59 0.79 1.23
------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income)............. (0.32) (0.11) (0.32) (0.14)
Distributions (from realized gains)................ (0.47) (0.02) (0.18) --
------ ------ ------ ------
Total distributions................................ (0.79) (0.13) (0.50) (0.14)
------ ------ ------ ------
Net Asset Value, End of Period......................... $11.20 $11.84 $11.38 $11.09
====== ====== ====== ======
TOTAL RETURN........................................... 1.45%++ 5.40% 7.61% 12.32%++
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions)................... $7.4 $7.6 $7.3 $3.7
Ratio of expenses to average net assets:
Before expense reimbursement....................... 1.71%+ 2.07% 2.88% 4.43%+
After expense reimbursement........................ 1.25%+ 1.09% 1.00% 1.00%+
Ratio of net investment income to average net assets:
Before expense reimbursement....................... 0.73%+ 1.78% 0.00% 0.07%+
After expense reimbursement........................ 1.19%+ 2.76% 1.88% 3.50%+
Portfolio turnover rate................................ 27%++ 40% 54% 18%++
</TABLE>
* Commencement of operations.
+ Annualized.
++ Not Annualized.
See Notes to the Financial Statements
66
<PAGE> 789
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Distributor Class
Investor Class October 12, 1999* Investor Class
Six Months Ended through Year Ended June 30,
December 31, 1999 December 31, 1999 ------------------------------------------
BALANCED FUND (Unaudited) (Unaudited) 1999 1998 1997 1996 1995
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period........ $19.00 $17.61 $19.84 $19.38 $18.27 $16.74 $15.71
------ ------ ------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................... 0.40 0.10 0.77 0.89 0.90(1) 0.94 0.89
Net realized and unrealized gain (loss)
on investments........................ (1.56) (0.12) (0.04) 1.58 1.86 1.53 1.53
------ ------ ------ ------ ------ ------ ------
Total from investment operations........ (1.16) (0.02) 0.73 2.47 2.76 2.47 2.42
------ ------ ------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment
income)............................... (0.42) (0.22) (0.75) (0.90) (0.99) (0.92) (0.80)
Distributions (from realized gains)..... (0.93) (0.93) (0.82) (1.11) (0.66) (0.02) (0.57)
Return of capital....................... -- -- -- -- -- -- (0.02)
------ ------ ------ ------ ------ ------ ------
Total distributions..................... (1.35) (1.15) (1.57) (2.01) (1.65) (0.94) (1.39)
------ ------ ------ ------ ------ ------ ------
Net Asset Value, End of Period.............. $16.49 $16.44 $19.00 $19.84 $19.38 $18.27 $16.74
====== ====== ====== ====== ====== ====== ======
TOTAL RETURN................................ (6.04)%++ (0.03)%++ 4.04% 13.29% 15.75% 15.04% 16.40%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions)........ $79.4 $0.02 $97.9 $104.6 $90.2 $70.6 $32.1
Ratio of expenses to average net assets:
Before expense reimbursement............ 1.13%+ 1.39%+ 0.98% 0.93% 0.98% 1.06% 1.19%
After expense reimbursement............. 0.95%+ 1.20%+ 0.95% 0.93% 0.98% 1.00% 1.00%
Ratio of net investment income to average
net assets:
Before expense reimbursement............ 4.06%+ 4.37%+ 3.99% 4.49% 4.77% 5.20% 5.44%
After expense reimbursement............. 4.24%+ 4.56%+ 4.02% 4.49% 4.77% 5.26% 5.63%
Portfolio turnover rate..................... 51%++,+++ 51%++,+++ 135% 121% 117% 92% 51%
</TABLE>
(1) Net investment income per share is calculated using ending balances prior
to consideration of adjustments for permanent book and tax differences.
* Commencement of operations.
+ Annualized.
++ Not Annualized.
+++ Portfolio turnover is calculated on the basis of the Fund as a whole without
distinguishing between the classes of shares issued.
See Notes to the Financial Statements
67
<PAGE> 790
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Investor Class Distributor Class Distributor Class
Six Months Ended Six Months Ended Investor Class June 2, 1999*
TOTAL RETURN December 31, 1999 December 31, 1999 Year Ended through
BOND FUND (Unaudited) (Unaudited) June 30, 1999 June 30, 1999
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period...................... $12.85 $12.85 $13.46 $12.88
------ ------ ------ ------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income..... 0.42 0.39 0.81 0.06
Net realized and
unrealized gain (loss)
on investments.......... (0.40) (0.38) (0.49) (0.03)
------ ------ ------ ------
Total from investment
operations.............. 0.02 0.01 0.32 0.03
------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net
investment income)...... (0.41) (0.40) (0.83) (0.06)
Distributions (from
realized gains)......... -- -- (0.10) --
------ ------ ------ ------
Total distributions....... (0.41) (0.40) (0.93) (0.06)
------ ------ ------ ------
Net Asset Value, End of
Period...................... $12.46 $12.46 $12.85 $12.85
====== ====== ====== ======
TOTAL RETURN................. 0.16%++ 0.05%++ 2.30% 0.23%++
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period
(millions).................. $110.5 $33.5 $124.3 $0.4
Ratio of expenses to average
net assets:
Before expense
reimbursement........... 0.91%+ 1.16%+ 0.79% 1.18%+
After expense
reimbursement........... 0.65%+ 0.90%+ 0.65% 0.90%+
Ratio of net investment
income to average net
assets:
Before expense
reimbursement........... 6.16%+ 5.91%+ 5.64% 5.98%+
After expense
reimbursement........... 6.42%+ 6.17%+ 5.78% 6.26%+
Portfolio turnover rate...... 135%++,+++ 135%++,+++ 233%+++ 233%++,+++
<CAPTION>
Investor Class Investor Class
Year Ended June 30, December 6, 1994*
TOTAL RETURN ------------------------ through
BOND FUND 1998 1997 1996 June 30, 1995
----------------------------------------------
----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period...................... $13.04 $12.78 $12.94 $12.00
------ ------ ------ ------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income..... 0.89 0.99 0.84(1) 0.46
Net realized and
unrealized gain (loss)
on investments.......... 0.50 0.30 0.06 0.94
------ ------ ------ ------
Total from investment
operations.............. 1.39 1.29 0.90 1.40
------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net
investment income)...... (0.97) (0.92) (0.93) (0.46)
Distributions (from
realized gains)......... -- (0.11) (0.13) --
------ ------ ------ ------
Total distributions....... (0.97) (1.03) (1.06) (0.46)
------ ------ ------ ------
Net Asset Value, End of
Period...................... $13.46 $13.04 $12.78 $12.94
====== ====== ====== ======
TOTAL RETURN................. 11.04% 10.48% 7.05% 11.88%++
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period
(millions).................. $45.2 $14.3 $43.4 $15.3
Ratio of expenses to average
net assets:
Before expense
reimbursement........... 1.02% 0.95% 0.98% 2.93%+
After expense
reimbursement........... 0.65% 0.65% 0.68% 0.80%+
Ratio of net investment
income to average net
assets:
Before expense
reimbursement........... 6.28% 6.78% 6.86% 4.92%+
After expense
reimbursement........... 6.65% 7.08% 7.16% 7.05%+
Portfolio turnover rate...... 195% 173% 51% 68%++
</TABLE>
* Commencement of operations.
(1) Net investment income per share is calculated using ending balances prior
to consideration of adjustments for permanent book and tax differences.
+ Annualized.
++ Not Annualized.
+++ Portfolio turnover is calculated on the basis of the Fund as a whole without
distinguishing between the classes of shares issued.
See Notes to the Financial Statements
68
<PAGE> 791
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Distributor Class
Investor Class September 24, 1999* Investor Class
Six Months Ended through Year Ended June 30,
December 31, 1999 December 31, 1999 ------------------------------------------
LOW DURATION FUND (Unaudited) (Unaudited) 1999 1998 1997 1996 1995
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period....... $ 9.91 $ 9.95 $10.20 $10.23 $10.12 $10.15 $ 9.93
------ ------ ------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income.................. 0.29 0.14 0.60 0.66 0.66 0.68 0.75
Net realized and unrealized gain (loss)
on investments....................... (0.06) (0.06) (0.28) 0.05 0.10 0.06 0.23
------ ------ ------ ------ ------ ------ ------
Total from investment operations....... 0.23 0.08 0.32 0.71 0.76 0.74 0.98
------ ------ ------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment
income).............................. (0.32) (0.21) (0.59) (0.68) (0.64) (0.72) (0.75)
Distributions (from realized gains).... -- -- (0.02) (0.06) (0.01) (0.05) (0.01)
------ ------ ------ ------ ------ ------ ------
Total distributions.................... (0.32) (0.21) (0.61) (0.74) (0.65) (0.77) (0.76)
------ ------ ------ ------ ------ ------ ------
Net Asset Value, End of Period............. $ 9.82 $ 9.82 $ 9.91 $10.20 $10.23 $10.12 $10.15
====== ====== ====== ====== ====== ====== ======
TOTAL RETURN............................... 2.32%++ 0.80%++ 3.15% 7.19% 7.79% 7.47% 10.23%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions)....... $370.2 $ 4.8 $410.0 $253.2 $171.2 $189.2 $123.3
Ratio of expenses to average net assets:
Before expense reimbursement........... 0.72%+ 0.95%+ 0.64% 0.65% 0.66% 0.60% 0.75%
After expense reimbursement............ 0.58%+ 0.83%+ 0.58% 0.58% 0.58% 0.58% 0.58%
Ratio of net investment income to average
net assets:
Before expense reimbursement........... 5.96%+ 5.89%+ 5.65% 6.39% 6.26% 7.07% 7.43%
After expense reimbursement............ 6.10%+ 6.01%+ 5.71% 6.46% 6.34% 7.09% 7.61%
Portfolio turnover rate.................... 72%++,+++ 72%++,+++ 201% 119% 202% 50% 71%
</TABLE>
* Commencement of operations.
+ Annualized.
++ Not Annualized.
+++ Portfolio turnover is calculated on the basis of the Fund as a whole without
distinguishing between the classes of shares issued.
See Notes to the Financial Statements
69
<PAGE> 792
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30,
Six Months Ended ------------------------------------------
December 31, 1999 1999 1998 1997 1996
SHORT-TERM INVESTMENT FUND (Unaudited) 1995
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period.............. $ 10.05 $10.13 $10.15 $10.17 $10.12 $10.21
------- ------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income......................... 0.28 0.57 0.63 0.58 0.66 0.66
Net realized and unrealized gain (loss) on
investments................................. (0.03) (0.11) 0.00 (0.01) 0.05 (0.09)
------- ------ ------ ------ ------ ------
Total from investment operations.............. 0.25 0.46 0.63 0.57 0.71 0.57
------- ------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
Dividends (from net investment income)........ (0.27) (0.54) (0.65) (0.59) (0.66) (0.66)
Return of capital............................. -- -- -- -- (0.00) --
------- ------ ------ ------ ------ ------
Total distributions........................... (0.27) (0.54) (0.65) (0.59) (0.66) (0.66)
------- ------ ------ ------ ------ ------
Net Asset Value, End of Period.................... $ 10.03 $10.05 $10.13 $10.15 $10.17 $10.12
======= ====== ====== ====== ====== ======
TOTAL RETURN...................................... 2.52%++ 4.70% 6.37% 5.77% 7.23% 5.78%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions).............. $59.3 $50.9 $28.0 $21.7 $18.7 $19.8
Ratio of expenses to average net assets:
Before expense reimbursement.................. 0.68%+ 0.68% 0.92% 0.96% 0.88% 1.26%
After expense reimbursement................... 0.48%+ 0.48% 0.48% 0.48% 0.48% 0.48%
Ratio of net investment income to average net
assets:
Before expense reimbursement.................. 5.39%+ 5.32% 5.92% 5.34% 6.15% 5.74%
After expense reimbursement................... 5.59%+ 5.52% 6.36% 5.82% 6.55% 6.52%
Portfolio turnover rate........................... 31%++ 144% 121% 154% 60% 81%
</TABLE>
+ Annualized.
++ Not Annualized.
See Notes to the Financial Statements
70
<PAGE> 793
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS
December 31, 1999 (Unaudited)
<TABLE>
<CAPTION>
COMMON STOCKS--97.9% SHARES VALUE
------------------------------------------------------------------------------------
<S> <C> <C>
AEROSPACE--4.9%
Lockheed Martin Corporation............................ 31,200 $ 682,500
Northrop Grumman Corporation........................... 16,500 892,031
Rockwell International Corporation..................... 6,000 287,250
-----------
1,861,781
-----------
ALUMINUM--3.5%
Alcoa, Inc. ........................................... 400 33,200
Reynolds Metals Company................................ 16,900 1,294,963
-----------
1,328,163
-----------
APPAREL & TEXTILES--0.7%
Russell Corporation.................................... 15,300 256,275
-----------
APPLIANCE & HOUSEHOLD FURNITURE--1.3%
Whirlpool Corporation.................................. 7,500 487,969
-----------
AUTO PARTS--4.7%
Dana Corporation....................................... 18,800 562,825
Delphi Automotive Systems Corporation.................. 15,925 250,819
Meritor Automotive, Inc. .............................. 10,000 193,750
Tenneco, Inc. ......................................... 8,600 80,087
TRW Inc. .............................................. 13,600 706,350
-----------
1,793,831
-----------
AUTOS & TRUCKS--5.4%
Ford Motor Company..................................... 20,600 1,100,813
General Motors Corporation............................. 13,200 959,475
-----------
2,060,288
-----------
BEVERAGES--0.9%
Anheuser-Busch Companies, Inc. ........................ 5,100 361,462
-----------
CHEMICALS--3.0%
The Dow Chemical Company............................... 5,300 708,213
Eastman Chemical Company............................... 8,700 414,881
-----------
1,123,094
-----------
</TABLE>
See Notes to the Financial Statements.
1
<PAGE> 794
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS, CONTINUED
December 31, 1999 (Unaudited)
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
CONTAINERS--1.2%
Pactiv Corporation..................................... 43,000 $ 456,875
-----------
ELECTRICAL UTILITIES--10.9%
CMS Energy Corporation................................. 12,600 392,963
Central & South West Corporation....................... 7,000 140,000
DTE Energy Company..................................... 6,100 191,387
Edison International................................... 7,100 185,931
Entergy Corporation.................................... 7,400 190,550
GPU, Inc. ............................................. 5,400 161,662
Illinova Corporation................................... 28,700 997,325
PECO Energy Company.................................... 12,900 448,275
P P & L Resources, Inc. ............................... 12,937 295,934
Public Service Enterprises Group, Inc. ................ 10,600 369,012
SCANA Corporation...................................... 17,800 478,375
ScottishPower plc ADR.................................. 3,828 107,184
Texas Utilities Company................................ 5,502 195,665
-----------
4,154,263
-----------
ENGINEERING & CONSTRUCTION--0.8%
Harsco Corporation..................................... 9,300 295,275
-----------
FOREST PRODUCTS--3.0%
Georgia-Pacific (Timber Group)......................... 12,300 302,887
Weyerhaeuser Company................................... 11,800 847,388
-----------
1,150,275
-----------
HEALTHCARE: DRUGS--0.7%
American Home Products Corporation..................... 6,500 256,344
-----------
INSURANCE: LIFE--2.7%
American General Corporation........................... 7,687 583,251
Lincoln National Corporation........................... 10,800 432,000
-----------
1,015,251
-----------
INSURANCE: PROPERTY CASUALTY--4.0%
The Allstate Corporation............................... 29,700 712,800
Safeco Corporation..................................... 15,600 388,050
St. Paul Companies, Inc. .............................. 12,800 431,200
-----------
1,532,050
-----------
</TABLE>
See Notes to the Financial Statements.
2
<PAGE> 795
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS, CONTINUED
December 31, 1999 (Unaudited)
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
LEISURE/TOYS--0.9%
Fortune Brands, Inc. .................................. 10,000 $ 330,625
-----------
MACHINERY--1.7%
CNH Global N.V......................................... 48,300 642,994
-----------
MEDICAL PRODUCTS & SUPPLIES--1.1%
Baxter International, Inc. ............................ 6,700 420,844
-----------
METALS: MISC.--0.6%
Phelps Dodge Corporation............................... 3,200 214,800
-----------
OFFICE EQUIPMENT & SUPPLIES--1.5%
Xerox Corporation...................................... 26,100 592,144
-----------
OIL--DOMESTIC--7.5%
Conoco Inc.--Class B................................... 14,184 352,827
Occidental Petroleum Corporation....................... 35,200 761,200
Phillips Petroleum Company............................. 16,900 794,300
Sunoco Inc. ........................................... 3,100 72,850
USX-Marathon Group, Inc. .............................. 23,200 572,750
Ultramar Diamond Shamrock Corporation.................. 14,100 319,894
-----------
2,873,821
-----------
OIL--INTERNATIONAL--0.4%
Texaco Inc. ........................................... 3,100 168,369
-----------
PAPER--4.3%
Georgia-Pacific Group.................................. 9,400 477,050
International Paper Company............................ 20,465 1,154,993
-----------
1,632,043
-----------
PHOTOGRAPHY/IMAGING--2.2%
Eastman Kodak Company.................................. 12,800 848,000
-----------
POLLUTION CONTROL--0.4%
Waste Management, Inc. ................................ 9,930 170,672
-----------
RAILROADS--1.6%
CSX Corporation........................................ 3,100 97,263
Norfolk Southern Corporation........................... 24,000 492,000
-----------
589,263
-----------
</TABLE>
See Notes to the Financial Statements.
3
<PAGE> 796
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS, CONTINUED
December 31, 1999 (Unaudited)
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
REGIONAL BANKS--5.7%
Bank One Corporation................................... 18,200 $ 583,537
First Security Corporation............................. 8,200 209,356
First Union Corporation................................ 13,370 438,703
Fleet Financial Group, Inc. ........................... 12,000 417,750
KeyCorp................................................ 14,200 314,175
UnionBanCal Corporation................................ 5,000 197,187
-----------
2,160,708
-----------
RETAIL: DEPARTMENT STORES--1.1%
May Department Stores Company.......................... 13,000 419,250
-----------
RETAIL: GENERAL MERCHANDISE--1.9%
J.C. Penney Company, Inc. ............................. 13,600 271,150
Sears, Roebuck & Company............................... 15,100 459,606
-----------
730,756
-----------
SAVINGS & LOANS--3.7%
Fannie Mae............................................. 12,300.. 767,981
Washington Mutual, Inc. ............................... 24,424 635,024
-----------
1,403,005
-----------
SMALL LOANS & FINANCE--1.6%
Associates First Capital Corporation--Class A.......... 742 20,359
Household International, Inc. ......................... 16,119 600,433
-----------
620,792
-----------
STEEL--2.4%
USX-U.S. Steel Group, Inc. ............................ 27,800 917,400
-----------
TELEPHONE--8.8%
AT&T Corporation....................................... 20,250 1,027,688
ALLTEL Corporation..................................... 9,400 777,263
Bell Atlantic Corporation.............................. 10,780 663,644
GTE Corporation........................................ 1,400 98,787
SBC Communications, Inc. .............................. 16,090 784,387
-----------
3,351,769
-----------
TOBACCO--2.3%
Philip Morris Companies, Inc. ......................... 37,700 874,169
-----------
</TABLE>
See Notes to the Financial Statements.
4
<PAGE> 797
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS, CONTINUED
December 31, 1999 (Unaudited)
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
TRUCKING--0.5%
Ryder System, Inc. .................................... 8,000 $ 195,500
-----------
Total common stocks (cost $33,319,332)................. 37,290,120
-----------
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL
VARIABLE RATE DEMAND NOTES*--1.9% AMOUNT
--------------------------------------------------------------------------------------
<S> <C> <C>
Pitney Bowes, Inc., 6.095%............................. $734,650 734,650
-----------
Total variable rate demand notes (cost $734,650)....... 734,650
-----------
Total investments--99.8% (cost $34,053,982)................. 38,024,770
Other assets in excess of liabilities--0.2%................. 80,190
-----------
TOTAL NET ASSETS--100.0%............................... $38,104,960
===========
</TABLE>
---------------
<TABLE>
<C> <S>
* Variable rate demand notes are considered short-term
obligations and are payable on demand. Interest rates change
periodically on specified dates. The rates listed are as of
December 31, 1999.
</TABLE>
See Notes to the Financial Statements.
5
<PAGE> 798
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES (UNAUDITED)
December 31, 1999
<TABLE>
<S> <C>
ASSETS:
Investments, at value (cost $34,053,982)............... $38,024,770
Dividends and interest receivable...................... 106,652
Prepaid expenses....................................... 4,958
-----------
Total assets...................................... 38,136,380
-----------
LIABILITIES:
Payable to Advisor..................................... 11,209
Payable to Custodian................................... 7,499
Accrued expenses and other liabilities................. 12,712
-----------
Total liabilities................................. 31,420
-----------
Net assets........................................ $38,104,960
===========
NET ASSETS CONSIST OF:
Paid in capital........................................ $33,731,872
Undistributed (distributions in excess of) net
investment income..................................... (8,603)
Undistributed net realized gains on investments........ 410,903
Net unrealized appreciation on investments............. 3,970,788
-----------
Net assets........................................ $38,104,960
===========
CALCULATION OF NET ASSET VALUE PER SHARE:
Shares outstanding (unlimited shares of no par value
authorized)........................................... 2,762,579
Net asset value per share (offering and redemption
price)................................................ $ 13.79
===========
</TABLE>
See Notes to the Financial Statements.
6
<PAGE> 799
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
STATEMENT OF OPERATIONS (UNAUDITED)
Six Months Ended December 31, 1999
<TABLE>
<S> <C>
INVESTMENT INCOME
Income
Dividends.............................................. $ 593,334
Interest............................................... 10,322
-----------
Total income...................................... 603,656
-----------
Expenses
Advisory fee........................................... 105,986
Legal and auditing fees................................ 3,714
Custodian fees and expenses............................ 7,160
Accounting fee......................................... 12,358
Administration fee..................................... 2,464
Trustees' fees and expenses............................ 2,555
Reports to shareholders................................ 9,540
Other expenses......................................... 907
-----------
Total expenses.................................... 144,684
Less, expense reimbursement............................ (38,698)
-----------
Net expenses...................................... 105,986
-----------
Net investment income..................................... 497,670
-----------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on securities transactions........... 2,055,261
Net change in unrealized depreciation of securities.... (8,104,827)
-----------
Net loss on investments........................... (6,049,566)
-----------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $(5,551,896)
===========
</TABLE>
See Notes to the Financial Statements.
7
<PAGE> 800
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, 1999 YEAR ENDED
(UNAUDITED) JUNE 30, 1999
----------------- -------------
<S> <C> <C>
OPERATIONS:
Net investment income................................ $ 497,670 $ 955,430
Net realized gain on securities transactions......... 2,055,261 1,951,485
Net change in unrealized appreciation (depreciation)
of securities...................................... (8,104,827) 76,985
----------- -----------
Net increase (decrease) in net assets resulting
from operations............................... (5,551,896) 2,983,900
----------- -----------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
Net investment income................................ (506,273) (957,593)
Net realized gain on securities transactions......... (3,053,972) (3,955,702)
----------- -----------
Total dividends and distributions............... (3,560,245) (4,913,295)
----------- -----------
FUND SHARE TRANSACTIONS:
Net proceeds from shares sold........................ 0 0
Shares issued in connection with payment of dividends
and distributions.................................. 3,560,245 4,913,295
Cost of shares redeemed.............................. (22,500) (29,999)
----------- -----------
Net increase in net assets from Fund share
transactions.................................. 3,537,745 4,883,296
----------- -----------
Total increase (decrease) in net assets................... (5,574,396) 2,953,901
NET ASSETS:
Beginning of period.................................. 43,679,356 40,725,455
----------- -----------
End of period*....................................... $38,104,960 $43,679,356
=========== ===========
*Including undistributed (distributions in excess of) net
investment income of:................................... $ (8,603) $ 0
=========== ===========
CHANGES IN SHARES OUTSTANDING:
Shares sold.......................................... 0 0
Shares issued in connection with payment of dividends
and distributions.................................. 262,901 307,125
Shares redeemed...................................... (1,470) (1,827)
----------- -----------
Net increase.................................... 261,431 305,298
=========== ===========
</TABLE>
See Notes to the Financial Statements.
8
<PAGE> 801
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
December 31, 1999
NOTE 1. ACCOUNTING POLICIES. The Equity Fund for Insurance Companies (the
"Fund") is a series of Hotchkis and Wiley Funds (the "Trust"), an
open-end, management investment company organized as a Massachusetts
business trust on August 22, 1984 and registered under the Investment
Company Act of 1940. The Fund commenced operations on January 29,
1993. The sole shareholder of the Fund is The Prudential Insurance
Company of America. The Fund seeks to provide current income and
long-term growth of income, accompanied by growth of capital. In
addition to the Fund, the Trust also offers the Balanced Fund, the
Small Cap Fund, the Equity Income Fund, the International Fund, the
Low Duration Fund, the Short-Term Investment Fund, the Total Return
Bond Fund, the Mid-Cap Fund, and the Global Equity Fund (collectively,
the "Funds"). The assets of each series are invested in separate,
independently managed portfolios. The following is a summary of
significant accounting policies followed by the Fund in the
preparation of the financial statements.
SECURITY VALUATION: Portfolio securities that are listed on a
securities exchange (whether domestic or foreign) or The Nasdaq Stock
Market ("NSM") are valued at the last sale price as of 4:00 p.m.,
Eastern Time, or, in the absence of recorded sales, at the average of
readily available closing bid and asked prices on such exchange or
NSM. Unlisted securities that are not included in NSM are valued at
the average of the quoted bid and asked price in the over-the-counter
market. Securities for which market quotations are not otherwise
available are valued at fair value as determined in good faith by
Hotchkis and Wiley (the "Advisor") under procedures established by the
Board of Trustees. Short-term investments which mature in less than 60
days are valued at amortized cost (unless the Board of Trustees
determines that this method does not represent fair value), if their
original maturity was 60 days or less, or by amortizing the values as
of the 61st day prior to maturity, if their original term to maturity
exceeded 60 days. Investments quoted in foreign currency are valued
daily in U.S. dollars on the basis of the foreign currency exchange
rate prevailing at the time of valuation.
FEDERAL INCOME TAXES: It is the Fund's policy to meet the
requirements of the Internal Revenue Code applicable to regulated
investment companies and the Fund intends to distribute substantially
all of its investment company net taxable income and net capital gains
to its shareholders. Therefore, no federal income tax provision is
required.
EXPENSE ALLOCATION: Common expenses incurred by the Trust are
allocated among the Funds based upon (i) relative average net assets,
(ii) as incurred on a specific identification basis, or (iii) evenly
among the Funds, depending on the nature of the expenditure.
USE OF ESTIMATES: The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and
9
<PAGE> 802
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (UNAUDITED), CONTINUED
December 31, 1999
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
DISTRIBUTIONS TO SHAREHOLDERS: Dividends from net investment
income are declared and paid quarterly. Distributions of net realized
capital gains, if any, will be declared at least annually.
OTHER: Security and shareholder transactions are recorded on
trade date. Realized gains and losses on sales of investments are
calculated on the identified cost basis. Dividend income and dividends
and distributions to shareholders are recorded on the ex-dividend
date. Interest income is recognized on the accrual basis. Generally
accepted accounting principles require that permanent financial
reporting and tax differences relating to shareholder distributions be
reclassified within the capital accounts.
NOTE 2. INVESTMENT ADVISORY AGREEMENT. The Fund has an investment advisory
agreement with the Advisor with whom certain officers and Trustees of
the Trust are affiliated. The Advisor is a division of Merrill Lynch
Asset Management, L.P., an indirect wholly-owned subsidiary of Merrill
Lynch & Co., Inc. The Advisor receives a fee, computed daily and
payable monthly, at an annual rate of 0.60% of the first $10 million
of the Fund's average daily net assets, and 0.50% of the average daily
net assets in excess of $10 million.
The Advisor provides continuous supervision of the investment
portfolio and pays all of the operating expenses relating to the Fund
other than the advisory fee. For the six months ended December 31,
1999, the Advisor paid $38,698 of operating expenses on behalf of the
Fund.
As permitted under Rule 10f-3 of the Investment Company Act of
1940, the Board of Trustees of the Trust has adopted procedures which
allow the Fund, under certain conditions described in the Rule, to
acquire newly-issued securities from a member of an underwriting group
in which an affiliated underwriter participates.
NOTE 3. PURCHASES AND SALES OF SECURITIES. Purchases and sales of investment
securities, other than short-term investments, for the six months
ended December 31, 1999 were $4,394,985 and $4,569,269, respectively.
There were no purchases or sales of long-term U.S. government
securities.
At December 31, 1999 (for financial reporting and federal income
tax purposes), net unrealized appreciation aggregated $3,970,788, of
which $9,266,408 related to appreciated securities and $5,295,620
related to depreciated securities. At December 31, 1999, the cost of
investments for book and federal income tax purposes was $34,053,982.
10
<PAGE> 803
HOTCHKIS
AND WILEY Equity Fund for Insurance Companies
--------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED JUNE 30,
DECEMBER 31, 1999 ----------------------------------------------
(UNAUDITED) 1999 1998 1997 1996 1995
----------------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period............ $17.46 $18.55 $16.32 $13.51 $11.53 $ 9.89
------ ------ ------ ------ ------ ------
Income from Investment Operations:
Net investment income....................... 0.20 0.41 0.41 0.39 0.34 0.41
Net realized and unrealized gain (loss) on
investments............................... (2.46) 0.70 3.31 3.30 2.26 1.59
------ ------ ------ ------ ------ ------
Total from investment operations............ (2.26) 1.11 3.72 3.69 2.60 2.00
------ ------ ------ ------ ------ ------
Less Distributions:
Dividends (from net investment income)...... (0.20) (0.41) (0.41) (0.40) (0.40) (0.34)
Distributions (from realized gains)......... (1.21) (1.79) (1.08) (0.48) (0.22) (0.02)
------ ------ ------ ------ ------ ------
Total distributions......................... (1.41) (2.20) (1.49) (0.88) (0.62) (0.36)
------ ------ ------ ------ ------ ------
Net Asset Value, End of Period.................. $13.79 $17.46 $18.55 $16.32 $13.51 $11.53
====== ====== ====== ====== ====== ======
Total Return.................................... (12.73)%++ 7.29% 23.69% 28.20% 22.93% 20.62%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (millions)............ $38.1 $43.7 $40.7 $33.0 $24.6 $17.4
Ratio of expenses to average net assets:
Before expense reimbursement................ 0.72%+ 0.65% 0.73% 0.75% 0.76% 1.05%
After expense reimbursement................. 0.53%+ 0.52% 0.52% 0.53% 0.54% 0.58%
Ratio of net investment income to average net
assets:
Before expense reimbursement................ 2.28%+ 2.28% 2.06% 2.50% 2.78% 3.58%
After expense reimbursement................. 2.47%+ 2.41% 2.27% 2.72% 3.00% 4.03%
Portfolio turnover.............................. 11%++ 14% 21% 22% 21% 29%
</TABLE>
+ Annualized.
++ Not Annualized.
See Notes to the Financial Statements.
11
<PAGE> 804
PART C
OTHER INFORMATION
ITEM 23. EXHIBITS.
(a)(1) Restated Declaration of Trust2
(2) Certificate of Designation2
(3) Amended and Restated Certificate of Designation5
(4) Form of Amendment to Declaration of Trust*
(5) Form of Amended and Restated Certificate of
Designation*
(b) By-Laws4
(d) (1) Investment Advisory Agreement relating to the
Balanced Fund2
(2) Investment Advisory Agreement relating to the
Equity Income Fund2
(3) Investment Advisory Agreement relating to the
International Fund2
(4) Investment Advisory Agreement relating to the
Equity Fund for Insurance Companies2
(5) Investment Advisory Agreement relating to the
Low Duration Fund2
(6) Investment Advisory Agreement relating to the
Total Return Bond Fund2
(7) Investment Advisory Agreement relating to the
Small Cap Fund2
(8) Investment Advisory Agreement relating to the
Short-Term Investment Fund2
(9) Investment Advisory Agreement
relating to the Mid-Cap Fund3
(10) Investment Advisory Agreement
relating to the Global Equity Fund3
(11) Sub-advisory Agreement with Mercury Asset
Management International Limited and Merrill
Lynch Asset Management U.K. Limited for the
International Fund5
(12) Sub-advisory Agreement with Mercury Asset
Management International Limited and Merrill
Lynch Asset Management U.K. Limited for the
Global Equity Fund5
(e) (1) Agreement with Merrill Lynch Funds Distributor,
Inc.4
(2) Form of Distribution Agreement with FAM
Distributors, Inc.*
(3) Form of Selected Dealer Agreement*
(g) Custodian Agreement with Brown Brothers Harriman
& Co.*
C-1
<PAGE> 805
(h) (1) Fund Accounting and Administration Servicing
Agreement with MLAM Fund Accounting*
(2) License Agreement with Merrill Lynch & Co., Inc.2
(3) Transfer Agency, Dividend Disbursing Agency and
Shareholder Servicing Agency Agreement with
Financial Data Services, Inc.*
(4) Amendment to Expense Cap Agreement*
(5) Form of Administration Agreement with Fund Asset
Management L.P.*
(6) Form of Amended and Restated Expense Cap
Agreement*
(7) Form of License Agreement Related to the Mercury
Name*
(8) Credit Agreement7
(i) (1) Legal opinion6
(2) Opinion and Consent of counsel**
(j) Consents of PricewaterhouseCoopers LLP*
(m) (1) Distribution Plan under Rule 12b-16
(2) Form of Amended and Restated Class A Distribution Plan
and Class A Distribution Plan Sub-Agreement*
(3) Form of Class B Distribution Plan and Class B
Distribution Plan Sub-Agreement*
(4) Form of Class C Distribution Plan and Class C
Distribution Plan Sub-Agreement*
(n) Amended and Restated Rule 18f-3 Plan*
(p) Code of Ethics*
1Incorporated herein by reference and previously filed as an exhibit
to Post-Effective Amendment No. 21 to the Registration Statement on Form N-1A
filed via EDGAR on October 3, 1996 (File No. 2-96219).
2Incorporated herein by reference and previously filed as an exhibit to
Post-Effective Amendment No. 23 to the Registration Statement on Form N-1A filed
via EDGAR on December 17, 1996 (File No. 2-96219).
3Incorporated herein by reference and previously filed as an exhibit to
Post-Effective Amendment No. 24 to the Registration Statement on Form N-1A filed
via EDGAR on July 30, 1997 (File No. 2-96219).
4Incorporated herein by reference and previously filed as an exhibit to
Post-Effective Amendment No. 25 to the Registration Statement on Form N-1A
filed via EDGAR on August 28, 1998 (File No. 2-96219).
5Incorporated herein by reference and previously filed as an exhibit to
Post-Effective Amendment No. 27 to the Registration Statement on Form N-1A
filed via EDGAR on January 29, 1999 (File No. 2-96219).
6Incorporated herein by reference and previously filed as an Exhibit to
Post-Effective Amendment No. 29 to the Registration Statement on Form N-1A
filed via EDGAR on August 20, 1999 (File No. 2-96219).
7Incorporated by reference and previously filed as Exhibit(h)(10) to
Post-Effective Amendment No. 2 to the Registration Statement on Form N-1A of
Hotchkis and Wiley Variable Trust filed via EDGAR on April 7, 2000 (File No.
333-24349).
--------------------------
* Filed herewith.
** To be filed by amendment.
ITEM 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
See "General Information -- Principal Holders" in the Statements of
Additional Information.
C-2
<PAGE> 806
ITEM 25. INDEMNIFICATION.
Section 12 of Article SEVENTH of Registrant's Declaration of Trust,
states as follows:
(c)(1) As used in this paragraph the following terms shall
have the meanings set forth below:
(i) the term "indemnitee" shall mean any present
or former Trustee, officer or employee of the Trust, any
present or former Trustee or officer of another trust or
corporation whose securities are or were owned by the Trust or
of which the Trust is or was a creditor and who served or
serves in such capacity at the request of the Trust, any
present or former investment advisor, sub-advisor or principal
underwriter of the Trust and the heirs, executors,
administrators, successors and assigns of any of the
foregoing; however, whenever conduct by an indemnitee is
referred to, the conduct shall be that of the original
indemnitee rather than that of the heir, executor,
administrator, successor or assignee;
(ii) the term "covered proceeding" shall mean any
threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative, to
which an indemnitee is or was a party or is threatened to be
made a party by reason of the fact or facts under which he or
it is an indemnitee as defined above;
(iii) the term "disabling conduct" shall mean
willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of the office
in question;
(iv) the term "covered expenses" shall mean
expenses (including attorney's fees), judgments, fines and
amounts paid in settlement actually and reasonably incurred by
an indemnitee in connection with a covered proceeding; and
(v) the term "adjudication of liability" shall
mean, as to any covered proceeding and as to any indemnitee,
an adverse determination as to the indemnitee whether by
judgment, order, settlement, conviction or upon a plea of nolo
contendere or its equivalent.
(d) The Trust shall not indemnify any indemnitee for any
covered expenses in any covered proceeding if there has been an
adjudication of liability against such indemnitee expressly based on a
finding of disabling conduct.
(e) Except as set forth in (d) above, the Trust shall
indemnify an indemnitee for covered expenses in any covered
proceeding, whether or not there is an adjudication of liability as to
such indemnitee, if a determination has been made that the indemnitee
was not liable by reason of disabling conduct by (i) a final decision
of the court or other body before which the covered proceeding was
brought; or (ii) in the absence of such decision, a reasonable
determination, based on a review of the facts, by either (a) the vote
of a majority of a quorum of Trustees who are neither "interested
persons," as defined in the 1940 Act, nor parties to the covered
proceeding or (b) an independent legal counsel in a written opinion;
provided that such Trustees or counsel, in reaching such
determination, may but need not presume the absence of disabling
conduct on the part of the indemnitee by reason of the manner in which
the covered proceeding was terminated.
(f) Covered expenses incurred by an indemnitee in
connection with a covered proceeding shall be advanced by the Trust to
an indemnitee prior to the final disposition of a covered proceeding
upon the request of the indemnitee for such advance and the
undertaking by or on behalf of the indemnitee to repay the advance
unless it is ultimately determined that the indemnitee is entitled to
indemnification thereunder, but only if one or more of the following
is the case: (i) the indemnitee shall provide a security for such
undertaking; (ii) the Trust shall be insured against losses arising
out of any lawful advances; or (iii) there shall have been a
determination, based on a review of the readily available facts (as
opposed to a full trial-type inquiry) that there is a reason to
believe that the indemnitee ultimately will be found entitled to
indemnification by either independent legal counsel in a written
opinion or by the vote of a majority of a
C-3
<PAGE> 807
quorum of trustees who are neither "interested persons" as defined in
the 1940 Act nor parties to the covered proceeding.
(g) Nothing herein shall be deemed to affect the right of
the Trust and/or any indemnitee to acquire and pay for any insurance
covering any or all indemnitees to the extent permitted by the 1940
Act or to affect any other indemnification rights to which any
indemnitee may be entitled to the extent permitted by the 1940 Act.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to trustees, officers and controlling
persons of Registrant pursuant to the foregoing provisions, or otherwise,
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in that
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by Registrant
of expenses incurred or paid by a trustee, officer or controlling person of
Registrant in the successful defense of any action, suit or proceeding) is
asserted by such trustee, officer or controlling person in connection with the
securities being registered, Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
ITEM 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
See "The Management Team--Management of the Fund" in the Prospectuses
constituting Part A of this Registration Statement and "Management of the Fund"
in the Statements of Additional Information constituting Part B of this
Registration Statement. Information as to Merrill Lynch Investment Management,
L.P., is included in its Form ADV filed with the Securities and Exchange
Commission (File No. 801-11583), as most recently amended, the text of which is
incorporated herein by reference.
ITEM 27. PRINCIPAL UNDERWRITERS.
(a) The Registrant's principal underwriter, FAM Distributors, Inc.
("FAM"), also acts as principal underwriter for the following open-end
registered investment companies:
The Asset Program, Inc., Financial Institutions Series Trust, Hotchkis
and Wiley Variable Trust, Master Focus Twenty Trust, Master Global Financial
Services Trust, Master Internet Strategies Trust, Master Large Cap Series
Trust, Master Premier Growth Trust, Mercury Global Holdings, Inc., Merrill
Lynch Adjustable Rate Securities Fund, Inc., Merrill Lynch Americas Income
Fund, Inc., Merrill Lynch Asset Builder Program, Inc., Merrill Lynch Asset
Growth Fund, Inc., Merrill Lynch Basic Value Fund, Inc., Merrill Lynch
California Municipal Series Trust, Merrill Lynch Balanced Capital Fund, Inc.,
Merrill Lynch Convertible Fund, Inc., Merrill Lynch Corporate Bond Fund, Inc.,
Merrill Lynch Corporate High Yield Fund, Inc., Merrill Lynch Developing Capital
Markets Fund, Inc., Merrill Lynch Disciplined Equity Fund, Inc., Merrill Lynch
Dragon Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch Fundamental Growth
Fund, Inc., Merrill Lynch Funds for Institutions Series, Merrill Lynch Global
Allocation Fund, Inc., Merrill Lynch Global Bond Fund for Investment and
Retirement, Merrill Lynch Global Growth Fund, Inc., Merrill Lynch Global
Resources Trust, Merrill Lynch Global SmallCap Fund, Inc., Merrill Lynch Global
Technology Fund, Inc., Merrill Lynch Global Utility Fund, Inc., Merrill Lynch
Global Value Fund, Inc., Merrill Lynch Growth Fund, Merrill Lynch Healthcare
Fund, Inc., Merrill Lynch Index Funds, Inc., Merrill Lynch Intermediate
Government Bond Fund, Merrill Lynch International Equity Fund, Merrill Lynch
Latin America Fund, Inc., Merrill Lynch Multi-State Limited Maturity Municipal
Series Trust, Merrill Lynch Multi-State Municipal Series Trust, Merrill Lynch
Municipal Bond Fund, Inc., Merrill Lynch Municipal Series Trust, Merrill Lynch
Pacific Fund, Inc., Merrill Lynch Phoenix Fund, Inc., Merrill Lynch Ready Assets
Trust, Merrill Lynch Real Estate Fund, Inc., Merrill Lynch Retirement Series
Trust, Merrill Lynch Series Fund, Inc., Merrill Lynch Short-Term Global Income
Fund, Inc., Merrill Lynch Small Cap Value Fund, Inc., Merrill Lynch Strategic
Dividend Fund, Merrill Lynch U.S. Government Mortgage Fund, Merrill Lynch U.S.
Treasury Money Fund, Merrill Lynch U.S.A. Government Reserves, Merrill Lynch
Utility Income Fund, Inc., Merrill Lynch Variable Series Funds, Inc., and
Merrill Lynch World Income Fund, Inc. FAM also acts as the principal
underwriter for the following closed-end registered investment companies:
Merrill Lynch High Income Municipal Bond Program, Inc., Merrill Lynch Municipal
Strategy Fund, Inc., Merrill Lynch Senior Floating Rate Fund, Inc., and Merrill
Lynch Senior Floating Rate Fund II, Inc. A separate division of FAM acts as the
principal underwriter of a number of other investment companies.
C-4
<PAGE> 808
(b) Set forth below is information concerning each director and
officer of FAM. The principal business address of each such person is P.O. Box
9081, Princeton, New Jersey 08543-9081, except that the address of Messrs.
Breen, Crook, Fatseas and Wasel is One Financial Center, 23rd Floor, Boston,
Massachusetts 02111-2665.
<TABLE>
<CAPTION>
Position(s) and Office(s) Position and Offices
Name with Princeton Funds Distributor with Registrant
---- -------------------------------- --------------------
<S> <C> <C>
Terry K. Glenn............. President and Director None
Michael G. Clark........... Treasurer and Director None
Thomas J. Verage........... Director None
Robert W. Crook............ Senior Vice President None
Michael J. Brady........... Vice President None
William M. Breen........... Vice President None
Donald C. Burke............ Vice President Vice President and Treasurer
James T. Fatseas........... Vice President None
Debra W. Landsman-Yaros.... Vice President None
Michelle T. Lau............ Vice President None
Salvatore Venezia.......... Vice President None
William Wasel.............. Vice President None
Robert Harris.............. Secretary Assistant Secretary
</TABLE>
(c) Not applicable.
ITEM 28. LOCATION OF ACCOUNTS AND RECORDS.
The accounts, books and other documents required to be maintained by
Registrant pursuant to Section 31(a) of the Investment Company Act of 1940 and
the rules promulgated thereunder are in the possession of Registrant or
Registrant's investment adviser, 725 S. Figueroa Street, Suite 4000, Los
Angeles, California 90017, 800 Scudders Mill Road, Plainsboro, New Jersey 08536,
or Registrant's transfer agent, Financial Data Services, Inc., 4800 Deer Lake
Drive East, Jacksonville, Florida 32246-6484, or Registrant's custodian, Brown
Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts 02109.
ITEM 29. MANAGEMENT SERVICES.
Not applicable.
ITEM 30. UNDERTAKINGS.
Not applicable.
C-5
<PAGE> 809
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Amendment to
the Registration Statement to be signed on its behalf by the undersigned, duly
authorized, in the City of Los Angeles and State of California on the 31st day
of July, 2000.
HOTCHKIS AND WILEY FUNDS
By: /s/ NANCY D. CELICK
-------------------------------
Nancy D. Celick
President
Pursuant to the requirements of the Securities Act of 1933, this
Amendment to the Registration Statement has been signed below by the following
persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ NANCY D. CELICK Principal Executive Officer July 31, 2000
----------------------------------------
Nancy D. Celick
/s/ DONALD C. BURKE Principal Financial and Accounting July 31, 2000
---------------------------------------- Officer
DONALD C. BURKE
/s/ MICHAEL S. BAXTER Trustee July 31, 2000
----------------------------------------
Michael S. Baxter
/s/ ROBERT L. BURCH III Trustee July 31, 2000
----------------------------------------
Robert L. Burch III
/s/ JOHN GAVIN Trustee July 31, 2000
----------------------------------------
John Gavin
/s/ JOE GRILLS Trustee July 31, 2000
----------------------------------------
Joe Grills
/s/ NIGEL HURST-BROWN Trustee July 31, 2000
----------------------------------------
Nigel Hurst-Brown
/s/ MADELEINE A. KLEINER Trustee July 31, 2000
----------------------------------------
Madeleine A. Kleiner
/s/ RICHARD R. WEST Trustee July 31, 2000
----------------------------------------
Richard R. West
</TABLE>
<PAGE> 810
HOTCHKIS AND WILEY FUNDS
EXHIBIT INDEX
Exhibit
Number Description
------- ----------
(a) (1) Restated Declaration of Trust2
(2) Certificate of Designation2
(3) Amended and Restated Certificate of
Designation5
(4) Form of Amendment to Declaration of Trust*
(5) Form of Amended and Restated Certificate of
Designation*
(b) By-Laws4
(d) (1) Investment Advisory Agreement relating to the
Balanced Fund2
(2) Investment Advisory Agreement relating to the Equity
Income Fund2
(3) Investment Advisory Agreement relating to the
International Fund2
(4) Investment Advisory Agreement relating to the Equity
Fund for Insurance Companies2
(5) Investment Advisory Agreement relating to the Low
Duration Fund2
(6) Investment Advisory Agreement to the Total Return
Bond Fund2
(7) Investment Advisory Agreement relating to the Small
Cap Fund2
(8) Investment Advisory Agreement relating to the
Short-Term Investment Fund2
(9) Investment Advisory Agreement relating to the Mid-Cap
Fund3
(10) Investment Advisory Agreement relating to the Global
Equity Fund3
(11) Sub-advisory Agreement with Mercury Asset Management
International Limited and Merrill Lynch Asset
Management U.K. Limited for the International Fund5
(12) Sub-advisory Agreement with Mercury Asset Management
International Limited and Merrill Lynch Asset
Management U.K. Limited for the Global Equity Fund5
(e) (1) Agreement with Merrill Lynch Funds Distributor, Inc.4
(2) Form of Distribution Agreement with FAM Distributors,
Inc.*
(3) Form of Selected Dealer Agreement*
(g) Custodian Agreement with Brown Brothers Harriman &
Co.*
(h) (1) Fund Accounting and Administration Servicing
Agreement with MLAM Fund Accounting*
(2) License Agreement with Merrill Lynch & Co., Inc.2
(3) Transfer Agency Dividend Disbursing Agency and
Shareholder Servicing Agreement with Financial Data
Services, Inc.*
(4) Amendment to Expense Cap Agreement*
(5) Form of Administration Agreement with Fund Asset
Management L.P.*
(6) Form of Amended and Restated Expense Cap Agreement*
(7) Form of License Agreement Related to the Mercury Name*
(8) Credit Agreement7
(i) (1) Legal opinion6
(2) Opinion and Consent of counsel**
(j) Consents of PricewaterhouseCoopers LLP*
<PAGE> 811
Exhibit
Number Description
------- -----------
(m) (1) Distribution Plan under Rule 12b-16
(2) Form of Amended and Restated Class A Distribution Plan and
Class A Distribution Plan Sub-Agreement*
(3) Form of Class B Distribution Plan and Class B Distribution
Plan Sub-Agreement*
(4) Form of Class C Distribution Plan and Class C Distribution
Plan Sub-Agreement*
(n) Amended and Restated Rule 18f-3 Plan*
(p) Code of Ethics*
1Incorporated herein by reference and previously filed as an exhibit
to Post-effective Amendment No. 21 to the Registration Statement on Form N-1A
filed via EDGAR on October 3, 1996 (File No. 2-91216).
2Incorporated herein by reference and previously filed as an exhibit
to Post-effective Amendment No. 23 to the Registration Statement on Form N-1A
filed via EDGAR on December 17, 1996 (File No. 2-91216).
3Incorporated herein by reference and previously filed as an exhibit
to Post-effective Amendment No. 24 to the Registration Statement on Form N-1A
filed via EDGAR on July 30, 1997 (File No. 2-91216).
4Incorporated herein by reference and previously filed as an exhibit
to Post-effective Amendment No. 25 to the Registration Statement on Form N-1A
filed via EDGAR on August 28, 1998 (File No. 2-91216).
5Incorporated herein by reference and previously filed as an exhibit
to Post-effective Amendment No. 27 to the Registration Statement on Form N-1A
filed via EDGAR on January 29, 1999 (File No. 2-91216).
6Incorporated herein by reference and previously filed as an Exhibit
to Post-Effective Amendment No. 29 to the Registration Statement on Form N-1A
filed via EDGAR on August 20, 1999 (File No. 2-91216).
7Incorporated by reference and previously filed as Exhibit (h)(10) to
Post-Effective Amendment No. 2 to the Registration Statement on Form N-1A of
Hotchkis and Wiley Variable Trust filed via EDGAR on April 7, 2000 (File No.
333-24349).
--------------------------
* Filed herewith
** To be filed by amendment
2
