STATEMENT OF ADDITIONAL INFORMATION
ADVANTUS SERIES FUND, INC.
May 1, 2000
As Supplemented July 31, 2000
This Statement of Additional Information is not a prospectus. This Statement
of Additional Information relates to the separate Prospectus dated May 1,
2000 and should be read in conjunction therewith.
The Fund's audited Annual Report, dated December 31, 2000, which either
accompanies this Statement of Additional Information or has previously been
provided to the investor to whom this Statement of Additional Information is
being sent, is incorporated herein by reference.
A copy of the Prospectus and Annual Report may be obtained by telephone from
Minnesota Life Insurance Company (Minnesota Life) at (800) 995-3850 or by
writing to Minnesota Life at 400 Robert Street North, St. Paul, Minnesota
55101-2098.
TABLE OF CONTENTS
GENERAL INFORMATION AND HISTORY 1
INVESTMENT OBJECTIVES AND POLICIES 2
Equity Securities of Small Capitalization Companies 2
Debt and Money Market Securities - Non-Money Market Portfolios 2
Low Rated Securities 5
Convertible Securities 6
Money Market Securities - Money Market Portfolio 7
U.S. Government Obligations 7
Obligations of Non-Domestic Banks 8
Variable Amount Master Demand Notes 8
Mortgage-Related Securities 9
U.S. Government Mortgage-Related Securities 10
Non-Governmental Mortgage-Related Securities 10
Collateralized Mortgage Obligations 11
Stripped Mortgage-Backed Securities 13
Asset-Backed and Stripped Asset-Backed Securities 13
Direct Investments in Mortgages - Whole Loans 15
Zero Coupon Securities 15
Pay-in-Kind and Delayed Interest Securities 17
Foreign Securities 17
Foreign Index Linked Securities 19
Swap Agreements 19
Currency Exchange Transactions 20
Foreign Currency Hedging Transactions 21
Closed-End Investment Companies 22
Loans of Portfolio Securities 22
Restricted and Illiquid Securities 23
When-Issued Securities and Forward Commitments 24
Mortgage Dollar Rolls 25
Real Estate Investment Trust Securities 26
Repurchase Agreements 26
Reverse Repurchase Agreements 27
Futures Contracts and Options on Futures Contracts 28
Warrants 33
Warrants with Cash Extractions 34
Index Depositary Receipts 34
Short Sales Against the Box 35
Investments in Russia 35
Defensive Purposes 37
INVESTMENT RESTRICTIONS 38
Additional Restrictions 40
PORTFOLIO TURNOVER 41
DIRECTORS AND EXECUTIVE OFFICERS 42
DIRECTOR LIABILITY 44
INVESTMENT ADVISORY AND OTHER SERVICES 45
General 45
Control and Management of Advantus Capital 46
Investment Advisory Agreement 46
Sub-Adviser - CSAM 51
Investment Sub-Advisory Agreement - CSAM 52
Sub-Adviser - Templeton Counsel 53
Investment Sub-Advisory Agreement - Templeton Counsel 53
Sub-Adviser - JBIM 54
Investment Sub-Advisory Agreement - JBIM 54
Sub-Adviser - Morgan Investment 55
Investment Sub-Advisory Agreement - Morgan Investment 55
Sub-Adviser - WSA 56
Investment Sub-Advisory Agreement - WSA 56
Sub-Adviser - CSAM 56
Investment Sub-Advisory Agreement - CSAM 57
Sub-Adviser - State Street Research 58
Investment Sub-Advisory Agreement - State Street Research 58
Administrative Services 59
Code of Ethics 60
Distribution Agreement 60
Payment of Certain Distribution Expenses of the Fund 61
Custodians 63
Independent Auditors 63
General Counsel 63
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE 63
Adviser 63
Sub-Advisers 66
PURCHASE AND REDEMPTION OF SHARES 66
FUND SHARES AND VOTING RIGHTS 67
NET ASSET VALUE 68
PERFORMANCE DATA 69
Current Yield Figures for Money Market Portfolio 69
Current Yield Figures for Other Portfolios 70
Total Return Figures For All Portfolios 71
Predictability of Return 74
TAXES 75
THE STANDARD & POOR'S LICENSE 76
FINANCIAL STATEMENTS 77
APPENDIX A - MORTGAGE-RELATED SECURITIES A-1
Underlying Mortgages A-1
Liquidity and Marketability A-1
Average Life A-1
Yield Calculations A-2
APPENDIX B - BOND AND COMMERCIAL PAPER RATINGS B-1
Bond Ratings B-1
Commercial Paper Ratings B-2
APPENDIX C - FUTURES CONTRACTS C-1
Example of Futures Contract Sale C-1
Example of Futures Contract Purchase C-1
Tax Treatment C-2
APPENDIX D - BRADY BONDS D-1
GENERAL INFORMATION AND HISTORY
Advantus Series Fund, Inc. ("Fund"), is a Minnesota corporation, each
of whose Portfolios operates as a no-load, diversified, open-end management
investment company, except that Global Bond Portfolio operates as a non-
diversified, open-end management investment company. The Fund was organized
on February 22, 1985. Prior to a change of its Name on May 1, 1997, the Fund
was known as MIMLIC Series Fund, Inc. The Fund is a series fund, which means
that it has several different Portfolios. The Portfolios of the Fund are as
follows:
? Growth Portfolio
? Bond Portfolio
? Money Market Portfolio
? Asset Allocation Portfolio
? Mortgage Securities Portfolio
? Index 500 Portfolio
? Capital Appreciation Portfolio
? International Stock Portfolio
? Small Company Growth Portfolio
? Maturing Government Bond Portfolios (three separate portfolios with
maturity dates of 2002, 2006 and 2010)
? Value Stock Portfolio
? Small Company Value Portfolio
? Global Bond Portfolio
? Index 400 Mid-Cap Portfolio
? Macro-Cap Value Portfolio
? Micro-Cap Growth Portfolio
? Real Estate Securities Portfolio
The investment adviser of the Fund is Advantus Capital Management, Inc.
("Advantus Capital"). Advantus Capital has entered into investment sub-
advisory agreements under which various investment managers provide
investment services. Credit Suisse Asset Management, LLC ("CSAM") serves as
investment sub-adviser to the Fund's Capital Appreciation Portfolio and the
Small Company Growth Portfolio. Templeton Investment Counsel, Inc.
("Templeton Counsel") serves as investment sub-adviser to the Fund's
International Stock Portfolio. Julius Baer Investment Management Inc.
("JBIM") serves as investment sub-adviser to the Fund's Global Bond Portfolio
pursuant to an investment sub-advisory agreement with Advantus Capital. J.P.
Morgan Investment Management Inc. ("Morgan Investment") serves as investment
sub-adviser to the Fund's Macro-Cap Value Portfolio pursuant to an investment
sub-advisory agreement with Advantus Capital. Wall Street Associates ("WSA")
serves as investment sub-adviser to the Fund's Micro-Cap Growth Portfolio
pursuant to an investment sub-advisory agreement with Advantus Capital.
State Street Research & Management Company ("State Street Research") serves
as investment sub-adviser for the Small Company Value Portfolio.
Currently, the shares of the Fund are sold only to Minnesota Life
Insurance Company ("Minnesota Life"), a Minnesota corporation, through
certain of its separate accounts to fund the benefits under variable annuity
contracts and variable life insurance policies (collectively, the
"Contracts") issued by Minnesota Life. The Fund may be used for other
purposes in the future. The Fund may also sell its shares to separate
accounts of Northstar Life Insurance Company, an indirect wholly-owned
subsidiary of Minnesota Life domiciled in the State of New York. The
separate accounts, which will be the owners of the shares of the Fund, will
invest in the shares of each Portfolio in accordance with instructions
received from the owners of the Contracts. Minnesota Life, through its
separate accounts which fund the Contracts, owns 100% of the shares
outstanding of each Portfolio of the Fund. As a result, Minnesota Life is a
controlling person of the Fund and through its ownership of shares of the
Fund, may elect all the directors of the Fund and approve other Fund actions.
Minnesota Life's address is 400 Robert Street North, St. Paul, Minnesota
55101-2098.
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives and principal investment policies of each of
the Portfolios are set forth in the text of the Fund's Prospectus under
"Investing in the Fund - Investment Objective, Policies and Practices." This
section contains detailed descriptions of the investment policies of the
Portfolios as identified in the Fund's Prospectus.
Equity Securities of Small Capitalization Companies
Small Company Growth Portfolio, Small Company Value Portfolio and
Micro-Cap Growth Portfolio will primarily invest in equity securities issued
by small capitalization companies. To the extent specified in the
Prospectus, certain other Portfolios may invest in equity securities issued
by small capitalization companies. Small capitalization companies may be in
a relatively early stage of development or may produce goods and services
which have favorable prospects for growth due to increasing demand or
developing markets. Frequently, such companies have a small management group
and single product or product-line expertise that may result in an enhanced
entrepreneurial spirit and greater focus which allow such firms to be
successful. The Portfolio's investment adviser or sub-adviser believes that
such companies may develop into significant business enterprises and that an
investment in such companies offers a greater opportunity for capital
appreciation than an investment in larger more established entities.
However, small capitalization companies frequently retain a large part of
their earnings for research, development and investment in capital assets, so
that the prospects for immediate dividend income are limited.
While securities issued by smaller capitalization companies have
historically produced better market results than the securities of larger
issuers, there is no assurance that they will continue to do so or that the
Portfolio will invest specifically in those companies which produce those
results. Because of the risks involved, the Portfolio is not intended to
constitute a complete investment program.
Debt and Money Market Securities - Non-Money Market Portfolios
To the extent specified in the Prospectus, certain non-Money Market
Portfolios may invest in long, intermediate and short-term debt securities
from various industry classifications and money market instruments. Such
instruments may include the following:
? Corporate obligations which at the time of purchase are rated within
the four highest grades assigned by Standard & Poor's Corporation
("S&P"), Moody's Investors Services, Inc. ("Moody's") or any other
national rating service, or, if not rated, are of equivalent
investment quality as determined by the Portfolio's investment
adviser or sub-adviser, as the case may be. To the extent that the
Portfolio invests in securities rated BBB or Baa by S&P or Moody's,
respectively, it will be investing in securities which have
speculative elements. As an operating policy, International Stock
Portfolio will not invest more than 5% of its assets in debt
securities rated BBB by S&P or Baa by Moody's. In addition, Asset
Allocation Portfolio, Bond Portfolio and Mortgage Securities
Portfolio may invest up to 10% of their respective net assets, and
International Stock Portfolio and Macro-Cap Value Portfolio may
invest up to 5% of their respective net assets, in securities rated
BB or Ba by S&P or Moody's, respectively; Global Bond Portfolio may
also invest up to 5% of its net assets in securities rated B or
higher by S&P or Moody's; and Value Stock Portfolio, Small Company
Value Portfolio and Micro-Cap Growth Portfolio may also invest up to
10% of their respective net assets in securities (including
convertible securities) rated at least B- by S&P or by B3 by
Moody's. See "Low Rated Securities," below. For a description of
the ratings used by Moody's and S&P, see Appendix B ("Bond and
Commercial Paper Ratings") below.
? Obligations of, or guaranteed by, the U.S. Government, its agencies
or instrumentalities.
? Debt obligations of banks.
Bond Portfolio may also purchase U.S. dollar denominated debt
securities of foreign governments and companies which are publicly traded in
the United States and rated within the four highest grades assigned by S&P or
Moody's.
Global Bond Portfolio may also purchase debt securities of foreign
companies and debt securities issued or guaranteed by foreign governments or
any of their agencies, instrumentalities or political subdivisions, or by
supranational organizations. The Portfolio may invest in fixed-income
securities issued or guaranteed by supranational organizations. Such
organizations are entities designated or supported by a government or
government entity to promote economic development, and include, among others,
the Asian Development Bank, the European Coal and Steel Community, the
European Economic Community and the World Bank. These organizations do not
have taxing authority and are dependent upon their members for payments of
interest and principal. Each supranational entity's lending activities are
limited to a percentage of its total capital (including "callable capital"
contributed by members at the entity's call), reserves and net income.
Securities issued by supranational organizations may be denominated in U.S.
dollars or in foreign currencies. Securities issued or guaranteed by
supranational organizations are considered by the Securities and Exchange
Commission to be securities in the same industry. Therefore, the Portfolio
will not concentrate 25% or more of the value of its assets in securities of
a single supranational organization.
Global Bond Portfolio may invest in Brady Bonds, which are created
through the exchange of existing commercial bank loans to foreign entities
for new obligations in connection with debt restructuring under a plan
introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady (the
"Brady Plan"). Brady Bonds have been issued only recently and, accordingly,
do not have a long payment history. They may be collateralized or
uncollateralized and issued in various currencies (although most are dollar-
denominated) and they are actively traded in the over-the-counter secondary
market. For a full discussion of Brady Bonds see Appendix D.
In addition to the instruments described above, which will generally be
long-term, but may be purchased by the Portfolio within one year of the date
of a security's maturity, certain Portfolios specified in the Prospectus may
also purchase other high quality securities including:
? Obligations (including certificates of deposit and bankers
acceptances) of U.S. banks, savings and loan associations, savings
banks which have total assets (as of the date of their most recent
annual financial statements at the time of investment) of not less
than $2,000,000,000; U.S. dollar denominated obligations of Canadian
chartered banks, London branches of U.S. banks and U.S. branches or
agencies of foreign banks which meet the above-stated asset size;
and obligations of any U.S. banks, savings and loan associations and
savings banks, regardless of the amount of their total assets,
provided that the amount of the obligations purchased does not
exceed $100,000 for any one U.S. bank, savings and loan association
or savings bank and the payment of the principal is insured by the
Federal Deposit Insurance Corporation or the Federal Savings and
Loan Insurance Corporation.
? Obligations of the International Bank for Reconstruction and
Development.
? Commercial paper (including variable amount master demand notes)
issued by U.S. corporations or affiliated foreign corporations and
rated (or guaranteed by a company whose commercial paper is rated)
at the date of investment Prime-1 by Moody's or A-1 by S&P or, if
not rated by either Moody's or S&P, issued by a corporation having
an outstanding debt issue rated Aa or better by Moody's or AA or
better by S&P and, if issued by an affiliated foreign corporation,
such commercial paper (not to exceed in the aggregate 10% of such
Portfolio's (other than Mortgage Securities Portfolio's) net assets)
is U.S. dollar denominated and not subject at the time of purchase
to foreign tax withholding.
The Portfolios may also invest in securities which are unrated if the
Portfolio's investment adviser or sub-adviser, as the case may be, determines
that such securities are of equivalent investment quality to the rated
securities described above. In the case of "split-rated" securities, which
result when nationally-recognized rating agencies rate the security at
different rating levels (e.g., BBB by S&P and Ba by Moody's), it is the
Portfolio's general policy to classify such securities at the higher rating
level where, in the judgment of the Portfolio's investment adviser or sub-
adviser, such classification reasonably reflects the security's quality and
risk.
The market value of debt securities generally varies in response to
changes in interest rates and the financial condition of each issuer. During
periods of declining interest rates, the value of debt securities generally
increases. Conversely, during periods of rising interest rates, the value of
such securities generally declines. These changes in market value will be
reflected in each Portfolio's net asset value.
These Portfolios may, however, acquire debt securities which, after
acquisition, are down-graded by the rating agencies to a rating which is
lower than the applicable minimum rating described above. In such an event
it is the Portfolios' general policy to dispose of such down-graded
securities except when, in the judgment of the Portfolios' investment adviser
or sub-adviser, it is to the Portfolios' advantage to continue to hold such
securities. In no event, however, will any Portfolio hold in excess of 5% of
its net assets in securities which have been down-graded subsequent to
purchase where such down-graded securities are not otherwise eligible for
purchase by the Portfolio. This 5% is in addition to securities which the
Portfolio may otherwise purchase under its usual investment policies.
Low Rated Securities
Bond Portfolio, Asset Allocation Portfolio and Mortgage Securities
Portfolio may also invest up to 10% of their respective net assets, and
International Stock Portfolio and Macro-Cap Value Portfolio may invest up to
5% of their respective net assets, in corporate bonds and mortgage-related
securities, including convertible securities, which, at the time of
acquisition, are rated BB or Ba by S&P or Moody's, respectively, or rated at
a comparable level by another independent publicly-recognized rating agency,
or, if not rated, are of equivalent investment quality as determined by the
Portfolio's investment adviser or sub-adviser, as the case may be. Global
Bond Portfolio may also invest up to 5% of its net assets in securities rated
B or higher by S&P or Moody's. Value Stock Portfolio, Small Company Value
Portfolio and Micro-Cap Growth Portfolio may invest up to 10% of their
respective net assets in debt securities (including convertible securities)
which are rated at least B- by S&P or B3 by Moody's, or rated at a comparable
level by another independent publicly-recognized rating agency, or, if not
rated, are of equivalent investment quality as determined by the Portfolio's
investment adviser. Each of these Portfolios may also hold an additional 5%
of its net assets in securities rated below "investment grade" (i.e. below
BBB) where such securities were either investment grade or eligible low rated
securities at the time of purchase but subsequently down-graded to a rating
not otherwise eligible for purchase by the Portfolio (see "Debt and Money
Market Securities - Non-Money Market Portfolios" above). Debt securities
rated below the four highest categories (i.e., below BBB) are not considered
investment grade obligations and are commonly called "junk bonds." These
securities are predominately speculative and present more credit risk than
investment grade obligations. Bonds rated below BBB are also regarded as
predominately speculative with respect to the issuer's continuing ability to
meet principal and interest payments.
Low rated and unrated debt securities generally involve greater
volatility of price and risk of principal and income, including the
possibility of default by, or bankruptcy of, the issuers of the securities.
In addition, the markets in which low rated and unrated debt securities are
traded are more limited than those in which higher rated securities are
traded. The existence of limited markets for particular securities may
diminish the Portfolios' ability to sell the securities at fair value either
to meet redemption requests or to respond to changes in the economy or in the
financial markets and could adversely affect and cause fluctuations in the
daily net asset value of the Portfolios' shares.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of low rated debt
securities, especially in a thinly traded market. Analysis of the
creditworthiness of issuers of low rated debt securities may be more complex
than for issuers of higher rated securities, and the ability of the
Portfolios to achieve their respective investment objective may, to the
extent of investment in low rated debt securities, be more dependent upon
such creditworthiness analysis than would be the case if the Portfolios were
investing in higher rated securities.
Low rated debt securities may be more susceptible to real or perceived
adverse economic and competitive industry conditions than investment grade
securities. The prices of low rated debt securities have been found to be
less sensitive to interest rate changes than higher rated investments, but
more sensitive to adverse economic downturns or individual corporate
developments. A projection of an economic downturn or of a period of rising
interest rates, for example, could cause a decline in low rated debt
securities prices because the advent of a recession could lessen the ability
of a highly leveraged company to make principal and interest payments on its
debt securities. If the issuer of low rated debt securities defaults, the
Portfolios may incur additional expenses to seek recovery. The low rated
bond market is relatively new, and many of the outstanding low rated bonds
have not endured a major business recession.
Convertible Securities
To the extent specified in the Prospectus, certain Portfolios may
invest in debt or preferred equity securities convertible into or
exchangeable for equity securities. Traditionally, convertible securities
have paid dividends or interest at rates higher than common stocks but lower
than non-convertible securities. They generally participate in the
appreciation or depreciation of the underlying stock into which they are
convertible, but to a lesser degree. The total return and yield of lower
quality (high yield/high risk) convertible bonds can be expected to fluctuate
more than the total return and yield of higher quality, shorter-term bonds,
but not as much as common stocks. Growth Portfolio, Small Company Growth
Portfolio, Real Estate Securities Portfolio, Macro-Cap Value Portfolio and
Capital Appreciation Portfolio will each limit its purchase of convertible
debt securities to those that, at the time of purchase, are rated at least
BBB or Baa by S&P or Moody's, respectively, or it not rated by S&P or
Moody's, are of equivalent investment quality as determined by the
Portfolio's investment adviser or sub-adviser. Bond Portfolio, Asset
Allocation Portfolio and Mortgage Securities Portfolio will each limit its
purchase of convertible debt securities to those that, at the time of
purchase, are rated at least BB or Ba by S&P or Moody's, respectively, or if
not rated by S&P or Moody's, are of equivalent investment quality as
determined by the Portfolio's investment adviser. Value Stock Portfolio,
Small Company Value Portfolio and Micro-Cap Growth Portfolio will each limit
its purchase of convertible debt securities to those that, at the time of
purchase, are rated at least B- by S&P or B3 by Moody's, or if not rated by
S&P or Moody's, are of equivalent investment quality as determined by the
Portfolio's investment adviser or sub-adviser. As an operating policy, none
of these Portfolios will purchase a non-investment grade convertible debt
security if immediately after such purchase such Portfolio would have more
than 10% of its total assets invested in such securities. See "Low Rated
Securities," above.
Money Market Securities - Money Market Portfolio
Subject to the limitations under Rule 2a-7 of the Investment Company
Act of 1940 (as described in "Investment Restrictions - Additional
Restrictions" below), Money Market Portfolio will invest in a managed
portfolio of money market instruments as follows:
? Obligations issued or guaranteed as to principal or interest by the
U.S. Government, or any agency or authority controlled or supervised
by and acting as an instrumentality of the U.S. Government pursuant
to authority granted by Congress.
? Obligations (including certificates of deposit and bankers
acceptances) of U.S. banks, savings and loan associations and
savings banks which at the date of the investment have total assets
(as of the date of their most recent annual financial statements) of
not less than $2,000,000,000; U.S. dollar denominated obligations of
Canadian chartered banks, London branches of U.S. banks, and U.S.
branches or agencies of foreign banks if such banks meet the above-
stated asset size; and obligations of any such U.S. banks, savings
and loan associations and savings banks, regardless of the amount of
their total assets, provided that the amount of the obligations does
not exceed $100,000 for any one U.S. bank, savings and loan
association or savings bank and the payment of the principal is
insured by the Federal Deposit Insurance Corporation.
? Obligations of the International Bank for Reconstruction and
Development.
? Commercial paper (including variable amount master demand notes)
issued by U.S. limited partnerships, corporations or affiliated
foreign corporations.
? Other corporate debt obligations that at the time of issuance were
long-term securities, but that have remaining maturities of 397
calendar days or less.
? Repurchase agreements with respect to any of the foregoing
obligations.
By limiting the maturity of its investments as described above, the
Portfolio seeks to lessen the changes in the value of its assets caused by
market factors. The Portfolio intends to maintain a constant net asset value
of $1.00 per share, but there can be no assurance it will be able to do so.
U.S. Government Obligations
Each of the Portfolios may invest in obligations of the U.S.
Government. These obligations are bills, certificates of indebtedness, notes
and bonds issued or guaranteed as to principal or interest by the U.S. or by
agencies or authorities controlled or supervised by and acting as
instrumentalities of the U.S. Government established under the authority
granted by Congress. Bills, notes and bonds issued by the U.S. Treasury are
direct obligations of the U.S. Government and differ in their interest rates,
maturities and times of issuance. Securities issued or guaranteed by
agencies or authorities controlled or supervised by and acting as
instrumentalities of the U.S. Government established under authority granted
by Congress include but are not limited to, the Government National Mortgage
Association ("GNMA"), the Export-Import Bank, the Student Loan Marketing
Association, the U.S. Postal Service, the Tennessee Valley Authority, the
Bank for Cooperatives, the Farmers Home Administration, the Federal Home Loan
Bank, the Federal Financing Bank, the Federal Intermediate Credit Banks, the
Federal Land Banks, the Farm Credit Banks and the Federal National Mortgage
Association. Some obligations of U.S. Government agencies, authorities and
other instrumentalities are supported by the full faith and credit of the
U.S. Treasury, such as securities of the Government National Mortgage
Association and the Student Loan Marketing Association; others by the right
of the issuer to borrow from the U.S. Treasury, such as securities of the
Federal Financing Bank and the U.S. Postal Service; and others only by the
credit of the issuing agency, authority or other instrumentality, such as
securities of the Federal Home Loan Bank and the Federal National Mortgage
Association ("FNMA").
Obligations of Non-Domestic Banks
As specified in the Prospectus, certain of the Portfolios may invest in
obligations of Canadian chartered banks, London branches of U.S. banks, and
U.S. branches and agencies of foreign banks, which may involve somewhat
greater opportunity for income than the other money market instruments in
which the Portfolios invest, but may also involve investment risks in
addition to any risks associated with direct obligations of domestic banks.
These additional risks include future political and economic developments,
the possible imposition of withholding taxes on interest income payable on
such obligations, the possible seizure or nationalization of foreign
deposits, the possible establishment of exchange controls or the adoption of
other governmental restrictions, as well as market and other factors which
may affect the market for or the liquidity of such obligations. Generally,
Canadian chartered banks, London branches of U.S. banks, and U.S. branches
and agencies of foreign banks are subject to fewer U.S. regulatory
restrictions than those applicable to domestic banks, and London branches of
U.S. banks may be subject to less stringent reserve requirements than
domestic branches. Canadian chartered banks, U.S. branches and agencies of
foreign banks, and London branches of U.S. banks may provide less public
information than, and may not be subject to the same accounting, auditing and
financial recordkeeping standards as, domestic banks. Each Portfolio will
not invest more than 25% of its total assets in obligations of Canadian
chartered banks, London branches of U.S. banks, and U.S. branches and
agencies of foreign banks.
Variable Amount Master Demand Notes
Money Market Portfolio may invest in variable amount master demand
notes. These instruments are short-term, unsecured promissory notes issued
by corporations to finance short-term credit needs. They allow the
investment of fluctuating amounts by the Portfolio at varying market rates of
interest pursuant to direct arrangements between Money Market Portfolio, as
lender, and the borrower. Variable amount master demand notes permit a
series of short-term borrowings under a single note. The lender has the
right to increase the amount under the note at any time up to the full amount
provided by the note agreement. Both the lender and the borrower have the
right to reduce the amount of outstanding indebtedness at any time. Because
variable amount master demand notes are direct lending arrangements between
the lender and borrower, it is not generally contemplated that such
instruments will be traded and there is no secondary market for the notes.
Typically, agreements relating to such notes provide that the lender shall
not sell or otherwise transfer the note without the borrower's consent.
Thus, variable amount master demand notes are illiquid assets. Such notes
provide that the interest rate on the amount outstanding varies on a daily
basis depending upon a stated short-term interest rate barometer. The
Portfolio's investment adviser will monitor the creditworthiness of the
borrower throughout the term of the variable amount master demand note.
Mortgage-Related Securities
Bond Portfolio, Asset Allocation Portfolio, Mortgage Securities
Portfolio and Global Bond Portfolio may invest in mortgage-related securities
(including securities which represent interests in pools of mortgage loans)
issued by government (some of which may be U.S. Government agency issued or
guaranteed securities as described herein) and non-government entities such
as banks, mortgage lenders or other financial institutions. These securities
may include both collateralized mortgage obligations and stripped mortgage-
backed securities. Mortgage loans are originated and formed into pools by
various organizations, including the Government National Mortgage Association
("GNMA"), the Federal National Mortgage Association ("FNMA"), the Federal
Home Loan Mortgage Corporation ("FHLMC") and various private organizations
including commercial banks and other mortgage lenders. Payments on mortgage-
related securities generally consist of both principal and interest, with
occasional repayments of principal due to refinancings, foreclosures or
certain other events. Some mortgage-related securities, such as
collateralized mortgage obligations, make payments of both principal and
interest at a variety of intervals. Certain mortgage-related securities,
such as GNMA securities, entitle the holder to receive such payments,
regardless of whether or not the mortgagor makes loan payments; certain
mortgage-related securities, such as FNMA securities, guarantee the timely
payment of interest and principal; certain mortgage-related securities, such
as FHLMC securities, guarantee the timely payment of interest and ultimate
collection of principal; and certain mortgage-related securities contain no
such guarantees but may offer higher rates of return. No mortgage-related
securities guarantee the Portfolio's yield or the price of its shares.
Each Portfolio expects its investments in mortgage-related securities
to be primarily in high-grade mortgage-related securities either (a) issued
by GNMA, FNMA or FHLMC or other United States Government owned or sponsored
corporations or (b) rated A or better by S&P or Moody's, or rated at a
comparable level by another independent publicly-recognized rating agency,
or, if not rated, are of equivalent investment quality as determined by the
Portfolio's investment adviser or sub-adviser, as the case may be. The
Portfolio may invest in mortgage-related securities rated BBB or Baa by S&P
or Moody's, respectively, or rated at a comparable level by another
independent publicly-recognized rating agency, or, if not rated, are of
equivalent investment quality as determined by the Portfolio's investment
adviser or sub-adviser, as the case may be, when deemed by the Portfolio's
investment adviser or sub-adviser to be consistent with the Portfolio's
respective objective. To the extent that the Portfolio invests in securities
rated BBB or Baa by S&P or Moody's, respectively, it will be investing in
securities which have speculative elements. (Each of these Portfolios may
also invest a portion of its assets in securities rated below BBB or Baa by
S&P or Moody's, respectively. See "Low Rated Securities" and "Convertible
Securities," above, for more information.) Mortgage Securities Portfolio may
not invest more than 35% of its total assets in securities rated BBB or Baa
or lower by S&P or Moody's, respectively. For further information about the
characteristics and risks of mortgage-related securities, and for a
description of the ratings used by Moody's and S&P, see Appendix A and B
("Mortgage-Related Securities" and "Bond and Commercial Paper Ratings")
below.
U.S. Government Mortgage-Related Securities
A governmental guarantor (i.e., backed by the full faith and credit of
the U.S. Government) of mortgage-related securities is GNMA. GNMA is a
wholly-owned U.S. Government corporation within the Department of Housing and
Urban Development. GNMA is authorized to guarantee, with the full faith and
credit of the U.S. Government, the timely payment of principal and interest
on securities issued by institutions approved by GNMA (such as savings and
loan institutions, commercial banks and mortgage bankers) and backed by pools
of FHA-insured or VA-guaranteed mortgages.
Government-related guarantors (i.e., not backed by the full faith and
credit of the U.S. Government) include FNMA and FHLMC. FNMA is a government-
sponsored corporation owned entirely by private stockholders. It is subject
to general regulation by the Secretary of Housing and Urban Development.
FNMA purchases residential mortgages from a list of approved seller/servicers
which include state and federally-chartered savings and loan associations,
mutual savings banks, commercial banks and credit unions and mortgage
bankers. Pass-through securities issued by FNMA are guaranteed as to timely
payment of principal and interest by FNMA but are not backed by the full
faith and credit of the U.S. Government.
FHLMC is a corporate instrumentality of the U.S. Government and was
created by Congress in 1970 for the purpose of increasing the availability of
mortgage credit for residential housing. Its stock is publicly traded.
FHLMC issues Participation Certificates ("PCs") which represent interests in
mortgages from FHLMC's national portfolio. FHLMC guarantees the timely
payment of interest and principal on most PCs. There are some PCs, however,
on which FHLMC guarantees the timely payment of interest but only the
ultimate payment of principal. PCs are not backed by the full faith and
credit of the U.S. Government.
Non-Governmental Mortgage-Related Securities
Mortgage Securities Portfolio, Bond Portfolio, Asset Allocation
Portfolio and Global Bond Portfolio may invest in non-governmental mortgage-
related securities. Commercial banks, savings and loan institutions, private
mortgage insurance companies, mortgage bankers and other secondary market
issuers also create pass-through pools of conventional residential and
commercial mortgage loans. Such issuers may in addition be the originators
and servicers of the underlying mortgage loans as well as the guarantors of
the mortgage-related securities. Pools created by such non-governmental
issuers generally offer a higher rate of interest than government and
government-related pools because there are no direct or indirect government
guarantees of payments in the former pools. However, timely payment of
interest and principal of these pools is supported by various forms of
insurance, guarantees and credit enhancements, including individual loan,
title, pool and hazard insurance. The insurance and guarantees are issued by
government entities, private insurers and the mortgage poolers. Such
insurance and guarantees and the creditworthiness of the issuers thereof will
be considered in determining whether a mortgage-related security meets the
Portfolio's investment quality standards. There can be no assurance that the
private insurers can meet their obligations under the policies. The
Portfolio may buy mortgage-related securities without insurance or guarantees
if through an examination of the loan experience and practices of the poolers
the Portfolio's investment adviser determines that the securities meet the
Portfolio's quality standards. Although the market for such securities is
becoming increasingly liquid, securities issued by certain private
organizations may not be readily marketable. The Portfolio will not purchase
mortgage-related securities or any other assets which in its investment
adviser's opinion are illiquid if, as a result, more than 15% of the value of
the Portfolio's net assets will be illiquid.
Collateralized Mortgage Obligations
Bond Portfolio, Asset Allocation Portfolio, Mortgage Securities
Portfolio and Global Bond Portfolio may invest in collateralized mortgage
obligations ("CMOs"), in which several different series of bonds or
certificates secured by pools of mortgage-backed securities or mortgage
loans, are issued. The series differ from each other in terms of the
priority rights which each has to receive cash flows with the CMO from the
underlying collateral. Each CMO series may also be issued in multiple
classes. Each class of a CMO series, often referred to as a "tranche," is
usually issued at a specific coupon rate and has a stated maturity. The
underlying security for the CMO may consist of mortgage-backed securities
issued or guaranteed by U.S. Government agencies or whole loans. CMOs backed
by U.S. Government agency securities retain the credit quality of such agency
securities and therefore present minimal credit risk. CMOs backed by whole
loans typically carry various forms of credit enhancements to protect against
credit losses and provide investment grade ratings. Unlike traditional
mortgage pass-through securities, which simply pass through interest and
principal on a pro rata basis as received, CMOs allocate the principal and
interest from the underlying mortgages among the several classes or branches
of the CMO in many ways. All residential, and some commercial, mortgage-
related securities are subject to prepayment risk. A CMO does not eliminate
that risk, but, by establishing an order of priority among the various
tranches for the receipt and timing of principal payments, it can reallocate
that risk among the tranches. Therefore, the stream of payments received by
a CMO bondholder may differ dramatically from that received by an investor
holding a traditional pass-through security backed by the same collateral.
In the traditional form of CMO, interest is paid currently on all
tranches but principal payments are applied sequentially to retire each
tranche in order of stated maturity. Traditional sequential payment CMOs
have evolved into numerous more flexible forms of CMO structures which can
vary frequency of payments, maturities, prepayment risk and performance
characteristics. The differences between these new types of CMOs relate
primarily to the manner in which each varies the amount and timing of
principal and interest received by each tranche from the underlying
collateral. Under all but the sequential payment structures, specific
tranches of CMOs have priority rights over other tranches with respect to the
amount and timing of cash flow from the underlying mortgages.
The primary risk associated with any mortgage security is the
uncertainty of the timing of cash flows; specifically, uncertainty about the
possibility of either the receipt of unanticipated principal in falling
interest rate environments (prepayment or call risk) or the failure to
receive anticipated principal in rising interest rate environments (extension
risk). In a CMO, that uncertainty may be allocated to a greater or lesser
degree to specific tranches depending on the relative cash flow priorities of
those tranches. By establishing priority rights to receive and reallocate
payments of prepaid principal, the higher priority tranches are able to offer
better call protection and extension protection relative to the lower
priority classes in the same CMO. For example, when insufficient principal
is received to make scheduled principal payments on all tranches, the higher
priority tranches receive their scheduled premium payments first and thus
bear less extension risk than lower priority tranches. Conversely, when
principal is received in excess of scheduled principal payments on all
tranches (call risk), the lower priority tranches are required to receive
such excess principal until they are retired and thus bear greater prepayment
risk than the higher priority tranches. Therefore, depending on the type of
CMO purchased, an investment may be subject to a greater or lesser risk of
prepayment, and experience a greater or lesser volatility in average life,
yield, duration and price, than other types of mortgage-related securities.
A CMO tranche may also have a coupon rate which resets periodically at a
specified increment over an index. These floating rate CMOs are typically
issued with lifetime caps on the level to which the floating coupon rate is
allowed to rise. The Portfolio may invest in such securities, usually
subject to a cap, provided such securities satisfy the same requirements
regarding cash flow priority applicable to the Portfolio's purchase of CMOs
generally. CMOs are typically traded over the counter rather than on
centralized exchanges. Because CMOs of the type purchased by the Portfolio
tend to have relatively more predictable yields and are relatively less
volatile, they are also generally more liquid than CMOs with greater
prepayment risk and more volatile performance profiles.
Bond Portfolio, Asset Allocation Portfolio and Mortgage Securities
Portfolio may also purchase CMOs known as "accrual" or "Z" bonds. An accrual
or Z bond holder is not entitled to receive cash payments until one or more
other classes of the CMO have been paid in full from payments on the mortgage
loans underlying the CMO. During the period in which cash payments are not
being made on the Z tranche, interest accrues on the Z tranche at a stated
rate, and this accrued interest is added to the amount of principal which is
due to the holder of the Z tranche. After the other classes have been paid
in full, cash payments are made on the Z tranche until its principal
(including previously accrued interest which was added to principal, as
described above) and accrued interest at the stated rate have been paid in
full. Generally, the date upon which cash payments begin to be made on a Z
tranche depends on the rate at which the mortgage loans underlying the CMO
are prepaid, with a faster prepayment rate resulting in an earlier
commencement of cash payments on the Z tranche. Like a zero coupon bond,
during its accrual period the Z tranche of a CMO has the advantage of
eliminating the risk of reinvesting interest payments at lower rates during a
period of declining market interest rates. At the same time, however, and
also like a zero coupon bond, the market value of a Z tranche can be expected
to fluctuate more widely with changes in market interest rates than would the
market value of a tranche which pays interest currently. Changes in market
interest rates also can be expected to influence prepayment rates on the
mortgage loans underlying the CMO of which a Z tranche is a part. As noted
above, such changes in prepayment rates will affect the date at which cash
payments begin to be made on a Z tranche, and therefore also will influence
its market value. As an operating policy, Bond Portfolio, Asset Allocation
Portfolio and Mortgage Securities Portfolio will not purchase a Z bond if the
respective Portfolio's aggregate investment in Z bonds which are then still
in their accrual periods would exceed 20% of the Portfolio's total assets (Z
bonds which have begun to receive cash payments are not included for purposes
of this 20% limitation).
Bond Portfolio, Asset Allocation Portfolio and Mortgage Securities
Portfolio may also invest in inverse or reverse floating CMOs. Inverse or
reverse floating CMOs constitute a tranche of a CMO with a coupon rate that
moves in the reverse direction to an applicable index. Accordingly, the
coupon rate will increase as interest rates decrease. The Portfolio would be
adversely affected, however, by the purchase of such CMOs in the event of an
increase in interest rates since the coupon rate will decrease as interest
rates increase, and, like other mortgage-related securities, the value will
decrease as interest rates increase. Inverse or reverse floating rate CMOs
are typically more volatile than fixed or floating rate tranches of CMOs, and
usually carry a lower cash flow priority. As an operating policy, Bond
Portfolio, Asset Allocation Portfolio and Mortgage Securities Portfolio will
treat inverse floating rate CMOs as illiquid and, therefore, will limit its
investments in such securities, together with all other illiquid securities,
to 15% of such Portfolio's net assets.
Stripped Mortgage-Backed Securities
Bond Portfolio, Asset Allocation Portfolio and Mortgage Securities
Portfolio may invest in stripped mortgage-backed securities. Stripped
mortgage-backed securities represent undivided ownership interests in a pool
of mortgages, the cash flow of which has been separated into its interest and
principal components. "IOs" (interest only securities) receive the interest
portion of the cash flow while "POs" (principal only securities) receive the
principal portion. Stripped mortgage-backed securities may be issued by U.S.
Government agencies or by private issuers. As interest rates rise and fall,
the value of IOs tends to move in the same direction as interest rates,
unlike other mortgage-backed securities (which tend to move in the opposite
direction compared to interest rates). Under the Internal Revenue Code of
1986, as amended, POs may generate taxable income from the current accrual of
original issue discount, without a corresponding distribution of cash to the
Portfolio.
The cash flows and yields on standard IO and PO classes are extremely
sensitive to the rate of principal payments (including prepayments) on the
related underlying mortgage assets. For example, a rapid or slow rate of
principal payments may have a material adverse effect on the performance and
prices of IOs or POs, respectively. If the underlying mortgage assets
experience greater than anticipated prepayments of principal, an investor may
fail to recoup fully its initial investment in an IO class of a stripped
mortgage-backed security, even if the IO class is rated AAA or Aaa or is
derived from a full faith and credit obligation (i.e., a GNMA). Conversely,
if the underlying mortgage assets experience slower than anticipated
prepayments of principal, the price on a PO class will be affected more
severely than would be the case with a traditional mortgage-backed security,
but unlike IOs, an investor will eventually recoup fully its initial
investment provided no default of the guarantor occurs. As an operating
policy, the Portfolio will limit its investments in IOs and POs to 15% of the
Portfolio's net assets, and will treat them as illiquid securities (which, in
the aggregate, may not exceed 15% of a Portfolio's net assets) except to the
extent such securities are deemed liquid by the Portfolio's adviser or sub-
adviser in accordance with standards established by the Fund's Board of
Directors. See "Restricted and Illiquid Securities" below.
Asset-Backed and Stripped Asset-Backed Securities
Bond Portfolio, Asset Allocation Portfolio, Mortgage Securities
Portfolio and Global Bond Portfolio may invest in asset-backed securities
rated within the four highest grades assigned by Moody's or S&P, or, if not
rated, are of equivalent investment quality as determined by the Portfolio's
investment adviser or sub-adviser. Asset-backed securities usually represent
interests in pools of consumer loans (typically trade, credit card or
automobile receivables). The credit quality of most asset-backed securities
depends primarily on the credit quality of the assets underlying such
securities, how well the entity issuing the security is insulated from the
credit risk of the originator or any other affiliated entities, the quality
of the servicing of the receivables, and the amount and quality of any credit
support provided to the securities. The rate of principal payment on asset-
backed securities may depend on the rate of principal payments received on
the underlying assets which in turn may be affected by a variety of economic
and other factors. As a result, the yield on any asset-backed security may
be difficult to predict with precision and actual yield to maturity may be
more or less than the anticipated yield to maturity. Some asset-backed
transactions are structured with a "revolving period" during which the
principal balance of the asset-backed security is maintained at a fixed
level, followed by a period of rapid repayment. This structure is intended
to insulate holders of the asset-backed security from prepayment risk to a
significant extent. Asset-backed securities may be classified as pass-
through certificates or collateralized obligations.
Pass-through certificates are asset-backed securities which represent
an undivided fractional ownership interest in an underlying pool of assets.
Pass-through certificates usually provide for payments of principal and
interest received to be passed through to their holders, usually after
deduction for certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest in the
underlying assets, the holders thereof bear directly the risk of any defaults
by the obligors on the underlying assets not covered by any credit support.
Asset-backed securities issued in the form of debt instruments, also
known as collateralized obligations, are generally issued as the debt of a
special purpose entity organized solely for the purpose of owning such assets
and issuing such debt. The assets collateralizing such asset-backed
securities are pledged to a trustee or custodian for the benefit of the
holders thereof. Such issuers generally hold no assets other than those
underlying the asset-backed securities and any credit support provided. As a
result, although payments on such asset-backed securities are obligations of
the issuers, in the event of defaults on the underlying assets not covered by
any credit support, the issuing entities are unlikely to have sufficient
assets to satisfy their obligations on the related asset-backed securities.
To lessen the effect of failures by obligors on underlying assets to
make payments, such securities may contain elements of credit support. Such
credit support falls into two classes: liquidity protection and protection
against ultimate default by an obligor on the underlying assets. Liquidity
protection refers to the provision of advances, generally by the entity
administering the pool of assets, to ensure that scheduled payments on the
underlying pool are made in a timely fashion. Protection against ultimate
default ensures ultimate payment of the obligations on at least a portion of
the assets in the pool. Such protection may be provided through guarantees,
insurance policies or letters of credit obtained from third parties, through
various means of structuring the transaction or through a combination of such
approaches.
Bond Portfolio, Asset Allocation Portfolio and Mortgage Securities
Portfolio may also invest in stripped asset-backed securities. Asset-backed
securities may be stripped to create interest-only and principal-only
securities in the same manner as mortgage-backed securities. See "Stripped
Mortgage-Backed Securities," above. The value of asset-backed IOs also tends
to move in the same direction as changes in interest rates, unlike other
asset-backed (or mortgage-backed) securities, which tend to move in the
opposite direction compared to interest rates. As with stripped mortgage-
backed securities, the cash flows and yields on asset-backed IOs and POs are
also extremely sensitive to the rate of principal payments on the related
underlying assets. See "Stripped Mortgage-Backed Securities," above. As an
operating policy, each of these Portfolios will limit its investments in IOs
and POs to 15% of the Portfolio's net assets, and will treat them as illiquid
securities (which, in the aggregate, may not exceed 15% of each Portfolio's
net assets) except to the extent such securities are deemed liquid by the
Portfolio's adviser in accordance with standards established by the
Portfolio's Board of Directors. See "Restricted and Illiquid Securities"
below.
Direct Investments in Mortgages - Whole Loans
Mortgage Securities Portfolio may invest up to 10% of the value of its
net assets directly in mortgages securing residential or commercial real
estate (i.e., the Portfolio becomes the mortgagee). Such investments are not
"mortgage-related securities" as described above. They are normally
available from lending institutions which group together a number of
mortgages for resale (usually from 10 to 50 mortgages) and which act as
servicing agent for the purchaser with respect to, among other things, the
receipt of principal and interest payments. (Such investments are also
referred to as "whole loans".) The vendor of such mortgages receives a fee
from Mortgage Securities Portfolio for acting as servicing agent. The vendor
does not provide any insurance or guarantees covering the repayment of
principal or interest on the mortgages. Unlike pass-through securities,
whole loans constitute direct investment in mortgages inasmuch as Mortgage
Securities Portfolio, rather than a financial intermediary, becomes the
mortgagee with respect to such loans purchased by the Portfolio. At present,
such investments are considered to be illiquid by the Portfolio's investment
adviser or sub-adviser. Mortgage Securities Portfolio will invest in such
mortgages only if its investment adviser has determined through an
examination of the mortgage loans and their originators (which may include an
examination of such factors as percentage of family income dedicated to loan
service and the relationship between loan value and market value) that the
purchase of the mortgages should not represent a significant risk of loss to
the Portfolio.
Zero Coupon Securities
The Maturing Government Bond Portfolios may invest in zero coupon
securities. In addition, Global Bond Portfolio may invest a lesser portion
of its assets in zero coupon securities. When held to maturity, the entire
return on zero coupon securities, which consists of the amortization of
discount, comes from the difference between their purchase price and their
maturity value. This difference is known at the time of purchase, so persons
holding a portfolio composed entirely of zero coupon securities, with no
expenses until maturity, would know the amount of their investment return at
the time of their initial payment. While these Portfolios will have
additional holdings, including cash, which will affect performance, they will
describe an anticipated yield to maturity from time to time. In order to
obtain this return, Contract owners electing to have payments allocated to a
Maturing Government Bond Portfolio should plan to maintain their investment
until the maturity of that Maturing Government Bond Portfolio.
While many factors may affect the yield to maturity of each Maturing
Government Bond Portfolio, one such factor which may operate to the detriment
of those Contract owners holding interests in such Portfolios until maturity,
is the ability of other Contract owners to purchase or redeem shares on any
business day.
Because each Maturing Government Bond Portfolio will be primarily
invested in zero coupon securities, Contract owners whose purchase payments
are invested in shares held to maturity, including those obtained through
reinvestment of dividends and distributions, will experience a return
consisting primarily of the amortization of discount on the underlying
securities in the Maturing Government Bond Portfolio. However, the net asset
value of the Portfolio's shares will increase or decrease with the daily
changes in the market value of that Maturing Government Bond Portfolio's
investments which will tend to vary inversely with changes in prevailing
interest rates. If shares of a Maturing Government Bond Portfolio are
redeemed prior to the maturity date of that Maturing Government Bond
Portfolio, a Contract owner may experience a significantly different
investment return than was anticipated at the time of purchase.
Zero coupon securities, like other investments in debt securities, are
subject to certain risks, including credit and market risks. Credit risk is
the function of the ability of an issuer of a security to maintain timely
interest payments and to pay the principal of a security upon maturity.
Securities purchased by the Maturing Government Bond Portfolios will be rated
at least single A or better by nationally recognized statistical rating
agencies. Securities rated single A are regarded as having an adequate
capacity to pay principal and interest, but with greater vulnerability to
adverse economic conditions and some speculative characteristics. The
Maturing Government Bond Portfolios will also attempt to minimize the impact
of individual credit risks by diversifying their portfolio investments.
Market risk is the risk of the price fluctuation of a security due
primarily to market interest rates prevailing generally in the economy.
Market risk may also include elements which take into account the underlying
credit rating of an issuer, the maturity length of a security, a security's
yield, and general economic and interest rate conditions. Zero coupon
securities do not make any periodic payments of interest prior to maturity
and the stripping of the securities causes the zero coupon securities to be
offered at a discount from their face amounts. The market value of the zero
coupon securities and, therefore the net asset value of the shares of the
Maturing Government Bond Portfolios, will fluctuate, perhaps markedly, and
changes in interest rates and other factors and may be subject to greater
fluctuations in response to changing interest rates than would a fund of
securities consisting of debt obligations of comparable coupon bearing
maturities. The amount of fluctuation increases with longer maturities.
Because they do not pay interest, zero coupon securities tend to be
subject to greater fluctuation of market value in response to changes in
interest rates than interest-paying securities of similar maturities.
Contract owners can expect more appreciation of the net asset value of a
Maturing Government Bond Portfolio's shares during periods of declining
interest rates than from interest-paying securities of similar maturity.
Conversely, when interest rates rise, the net asset value of a Maturing
Government Bond Portfolio's shares will normally decline more in price than
interest-paying securities of a similar maturity. Price fluctuations are
expected to be greatest in the longer-maturity Portfolios and are expected to
diminish as a Maturing Government Bond Portfolio approaches its target date.
These fluctuations may make the Maturing Government Bond Portfolios an
inappropriate selection as a basis for variable annuity payments. Interest
rates can change suddenly and unpredictably.
When held to maturity, the return on zero coupon securities consists
entirely of the difference between the maturity value and the purchase price
of securities held in the Portfolio. While this difference allows investors
to measure initial investment return, it also must be considered in light of
changing economic conditions. Inflationary risk, that is the risk attendant
to holding fixed-rate investments during a period of generally upward
changing price levels in the economy, must be considered in selecting a
Maturing Government Bond Portfolio.
Pay-in-Kind and Delayed Interest Securities
Global Bond Portfolio may also invest in pay-in-kind securities and
delayed interest securities. Pay-in-kind securities pay interest through the
issuance to the holders of additional securities. Delayed interest
securities are securities that remain zero coupon securities until a
predetermined date at which time the stated coupon rate becomes effective and
interest becomes payable at regular intervals. Because interest on pay-in-
kind and delayed interest securities is not paid on a current basis, the
values of securities of this type are subject to greater fluctuations than
the values of securities that distribute income regularly and they may be
more speculative than such securities. Accordingly, the values of these
securities may be highly volatile as interest rates rise or fall. In
addition, the Portfolio's investments in pay-in-kind and delayed interest
securities will result in special tax consequences.
Foreign Securities
Growth Portfolio, Small Company Growth Portfolio, Value Stock
Portfolio, Small Company Value Portfolio, Macro-Cap Value Stock and Micro-Cap
Growth Portfolio may invest up to 10% and Capital Appreciation Portfolio may
invest up to 20% of the market value of their respective total assets in
securities of foreign issuers which are not publicly traded in the U.S.
(Securities of foreign issuers which are publicly traded in the U.S., usually
in the form of sponsored American Depositary Receipts (ADRs), are not subject
to such limitations.) Bond Portfolio may also invest in debt securities
issued by foreign governments and companies provided that such securities are
U.S. dollar-denominated and publicly traded in the United States. In
addition, International Stock Portfolio and Global Bond Portfolio may invest
in such securities without limitation. Investing in securities of foreign
issuers may result in greater risk than that incurred in investing in
securities of domestic issuers. There is the possibility of expropriation,
nationalization or confiscatory taxation, taxation of income earned in
foreign nations or other taxes imposed with respect to investments in foreign
nations; foreign exchange controls (which may include suspension of the
ability to transfer currency from a given country), default in foreign
government securities, political or social instability or diplomatic
developments which could affect investments in securities of issuers in those
nations. In addition, in many countries there is less publicly available
information about issuers than is available in reports about companies in the
U.S. Foreign companies are not generally subject to uniform accounting,
auditing and financial reporting standards, and auditing practices and
requirements may not be comparable to those applicable to U.S. companies.
Further, the Portfolio may encounter difficulties or be unable to pursue
legal remedies and obtain judgments in foreign courts. Commission rates in
foreign countries, which are sometimes fixed rather than subject to
negotiation as in the U.S., are likely to be higher. Further, the settlement
period of securities transactions in foreign markets may be longer than in
domestic markets. In many foreign countries there is less government
supervision and regulation of business and industry practices, stock
exchanges, brokers and listed companies than in the U.S. The foreign
securities markets of many of the countries in which the Portfolio may invest
may also be smaller, less liquid, and subject to greater price volatility
than those in the U.S. Also, some countries may withhold portions of
interest, dividends and gains at the source. The Portfolio may also be
unfavorably affected by fluctuations in the relative rates of exchange
between the currencies of different nations (i.e., when the currency being
exchanged has decreased in value relative to the currency being purchased).
There are further risk considerations, including possible losses through the
holding of securities in domestic and foreign custodial banks and
depositories.
The countries of the European Monetary Union began the process of
converting their individual country currencies to the Euro on January 1,
1999. There is also a risk that the value of foreign securities of companies
located in EMU countries may decrease due to market volatility resulting from
the conversion of certain EMU country currencies to the Euro. It is not
possible to predict the impact of the Euro on the business or financial
condition of European issues or on the Portfolio. The transition and the
elimination of currency risk among EMU countries may change the economic
environment and behavior of investors, particularly in European markets. To
the extent the Portfolio holds non-U.S. dollar (Euro or other) denominated
securities, it will still be exposed to currency risk due to fluctuations in
those currencies versus the U.S. dollar.
Furthermore, International Stock Portfolio may invest in securities
issued by governments, governmental agencies and companies located in
developing market countries. The Portfolio considers countries having
developing markets to be all countries that are generally considered to be
developing or emerging countries by the International Bank for Reconstruction
and Development (more commonly referred to as the World Bank) and the
International Finance Corporation, as well as countries that are classified
by the United Nations or otherwise regarded by their authorities as
developing. Currently, the countries not included in this category are
Ireland, Spain, New Zealand, Australia, the United Kingdom, Italy, the
Netherlands, Belgium, Austria, France, Canada, Germany, Denmark, the United
States, Sweden, Finland, Norway, Japan and Switzerland. In addition,
developing market securities means (i) securities of companies the principal
securities trading market for which is a developing market country, as
defined above, (ii) securities, traded in any market, of companies that
derive 50% or more of their total revenue from either goods or services
produced in such developing market countries or sales made in such developing
market countries or (iii) securities of companies organized under the laws
of, and with a principal office in, a developing market country.
International Stock Portfolio will at all times, except during temporary
defensive periods, maintain investments in at least three countries having
developing markets.
An ADR is sponsored if the original issuing company has selected a
single U.S. bank to serve as its U.S. depositary and transfer agent. This
relationship requires a deposit agreement which defines the rights and duties
of both the issuer and depositary. Companies that sponsor ADRs must also
provide their ADR investors with English translations of company information
made public in their own domiciled country. Sponsored ADR investors also
generally have the same voting rights as ordinary shareholders, barring any
unusual circumstances. ADRs which meet these requirements can be listed on
U.S. stock exchanges. Unsponsored ADRs are created at the initiative of a
broker or bank reacting to demand for a specific foreign stock. The broker
or bank purchases the underlying shares and deposits them in a depositary.
Unsponsored shares issued after 1983 are not eligible for U.S. stock exchange
listings. Furthermore, they do not generally include voting rights.
In addition, International Stock Portfolio, Global Bond Portfolio and
Macro-Cap Value Portfolio may invest in European Depositary Receipts, which
are receipts evidencing an arrangement with a European bank similar to that
for ADRs and which are designed for use in the European securities markets.
Furthermore, Global Bond Portfolio may invest in Global Depositary Receipts,
which are receipts evidencing an arrangement with a foreign bank similar to
that for ADRs and which are designed for use in European and other foreign
securities markets. European Depositary Receipts and Global Depositary
Receipts are not necessarily denominated in the currency of the underlying
security.
Foreign Index Linked Securities
Global Bond Portfolio may invest up to 10% of its total assets in
instruments that return principal and/or pay interest to investors in amounts
which are linked to the level of a particular foreign index ("Foreign Index
Linked Securities"). A foreign index may be based upon the exchange rate of
a particular currency or currencies or the differential between two
currencies, or the level of interest rates in a particular country or
countries or the differential in interest rates between particular countries.
In the case of Foreign Index Linked Securities linking the principal amount
to a foreign index, the amount of principal payable by the issuer at maturity
will increase or decrease in response to changes in the level of the foreign
index during the term of the Foreign Index Linked Securities. In the case of
Foreign Index Linked Securities linking the interest component to a foreign
index, the amount of interest payable will adjust periodically in response to
changes in the level of the foreign index during the term of the Foreign
Index Linked Security. Foreign Index Linked Securities may be issued by a
U.S. or foreign governmental agency or instrumentality or by a private
domestic or foreign issuer. Only Foreign Index Linked Securities issued by
foreign governmental agencies or instrumentalities or by foreign issuers will
be considered foreign securities for purposes of the Portfolio's investment
policies and restrictions.
Foreign Index Linked Securities may offer higher yields than comparable
securities linked to purely domestic indexes but also may be more volatile.
Foreign Index Linked Securities are relatively recent innovations for which
the market has not yet been fully developed and, accordingly, they typically
are less liquid than comparable securities linked to purely domestic indexes.
In addition, the value of Foreign Index Linked Securities will be affected by
fluctuations in foreign exchange rates or in foreign interest rates. If the
Portfolio's investment sub-adviser is incorrect in its prediction as to the
movements in the direction of particular foreign currencies or foreign
interest rates, the return realized by the Portfolio on Foreign Index Linked
Securities may be lower than if the Portfolio had invested in a similarly
rated domestic security.
Swap Agreements
Global Bond Portfolio 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 Portfolio than if the Portfolio had invested directly
in an instrument that yielded that 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. Commonly used swap agreements include interest rate caps,
under which, in return for a premium, one party agrees to make payments to
the other to the extent that interest rates exceed a specified rate, or
"cap;" interest rate floors, under which, in return for a premium, one party
agrees to make payments to the other to the extent that interest rates fall
below a specified level, or "floor;" and interest rate collars, under which a
party sells a cap and purchases a floor or vice versa in an attempt to
protect itself against interest rate movements exceeding given minimum or
maximum levels.
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. Most swap agreements entered into by the Portfolio would
calculate the obligations of the parties to the agreement on a "net basis."
Consequently, the Portfolio's obligations (or rights) under a swap agreement
will generally be equal 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 Portfolio's obligations under a swap
agreement will be accrued daily (offset against amounts owed to the
Portfolio) and any accrued but unpaid net amounts owed to a swap counterparty
will be covered by the maintenance of a segregated account consisting of cash
or liquid securities to avoid any potential leveraging of the Portfolio's
securities. The Portfolio 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 Portfolio's assets.
Whether the Portfolio's use of swap agreements will be successful in
furthering its investment objective will depend on the Portfolio's investment
sub-adviser's ability to predict correctly 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 Portfolio 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 counterparty. The Portfolio's investment sub-adviser will
cause the Portfolio to enter into swap agreements only with counterparties
that would be eligible for consideration as repurchase agreement
counterparties under the Fund's repurchase agreement guidelines. Certain
restrictions imposed on the Portfolio by the Internal Revenue Code may limit
the Portfolio's ability to use swap agreements. The swaps market is
relatively new market and is largely unregulated. It is possible that
developments in the swaps market, including potential government regulation,
could adversely affect a portfolio's ability to terminate existing swap
agreements or to realize amounts to be received under such agreements.
Currency Exchange Transactions
International Stock Portfolio and Global Bond Portfolio usually effect
currency exchange transactions on a spot (i.e. cash) basis at the spot rate
prevailing in the foreign exchange market. However, some price spread on
currency exchange will be incurred when the Portfolio converts assets from
one currency to another. Further, the Portfolio may be affected either
unfavorably or favorably by fluctuations in the relative rates of exchange
between the currencies of different nations. For example, in order to
realize the value of a foreign investment, the Portfolio must convert that
value, as denominated in its foreign currency, into U.S. dollars using the
applicable currency exchange rate. The exchange rate represents the current
price of a U.S. dollar relative to that foreign currency; that is, the amount
of such foreign currency required to buy one U.S. dollar. If the Portfolio
holds a foreign security which has appreciated in value as measured in the
foreign currency, the level of appreciation actually realized by the
Portfolio may be reduced or even eliminated if the foreign currency has
decreased in value relative to the U.S. dollar subsequent to the date of
purchase. In such a circumstance, the cost of a U.S. dollar purchased with
that foreign currency has gone up and the same amount of foreign currency
purchases fewer dollars than at an earlier date.
Foreign Currency Hedging Transactions
Forward Exchange Contracts. International Stock Portfolio and Global
Bond Portfolio have authority to deal in forward foreign currency exchange
contracts between currencies of the different countries in which such
Portfolios will invest as a hedge against possible variations in the foreign
exchange rate between these currencies. This is accomplished through
contractual agreements to purchase or sell a specified currency at a
specified future date and price set at the time of the contract. Forward
exchange contracts are individually negotiated and privately traded by
currency traders and their customers. The Portfolio's dealings in forward
foreign exchange contracts will be limited to hedging involving either
specific transactions or portfolio positions. Transaction hedging is the
purchase or sale of forward foreign currency with respect to specific
receivables or payables of the Portfolio arising from the purchase and sale
of portfolio securities, the sale and redemption of shares of the Portfolio,
or the payment of dividends and distributions by the Portfolio. Position
hedging is the sale of forward foreign exchange contracts with respect to
portfolio security positions denominated or quoted in such foreign currency.
The Portfolio will not engage in naked forward foreign exchange contracts.
In addition, when the Portfolio's investment sub-adviser believes that
the currency of a particular foreign country may suffer or enjoy a
substantial movement against another currency, it may enter into a forward
contract to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Portfolio's securities
denominated in such foreign currency. The projection of short-term currency
market movement is extremely difficult, and the successful execution of a
short-term hedging strategy is highly uncertain.
It is impossible to forecast with absolute precision the market value
of portfolio securities at the expiration of the contract. Accordingly, it
may be necessary for the Portfolio to purchase additional foreign currency on
the spot market (and bear the expense of such purchase) if the market value
of the security is less than the amount of foreign currency the Portfolio 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 Portfolio is obligated to deliver.
If the Portfolio retains the portfolio security and engages in an
offsetting transaction, the Portfolio will incur a gain or a loss to the
extent that there has been movement in forward contract prices. If the
Portfolio engages in an offsetting transaction, it may subsequently enter
into a new forward contract to sell the foreign currency. Should forward
prices decline during the period between the Portfolio entering into a
forward contract for the sale of a foreign currency and the date it enters
into an offsetting contract for the purchase of the foreign currency, the
Portfolio will realize a gain to the extent the price of the currency it has
agreed to sell exceeds the price of the currency it has agreed to purchase.
Should forward prices increase, the Portfolio will suffer a loss to the
extent the price of the currency it has agreed to purchase exceeds the price
of the currency it has agreed to sell.
Currency Futures Contracts. International Stock Portfolio and Global
Bond Portfolio may also enter into exchange-traded contracts for the purchase
or sale for future delivery of foreign currencies ("foreign currency
futures"). This investment technique will be used only to hedge against
anticipated future changes in exchange rates which otherwise might adversely
affect the value of the Portfolio's securities or adversely affect the prices
of securities that the Portfolio intends to purchase at a later date. The
successful use of foreign currency futures will usually depend on the ability
of the Portfolio's investment sub-adviser to forecast currency exchange rate
movements correctly. Should exchange rates move in an unexpected manner, the
Fund may not achieve the anticipated benefits of foreign currency futures or
may realize losses.
Closed-End Investment Companies
Some countries, such as South Korea, Chile and India, have authorized
the formation of closed-end investment companies to facilitate indirect
foreign investment in their capital markets. In accordance with the
Investment Company Act of 1940, International Stock Portfolio may invest up
to 10% of its total assets in securities of closed-end investment companies.
This restriction on investments in securities of closed-end investment
companies may limit opportunities for the International Stock Portfolio to
invest indirectly in certain developing markets. Shares of certain closed-
end investment companies may at times be acquired only at market prices
representing premiums to their net asset values. If the International Stock
Portfolio acquires shares of closed-end investment companies, shareholders
would bear both their proportionate share of expenses of the International
Stock Portfolio (including management and advisory fees) and, indirectly, the
expenses of such closed-end investment companies.
Loans of Portfolio Securities
For the purpose of realizing additional income, to the extent specified
in the Prospectus, certain Portfolios may make secured loans of Portfolio
securities amounting to not more than one-third of their respective total
assets (which, for purposes of this limitation, will include the value of
collateral received in return for securities loaned). Collateral received in
connection with securities lending shall not be considered Fund assets,
however, for purposes of compliance with any requirement described in a
Fund's prospectus that the Fund invest a specified minimum percentage of its
assets in certain types of securities (e.g., securities of small companies).
Securities loans are made to broker-dealers or financial institutions
pursuant to agreements requiring that the loans be continuously secured by
collateral at least equal at all times to the value of the securities lent.
The collateral received will consist of cash, letters of credit or securities
issued or guaranteed by the U.S. Government, its agencies or
instrumentalities. While the securities are being lent, the Portfolio will
continue to receive the equivalent of the interest or dividends paid by the
issuer on the securities, as well as interest on the investment of the
collateral or a fee from the borrower. Although the Portfolio does not
expect to pay commissions or other front-end fees (including finders fees) in
connection with loans of securities (but in some cases may do so), a portion
of the additional income realized will be shared with the Portfolio's
custodian for arranging and administering such loans. The Portfolio has a
right to call each loan and obtain the securities on five business days'
notice. The Portfolio will not have the right to vote securities while they
are being lent, but it will call a loan in anticipation of any important
vote. The risks in lending portfolio securities, as with other extensions of
secured credit, consist of possible delay in receiving additional collateral
or in the recovery of the securities or possible loss of rights in the
collateral should the borrower fail financially. Loans will only be made to
firms deemed by the Portfolio's investment adviser or sub-adviser, as the
case may be, to be of good standing and to have sufficient financial
responsibility, and will not be made unless, in the judgment of the
Portfolio's investment adviser or sub-adviser, the consideration to be earned
from such loans would justify the risk. The creditworthiness of entities to
which the Portfolio makes loans of portfolio securities is monitored by the
Portfolio's investment adviser or sub-adviser throughout the term of each
loan.
Restricted and Illiquid Securities
Each Portfolio may invest up to 15% (10% in the case of Money Market
Portfolio) of its respective net assets in securities restricted as to
disposition under the federal securities laws or otherwise, or other illiquid
assets. An investment is generally deemed to be "illiquid" if it cannot be
disposed of within seven days in the ordinary course of business at
approximately the amount at which the investment company is valuing the
investment. "Restricted securities" are securities which were originally
sold in private placements and which have not been registered under the
Securities Act of 1933 (the "1933 Act"). Such securities generally have been
considered illiquid by the staff of the Securities and Exchange Commission
(the "SEC"), since such securities may be resold only subject to statutory
restrictions and delays or if registered under the 1933 Act. Because of such
restrictions, the Portfolio may not be able to dispose of a block of
restricted securities for a substantial period of time or at prices as
favorable as those prevailing in the open market should like securities of an
unrestricted class of the same issuer be freely traded. The Portfolio may be
required to bear the expenses of registration of such restricted securities.
The SEC has acknowledged, however, that a market exists for certain
restricted securities (for example, securities qualifying for resale to
certain "qualified institutional buyers" pursuant to Rule 144A under the 1933
Act). Additionally, the Portfolio's investment adviser and sub-adviser, as
the case may be, believe that a similar market exists for commercial paper
issued pursuant to the private placement exemption of Section 4(2) of the
1933 Act and for certain interest-only and principal-only classes of
mortgage-backed and asset-backed securities. Each Portfolio may invest
without limitation in these forms of restricted securities if such securities
are deemed by the Portfolio's investment adviser or sub-adviser to be liquid
in accordance with standards established by the Fund's Board of Directors.
Under these guidelines, the Portfolio's investment adviser or sub-adviser
must consider (a) the frequency of trades and quotes for the security, (b)
the number of dealers willing to purchase or sell the security and the number
of other potential purchasers, (c) dealer undertakings to make a market in
the security, and (d) 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 transfer). At the
present time, it is not possible to predict with accuracy how the markets for
certain restricted securities will develop. Investing in such restricted
securities could have the effect of increasing the level of the Portfolio's
illiquidity to the extent that qualified purchasers of the securities become,
for a time, uninterested in purchasing these securities.
If through the appreciation of restricted securities or the
depreciation of unrestricted securities, the Portfolio is in a position where
more than 15% (10% in the case of Money Market Portfolio) of its net assets
are invested in restricted and other illiquid securities, the Portfolio will
take appropriate steps to protect liquidity.
When-Issued Securities and Forward Commitments
Bond Portfolio, Asset Allocation Portfolio, Mortgage Securities
Portfolio, International Stock Portfolio, Global Bond Portfolio, Macro-Cap
Value Portfolio and Real Estate Securities Portfolio may each purchase
securities offered on a "when-issued" basis and may purchase or sell
securities on a "forward commitment" basis. When such transactions are
negotiated, the price, which is generally expressed in yield terms, is fixed
at the time the commitment is made, but delivery and payment for the
securities takes place at a later date. Normally, the settlement date occurs
within two months after the transaction, but delayed settlements beyond two
months may be negotiated. During the period between a commitment to purchase
by the Portfolio and settlement, no payment is made for the securities
purchased by the Portfolio and, thus, no interest accrues to the Portfolio
from the transaction.
The use of when-issued transactions and forward commitments enables the
Portfolio to hedge against anticipated changes in interest rates and prices.
For instance, in periods of rising interest rates and falling prices, the
Portfolio might sell securities in its portfolio on a forward commitment
basis to limit its exposure to falling prices. In periods of falling
interest rates and rising prices, the Portfolio might sell a security in its
portfolio and purchase the same or a similar security on a when-issued or
forward commitment basis, thereby fixing the purchase price to be paid on the
settlement date at an amount below that to which the Portfolio anticipates
the market price of such security to rise and, in the meantime, obtaining the
benefit of investing the proceeds of the sale of its portfolio security at
currently higher cash yields. Of course, the success of this strategy
depends upon the ability of the Portfolio's investment adviser or sub-adviser
to correctly anticipate increases and decreases in interest rates and prices
of securities. If the Portfolio's investment adviser or sub-adviser
anticipates a rise in interest rates and a decline in prices and,
accordingly, the Portfolio sells securities on a forward commitment basis in
order to hedge against falling prices, but in fact interest rates decline and
prices rise, the Portfolio will have lost the opportunity to profit from the
price increase. If the investment adviser or sub-adviser anticipates a
decline in interest rates and a rise in prices, and, accordingly, the
Portfolio sells a security in its portfolio and purchases the same or a
similar security on a when-issued or forward commitment basis in order to
enjoy currently high cash yields, but in fact interest rates increase and
prices fall, the Portfolio will have lost the opportunity to profit from
investment of the proceeds of the sale of the security at the increased
interest rates. The likely effect of this hedging strategy, whether the
Portfolio's investment adviser or sub-adviser is correct or incorrect in its
prediction of interest rate and price movements, is to reduce the chances of
large capital gains or losses and thereby reduce the likelihood of wide
variations in the Portfolio's net asset value.
When-issued securities and forward commitments may be sold prior to the
settlement date, but, except for mortgage dollar roll transactions (as
discussed below), the Portfolio enters into when-issued and forward
commitments only with the intention of actually receiving or delivering the
securities, as the case may be. The Portfolio may hold a when-issued
security or forward commitment until the settlement date, even if the
Portfolio will incur a loss upon settlement. To facilitate transactions in
when-issued securities and forward commitments, the Portfolio's custodian
bank maintains, in a separate account of the Portfolio, liquid assets, such
as cash, short-term securities and other liquid securities (marked to the
market daily), having a value equal to, or greater than, any commitments to
purchase securities on a when-issued or forward commitment basis and, with
respect to forward commitments to sell portfolio securities of the Portfolio,
the portfolio securities themselves. If the Portfolio, however, chooses to
dispose of the right to acquire a when-issued security prior to its
acquisition or dispose of its right to deliver or receive against a forward
commitment, it can incur a gain or loss. (At the time the Portfolio makes
the commitment to purchase or sell a security on a when-issued or forward
commitment basis, it records the transaction and reflects the value of the
security purchased or, if a sale, the proceeds to be received, in determining
its net asset value.)
The Portfolio may also enter into such transactions to generate
incremental income. In some instances, the third-party seller of when-issued
or forward commitment securities may determine prior to the settlement date
that it will be unable or unwilling to meet its existing transaction
commitments without borrowing securities. If advantageous from a yield
perspective, the Portfolio may, in that event, agree to resell its purchase
commitment to the third-party seller at the current market price on the date
of sale and concurrently enter into another purchase commitment for such
securities at a later date. As an inducement for the Portfolio to
"roll over" its purchase commitment, the Portfolio may receive a negotiated
fee. These transactions, referred to as "mortgage dollar rolls," are entered
into without the intention of actually acquiring securities. For a
description of mortgage dollar rolls and the Portfolios that may invest in
such transactions, see "Mortgage Dollar Rolls" below.
The purchase of securities on a when-issued or forward commitment basis
exposes the Portfolio to risk because the securities may decrease in value
prior to their delivery. Purchasing securities on a when-issued or forward
commitment basis involves the additional risk that the return available in
the market when the delivery takes place will be higher than that obtained in
the transaction itself. The Portfolio's purchase of securities on a when-
issued or forward commitment basis while remaining substantially fully
invested increases the amount of the Portfolio's assets that are subject to
market risk to an amount that is greater than the Portfolio's net asset
value, which could result in increased volatility of the price of the
Portfolio's shares. No more than 30% of the value of such Portfolio's (other
than Macro-Cap Value Portfolio's) total assets will be committed to when-
issued or forward commitment transactions, and of such 30%, no more than two-
thirds (i.e., 20% of its total assets) may be invested in mortgage dollar
rolls. No more than 15% of the value of Macro-Cap Value Portfolio's total
assets will be committed to when-issued or forward commitment transactions.
Mortgage Dollar Rolls
In connection with its ability to purchase securities on a when-issued
or forward commitment basis, Bond Portfolio, Asset Allocation Portfolio,
Mortgage Securities Portfolio and Global Bond Portfolio may enter into
mortgage "dollar rolls" in which the Portfolio sells securities for delivery
in the current month and simultaneously contracts with the same counterparty
to repurchase similar (same type, coupon and maturity) but not identical
securities on a specified future date. In a mortgage dollar roll, the
Portfolio gives up the right to receive principal and interest paid on the
securities sold. However, the Portfolio would benefit to the extent of any
difference between the price received for the securities sold and the lower
forward price for the future purchase plus any fee income received. Unless
such benefits exceed the income, capital appreciation and gain or loss due to
mortgage prepayments that would have been realized on the securities sold as
part of the mortgage dollar roll, the use of this technique will diminish the
investment performance of the Portfolio compared with what such performance
would have been without the use of mortgage dollar rolls. The Portfolio will
hold and maintain in a segregated account until the settlement date cash or
liquid securities in an amount equal to the forward purchase price. The
benefits derived from the use of mortgage dollar rolls may depend upon the
ability of the Portfolio's investment adviser or sub-adviser, as the case may
be, to predict correctly mortgage prepayments and interest rates. There is
no assurance that mortgage dollar rolls can be successfully employed. In
addition, the use of mortgage dollar rolls by the Portfolio while remaining
substantially fully invested increases the amount of the Portfolio's assets
that are subject to market risk to an amount that is greater than the
Portfolio's net asset value, which could result in increased volatility of
the price of the Portfolio's shares.
For financial reporting and tax purposes, mortgage dollar rolls are
considered as two separate transactions: one involving the sale of a
security and a separate transaction involving a purchase. The Portfolios do
not currently intend to enter into mortgage dollar rolls that are accounted
for as a "financing" rather than as a separate sale and purchase
transactions.
Real Estate Investment Trust Securities
Real Estate Securities Portfolio may invest in real estate investment
trust securities ("REIT"). A REIT is a corporation or a business trust that
would otherwise be taxed as a corporation, which meets certain requirements
of the Internal Revenue Code of 1986, as amended the "Code"). The Code
permits a qualifying REIT to deduct dividends paid, thereby effectively
eliminating corporate level federal income tax and making the REIT a pass-
through vehicle for federal income tax purposes. In order to qualify as a
REIT, a company must derive at least 75% of its gross income from real estate
sources (rents, mortgage interest, and gains from sale of real estate
assets), 75% of its assets must be in real estate, mortgages or REIT stock,
and must distribute to shareholder annually 95% or more of its otherwise
taxable income.
REITs are sometimes informally characterized as equity REITs, mortgage
REITs and hybrid REITS. An equity REIT invests primarily in the fee
ownership or leasehold ownership of land and buildings and derives its income
primarily from rental income. A mortgage REIT invests primarily in mortgages
on real estate, and derives primarily from interest payments received on
credit it has granted. A hybrid REIT combines the characteristics of equity
REITs and mortgage REITs. It is anticipated, although not required, that
under normal circumstances, a majority of the Portfolio's investments in
REITS will consist of equity REITs.
Repurchase Agreements
Growth Portfolio, Bond Portfolio, Mortgage Securities Portfolio, Asset
Allocation Portfolio, Index 500 Portfolio, Capital Appreciation Portfolio,
International Stock Portfolio, Small Company Growth Portfolio, the Maturing
Government Bond Portfolios, Value Stock Portfolio, Small Company Value
Portfolio, Global Bond Portfolio, Index 400 Mid-Cap Portfolio, Macro-Cap
Value Portfolio, Micro-Cap Growth Portfolio and Real Estate Securities
Portfolio may enter into repurchase agreements. Repurchase agreements are
agreements by which the Portfolio purchases a security and obtains a
simultaneous commitment from the seller (a member bank of the Federal Reserve
System or, if permitted by law or regulation and if the Board of Directors of
the Portfolio has evaluated its creditworthiness through adoption of
standards of review or otherwise, a securities dealer) to repurchase the
security at an agreed upon price and date. The creditworthiness of entities
with whom the Portfolio enters into repurchase agreements is monitored by the
Portfolio's investment adviser or sub-adviser throughout the term of the
repurchase agreement. The resale price is in excess of the purchase price
and reflects an agreed upon market rate unrelated to the coupon rate on the
purchased security. Such transactions afford the Portfolio the opportunity
to earn a return on temporarily available cash. The Portfolio's custodian,
or a duly appointed subcustodian, holds the securities underlying any
repurchase agreement in a segregated account or such securities may be part
of the Federal Reserve Book Entry System. The market value of the collateral
underlying the repurchase agreement is determined on each business day. If
at any time the market value of the collateral falls below the repurchase
price of the repurchase agreement (including any accrued interest), the
Portfolio promptly receives additional collateral, so that the total
collateral is in an amount at least equal to the repurchase price plus
accrued interest. While the underlying security may be a bill, certificate
of indebtedness, note or bond issued by an agency, authority or
instrumentality of the U.S. Government, the obligation of the seller is not
guaranteed by the U.S. Government. In the event of a bankruptcy or other
default of a seller of a repurchase agreement, the Portfolio could experience
both delays in liquidating the underlying security and losses, including:
(a) possible decline in the value of the underlying security during the
period while the Portfolio seeks to enforce its rights thereto; (b) possible
subnormal levels of income and lack of access to income during this period;
and (c) expenses of enforcing its rights.
Reverse Repurchase Agreements
Money Market Portfolio, Asset Allocation Portfolio and Global Bond
Portfolio may also enter into reverse repurchase agreements. Reverse
repurchase agreements are the counterparts of repurchase agreements, by which
the Portfolio sells a security and agrees to repurchase the security from the
buyer at an agreed upon price and future date. Because certain of the
incidents of ownership of the security are retained by the Portfolio, reverse
repurchase agreements may be considered a form of borrowing by the Portfolio
from the buyer, collateralized by the security. The Portfolio uses the
proceeds of a reverse repurchase agreement to purchase other money market
securities either maturing, or under an agreement to resell, at a date
simultaneous with or prior to the expiration of the reverse repurchase
agreement. The Portfolio utilizes reverse repurchase agreements when the
interest income to be earned from investment of the proceeds of the reverse
repurchase transaction exceeds the interest expense of the transaction.
The use of reverse repurchase agreements by the Portfolio allows it to
leverage its portfolio. While leveraging offers the potential for increased
yield, it magnifies the risks associated with the Portfolio's investments and
reduces the stability of the Portfolio's net asset value per share. To limit
this risk, the Portfolio will not enter into a reverse repurchase agreement
if all such transactions, together with any money borrowed, exceed 5% of the
Portfolio's net assets. In addition, when entering into reverse repurchase
agreements, the Portfolio will deposit and maintain in a segregated account
with its custodian liquid assets, such as cash or cash equivalents and other
appropriate short-term securities and high grade debt obligations, in an
amount equal to the repurchase price (which shall include the interest
expense of the transaction). Moreover, Money Market Portfolio will not enter
into reverse repurchase agreements if and to the extent such transactions
would, as determined by the Portfolio's investment adviser, materially
increase the risk of a significant deviation in the Portfolio's net asset
value per share. See "Net Asset Value" below.
Futures Contracts and Options on Futures Contracts
Futures Contracts. Consistent with their investment objectives and
strategies, the Portfolios may enter into interest rate futures contracts,
stock index futures contracts and foreign currency futures contracts.
(Unless otherwise specified, interest rate futures contracts, stock index
futures contracts and foreign currency futures contracts are collectively
referred to as "futures contracts.")
A futures contract is a bilateral agreement providing for the purchase
and sale of a specified type and amount of a financial instrument or foreign
currency, or for the making and acceptance of a cash settlement, at a stated
time in the future for a fixed price. By its terms, a futures contract
provides for a specified settlement date on which, in the case of the
majority of interest rate and foreign currency futures contracts, the fixed
income securities or currency underlying the contract are delivered by the
seller and paid for by the purchaser, or on which, in the case of stock index
futures contracts and certain interest rate and foreign currency futures
contracts, the difference between the price at which the contract was entered
into and the contract's closing value is settled between the purchaser and
the seller in cash. Futures contracts differ from options in that they are
bilateral agreements, with both the purchaser and the seller equally
obligated to complete the transaction. Futures contracts call for settlement
only on the expiration date, and cannot be "exercised" at any other time
during their term.
Interest rate futures contracts currently are traded on a variety of
fixed income securities, including long-term U.S. Treasury Bonds, Treasury
Notes, Government National Mortgage Association modified pass-through
mortgage-backed securities, and U.S. Treasury Bills. In addition, interest
rate futures contracts include contracts on indexes of municipal securities.
Foreign currency futures contracts currently are traded on the British pound,
Canadian dollar, Japanese yen, Swiss franc, West German mark, and on
Eurodollar deposits.
Stock index futures contracts include contracts on the S&P 500 Index
and other broad-based stock market indexes, as well as contracts based on
narrower market indexes or indexes of securities of particular industry
groups. A stock index assigns relative values to the common stocks included
in the index and the index fluctuates with the value of the common stocks so
included. The parties to a stock index futures contract agree to make a cash
settlement on a specific future date in an amount determined by the value of
the stock index on the last trading day of the contract. The amount is a
specified dollar amount times the difference between the value of the index
on the last trading day and the value on the day the contract was struck.
Purchases or sales of stock index futures contracts are used to attempt
to protect current or intended stock investments from broad fluctuations in
stock prices. Interest rate and foreign currency futures contracts are
purchased or sold to attempt to hedge against the effects of interest or
exchange rate changes on a Portfolio's current or intended investments in
fixed income or foreign securities. In the event that an anticipated
decrease in the value of a Portfolio's securities occurs as a result of a
general stock market decline, a general increase in interest rates, or a
decline in the dollar value of foreign currencies in which portfolio
securities are denominated, the adverse effects of such changes may be
offset, in whole or in part, by gains on the sale of futures contracts.
Conversely, the increased cost of a Portfolio's securities to be acquired,
caused by a general rise in the stock market, a general decline in interest
rates, or a rise in the dollar value of foreign currencies, may be offset, in
whole or in part, by gains on futures contracts purchased by such Portfolio.
Although many futures contracts by their terms call for actual delivery
or acceptance of the financial instrument, in most cases the contracts are
closed out before the settlement date without the making or taking of
delivery. Closing out a short position is effected by purchasing a futures
contract for the same aggregate amount of the specific type of financial
instrument and the same delivery month. If the price of the initial sale of
the futures contract exceeds the price of the offsetting purchase, the seller
is paid the difference and realizes a gain. Conversely, if the price of the
offsetting purchase exceeds the price of the initial sale, the trader
realizes a loss. Similarly, the closing out of a long position is effected
by the purchaser entering into a futures contract sale. If the offsetting
sale price exceeds the purchase price, the purchaser realizes a gain and, if
the purchase price exceeds the offsetting sale price, the purchaser realizes
a loss.
The purchase or sale of a futures contract differs from the purchase or
sale of a security in that no purchase price is paid or received. Instead,
an amount of cash or cash equivalents, which varies but may be as low as 5%
or less of the value of the contract, must be deposited with the broker as
"initial margin." Subsequent payments to and from the broker, referred to as
"variation margin," are made on a daily basis as the value of the index or
instrument underlying the futures contract fluctuates, making positions in
the futures contracts more or less valuable, a process known as "marking to
the market."
U.S. futures contracts may be purchased or sold only on an exchange,
known as a "contract market," designated by the Commodity Futures Trading
Commission ("CFTC") for the trading of such contract, and only through a
registered futures commission merchant which is a member of such contract
market. A commission must be paid on each completed purchase and sale
transaction. The contract market clearing house guarantees the performance
of each party to a futures contract by in effect taking the opposite side of
such contract. At any time prior to the expiration of a futures contract, a
trader may elect to close out its position by taking an opposite position on
the contract market on which the position was entered into, subject to the
availability of a secondary market, which will operate to terminate the
initial position. At that time, a final determination of variation margin is
made and any loss experienced by the trader is required to be paid to the
contract market clearing house while any profit due to the trader must be
delivered to it. Futures contracts may also be traded on foreign exchanges.
Options on Futures Contracts. The Portfolios also may purchase and
sell put and call options on futures contracts and enter into closing
transactions with respect to such options to terminate existing positions.
The Portfolios may use such options on futures contracts in connection with
their hedging strategies in lieu of purchasing and writing options directly
on the underlying securities or purchasing and selling the underlying futures
contracts.
An option on a futures contract provides the holder with the right to
enter into a "long" position in the underlying futures contract, in the case
of a call option, or a "short" position in the underlying futures contract,
in the case of a put option, at a fixed exercise price up to a stated
expiration date or, in the case of certain options, on such date. Upon
exercise of the option by the holder, the contract market clearing house
establishes a corresponding short position for the writer of the option, in
the case of a call option, or a corresponding long position, in the case of a
put option. In the event that an option is exercised, the parties will be
subject to all the risks associated with the trading of futures contracts,
such as payment of variation margin deposits. In addition, the writer of an
option on a futures contract, unlike the holder, is subject to initial and
variation margin requirements on the option position.
A position in an option on a futures contract may be terminated by the
purchaser or the seller prior to expiration by affecting a closing purchase
or sale transaction, subject to the availability of a liquid secondary
market, which is the purchase or sale of an option of the same series (i.e.,
the same exercise price and expiration date) as the option previously
purchased or sold. The difference between the premiums paid and received
represents the trader's profit or loss on the transaction.
Options on futures contracts that are written or purchased by the
Portfolios on United States exchanges are traded on the same contract market
as the underlying futures contract and, like futures contracts, are subject
to regulation by the CFTC and the performance guarantee of the exchange
clearing house. In addition, options on futures contracts may be traded on
foreign exchanges.
Risks of Futures Contracts and Options on Futures Contracts. The use
of futures contracts and options on futures contracts will expose the
Portfolios to additional investment risks and transactions costs. Risks
include:
? the risk that interest rates, securities prices or currency markets
will not move in the direction that the Portfolio's investment adviser
or sub-adviser anticipates;
? an imperfect correlation between the price of the instrument and
movements in the prices of any securities or currencies being hedged;
? the possible absence of a liquid secondary market for any particular
instrument and possible exchange imposed price fluctuation limits;
? leverage risk, which is the risk that adverse price movements in an
instrument can result in a loss substantially greater than a
Portfolio's initial investment in that instrument; and
? the risk that the counterparty to an instrument will fail to perform
its obligations.
Regulatory Matters. To the extent required to comply with applicable
Securities and Exchange Commission releases and staff positions, when
entering into futures contracts each Portfolio will maintain, in a segregated
account, cash or liquid securities equal to the value of such contracts.
The CFTC, a federal agency, regulates trading activity on the exchanges
pursuant to the Commodity Exchange Act, as amended. The CFTC requires the
registration of "commodity pool operators," defined as any person engaged in
a business which is of the nature of a company, syndicate or a similar form
of enterprise, and who, in connection therewith, solicits, accepts or
receives from others, funds, securities or property for the purpose of
trading in any commodity for future delivery on or subject to the rules of
any contract market. The CFTC has adopted Rule 4.5, which provides an
exclusion from the definition of commodity pool operator for any registered
investment company which meets the requirements of the Rule. Rule 4.5
requires, among other things, that an investment company wishing to avoid
commodity pool operator status use futures and options positions only (a) for
"bona fide hedging purposes" (as defined in CFTC regulations) or (b) for
other purposes so long as aggregate initial margins and premiums required in
connection with non-hedging positions do not exceed 5% of the liquidation
value of the investment company's portfolio. Any investment company wishing
to claim the exclusion provided in Rule 4.5 must file a notice of eligibility
with both the CFTC and the National Futures Association. Before engaging in
transactions involving interest rate futures contracts, the Fund will file
such notices and meet the requirements of Rule 4.5, or such other
requirements as the CFTC or its staff may from time to time issue, in order
to render registration as a commodity pool operator unnecessary.
For examples of futures contracts and their tax treatment, see Appendix
C to this Statement of Additional Information.
Options
To the extent permitted in the Prospectus, each Portfolio may write
(i.e., sell) covered call and secured put options and purchase and sell put
and call options written by others. Each Portfolio will limit the total
market value of securities against which it may write call or put options to
20% of its total assets. In addition, no Portfolio will commit more than 5%
of its total assets to premiums when purchasing put or call options.
A put option gives the purchaser the right to sell a security or other
instrument to the writer of the option at a stated price during the term of
the option. A call option gives the purchaser the right to purchase a
security or other instrument from the writer of the option at a stated price
during the term of the option. Thus, if a Portfolio writes a call option on
a security, it becomes obligated during the term of the option to deliver the
security underlying the option upon payment of the exercise price. If a
Portfolio writes a put option, it becomes obligated during the term of the
option to purchase the security underlying the option at the exercise price
if the option is exercised.
Portfolios may use put and call options for a variety of purposes. For
example, if a portfolio manager wishes to hedge a security a Portfolio owns
against a decline in price, the manager may purchase a put option on the
underlying security; i.e., purchase the right to sell the security to a third
party at a stated price. If the underlying security then declines in price,
the manager can exercise the put option, thus limiting the amount of loss
resulting from the decline in price. Similarly, if the manager intends to
purchase a security at some date in the future, the manager may purchase a
call option on the security today in order to hedge against an increase in
its price before the intended purchase date. Put and call options also can
be used for speculative purposes. For example, if a portfolio manager
believes that the price of stocks generally is going to rise, the manager may
purchase a call option on a stock index, the components of which are
unrelated to the stocks held or intended to be purchased. Finally, a
portfolio manager may write options on securities owned in order to realize
additional income. Portfolios receive premiums from writing call or put
options, which they retain whether or not the options are exercised.
By writing a call option, a Portfolio might lose the potential for gain
on the underlying security while the option is open, and by writing a put
option a Portfolio might become obligated to purchase the underlying security
for more than its current market price upon exercise. If a Portfolio
purchases a put or call option, any loss to the Portfolio is limited to the
premium paid for, and transaction costs paid in connection with, the option.
Options on Securities. An option on a security provides the purchaser,
or "holder," with the right, but not the obligation, to purchase, in the case
of a "call" option, or sell, in the case of a "put" option, the security or
securities underlying the option, for a fixed exercise price up to a stated
expiration date or, in the case of certain options, on such date. The holder
pays a nonrefundable purchase price for the option, known as the "premium."
The maximum amount of risk the purchaser of the option assumes is equal to
the premium plus related transaction costs, although this entire amount may
be lost. The risk of the seller, or "writer," however, is potentially
unlimited, unless the option is "covered." A call option written by a
Portfolio is "covered" if the Portfolio owns the underlying security covered
by the call or has an absolute and immediate right to acquire that security
without additional cash consideration (or for additional cash consideration
held in a segregated account by its custodian) upon conversion or exchange of
other securities held in its portfolio. A call option is also covered if the
Portfolio holds a call on the same security and in the same principal amount
as the call written where the exercise price of the call held (a) is equal to
or less than the exercise price of the call written or (b) is greater than
the exercise price of the call written if the difference is maintained by the
Portfolio in cash and liquid securities in a segregated account with its
custodian. A put option written by a Portfolio is "covered" if the Portfolio
maintains cash and liquid securities with a value equal to the exercise price
in a segregated account with its custodian, or else holds a put on the same
security and in the same principal amount as the put written where the
exercise price of the put held is equal to or greater than the exercise price
of the put written. If the writer's obligation is not so covered, it is
subject to the risk of the full change in value of the underlying security
from the time the option is written until exercise.
Upon exercise of the option, the holder is required to pay the purchase
price of the underlying security, in the case of a call option, or to deliver
the security in return for the purchase price in the case of a put option.
Conversely, the writer is required to deliver the security, in the case of a
call option, or to purchase the security, in the case of a put option.
Options on securities which have been purchased or written may be closed out
prior to exercise or expiration by entering into an offsetting transaction on
the exchange on which the initial position was established, subject to the
availability of a liquid secondary market.
Options on securities and options on indexes of securities, discussed
below, are traded on national securities exchanges, such as the Chicago Board
Options Exchange and the New York Stock Exchange, which are regulated by the
SEC. The Options Clearing Corporation guarantees the performance of each
party to an exchange-traded option, by in effect taking the opposite side of
each such option. A holder or writer may engage in transactions in exchange-
traded options on securities and options on indexes of securities only
through a registered broker-dealer which is a member of the exchange on which
the option is traded.
In addition, options on securities and options on indexes of securities
may be traded on exchanges located outside the United States and over-the-
counter through financial institutions dealing in such options as well as the
underlying instruments. While exchange-traded options have a continuous
liquid market, over-the-counter options may not.
Options on Stock Indexes. In contrast to an option on a security, an
option on a stock index provides the holder with the right to make or receive
a cash settlement upon exercise of the option, rather than the right to
purchase or sell a security. The amount of this settlement is equal to (a)
the amount, if any, by which the fixed exercise price of the option exceeds
(in the case of a call) or is below (in the case of a put) the closing value
of the underlying index on the date of exercise, multiplied by (b) a fixed
"index multiplier." The purchaser of the option receives this cash
settlement amount if the closing level of the stock index on the day of
exercise is greater than, in the case of a call, or less than, in the case of
a put, the exercise price of the option. The writer of the option is
obligated, in return for the premium received, to make delivery of this
amount if the option is exercised. As in the case of options on securities,
the writer or holder may liquidate positions in stock index options prior to
exercise or expiration by entering into closing transactions on the exchange
on which such positions were established, subject to the availability of a
liquid secondary market.
A Portfolio will cover all options on stock indexes by owning
securities whose price changes, in the opinion of the Portfolio's adviser or
sub-adviser, are expected to be similar to those of the index, or in such
other manner as may be in accordance with the rules of the exchange on which
the option is traded and applicable laws and regulations. Nevertheless,
where a Portfolio covers a call option on a stock index through ownership of
securities, such securities may not match the composition of the index. In
that event, the Portfolio will not be fully covered and could be subject to
risk of loss in the event of adverse changes in the value of the index. The
Portfolios will secure put options on stock indexes by segregating assets
equal to the option's exercise price, or in such other manner as may be in
accordance with the rules of the exchange on which the option is traded and
applicable laws and regulations.
The index underlying a stock option index may be a "broad-based" index,
such as the Standard & Poor's 500 Index or the New York Stock Exchange
Composite Index, the changes in value of which ordinarily will reflect
movements in the stock market in general. In contrast, certain options may
be based upon narrower market indexes, such as the Standard & Poor's 100
Index, or on indexes of securities of particular industry groups, such as
those of oil and gas or technology companies. A stock index assigns relative
values to the stocks included in the index and the index fluctuates with
changes in the market values of the stocks so included.
Warrants
Growth Portfolio, Asset Allocation Portfolio, Bond Portfolio, Capital
Appreciation Portfolio, International Stock Portfolio, Small Company Growth
Portfolio, Value Stock Portfolio, Small Company Value Portfolio, Global Bond
Portfolio, Macro-Cap Value Portfolio, Micro-Cap Growth Portfolio and Real
Estate Securities Portfolio may invest in warrants; however, not more than 5%
of their respective net assets (at the time of purchase) will be invested in
warrants other than warrants acquired in units or attached to other
securities. Of such 5%, not more than 2% of the Portfolio's respective
assets at the time of purchase may be invested in warrants that are not
listed on the New York or American Stock Exchanges. Warrants are instruments
that allow investors to purchase underlying shares at a specified price
(exercise price) at a given future date. The market price of a warrant is
determined by market participants by the addition of two distinct components:
(1) the price of the underlying shares less the warrant's exercise price, and
(2) the warrant's premium that is attributed to volatility and leveraging
power. Warrants are pure speculation in that they have no voting rights, pay
no dividends and have no rights with respect to the assets of the corporation
issuing them. The prices of warrants do not necessarily move parallel to the
prices of the underlying securities.
It is not expected that Bond Fund or Global Bond Portfolio will invest
in common stocks or equity securities other than warrants, but it may retain
for reasonable periods of time up to 5% of their respective total assets in
common stocks acquired upon conversion of debt securities or preferred stocks
or upon exercise of warrants.
Warrants with Cash Extractions
International Stock Portfolio may also invest up to 5% of its assets in
warrants used in conjunction with the cash extraction method. If an investor
wishes to replicate an underlying share, the investor can use the warrant
with cash extraction method by purchasing warrants and holding cash. The
cash component would be determined by subtracting the market price of the
warrant from the underlying share price.
For example, ASSUME one share for company "Alpha" has a current share
price of $40 and issued warrants can be converted one for one share at an
exercise price of $31 exercisable two years from today. Also ASSUME that the
market price of the warrant is $10 ($40 - $31 + $1) because investors are
willing to pay a premium ($1) for previously stated reasons. If an investor
wanted to replicate an underlying share by engaging in a warrant with cash
extraction strategy, the amount of cash the investor would need to hold for
every warrant would be $30 ($40 - $10 = $30). A warrant with cash extraction
is, thus, simply a synthetically created quasi-convertible bond.
If an underlying share issues no or a low dividend and has an
associated warrant with a market price that is low relative to its share
price, a warrant with cash extraction may provide attractive cash yields and
minimize capital loss risk, provided the underlying share is also considered
a worthy investment. For example, ASSUME Alpha's share is an attractive
investment opportunity and its share pays no dividend. Given the information
regarding Alpha provided above, also ASSUME that short-term cash currently
yields 5% per year and that the investor plans to hold the investment at
least two years, barring significant near-term capital appreciation. If the
share price were to fall below $30, the warrant with cash extraction strategy
would yield a lower loss than the underlying share because an investor cannot
lose more than the purchase cost of the warrant (capital risk minimized).
The cash component for this strategy would yield $3.08 after two years
(compound interest). The total value of the underlying investment would be
$43.08 versus $40.00 for the non-yielding underlying share (attractive
yield). Finally, it is important to note that this strategy will not be
pursued if it is not economically more attractive than underlying shares.
Index Depositary Receipts
Growth Portfolio, Asset Allocation Portfolio, Index 500 Portfolio,
Capital Appreciation Portfolio, Small Company Growth Portfolio, Value Stock
Portfolio, Small Company Value Portfolio, Index 400 Mid-Cap Portfolio, Macro-
Cap Value Portfolio and Micro-Cap Growth Portfolio may each invest up to 5%
of its total assets in one or more types of depositary receipts ("DRs") as a
means of tracking the performance of a designated stock index while
maintaining liquidity. The Portfolio may invest in S&P 500 Depositary
Receipts ("SPDRs"), which track the S&P 500 Index; S&P MidCap 400 Depositary
Receipts ("MidCap SPDRs"), which track the S&P MidCap 400 Index; and "Dow
Industrial Diamonds," which track the Dow Jones Industrial Average, or in
other DRs which track indexes, provided that such investments are consistent
with the Portfolio's investment objective as determined by the Portfolio's
investment adviser or sub-adviser. Each of these securities represents
shares of ownership of a long term unit investment trust (a type of
investment company) that holds all of the stock included in the relevant
underlying index.
DRs carry a price which equals a specified fraction of the value of the
designated index and are exchange traded. As with other equity transactions,
brokers charge a commission in connection with the purchase of DRs. In
addition, an asset management fee is charged in connection with the
underlying unit investment trust (which is in addition to the asset
management fee paid by the Portfolio).
Trading costs for DRs are somewhat higher than those for stock index
futures contracts, but, because DRs trade like other exchange-listed
equities, they represent a quick and convenient method of maximizing the use
of the Portfolio's assets to track the return of a particular stock index.
DRs share in the same market risks as other equity investments.
Short Sales Against the Box
Each Portfolio may sell securities "short against the box"; provided
that each Portfolio will not at the time of any short sales aggregate in
total sales price more than 10% of its total assets. Whereas a short sale is
the sale of a security the Portfolio does not own, a short sale is "against
the box" if, at all times during which the short position is open, the
Portfolio owns at least an equal amount of the securities sold short or other
securities convertible into or exchangeable without further consideration for
securities of the same issue as the securities sold short. Short sales
against the box are typically used by sophisticated investors to defer
recognition of capital gains or losses. The Portfolios have no present
intention to sell securities short in this fashion.
Investments in Russia
International Stock Portfolio may invest in securities of Russian
companies, which involves risks and special considerations not typically
associated with investing in United States securities markets. Since the
breakup of the Soviet Union at the end of 1991, Russia has experienced
dramatic political and social change. The political system in Russia is
emerging from a long history of extensive state involvement in economic
affairs. The country is undergoing a rapid transition from a centrally-
controlled command system to a market-oriented, democratic model. The
Portfolio may be affected unfavorably by political or diplomatic
developments, social instability, changes in government policies, taxation
and interest rates, currency repatriation restrictions and other political
and economic developments in the law or regulations in Russia and, in
particular, the risks of expropriation, nationalization and confiscation of
assets and changes in legislation relating to foreign ownership.
The planned economy of the former Soviet Union was run with
qualitatively different objectives and assumptions from those prevalent in a
market system and Russian businesses do not have any recent history of
operating within a market-oriented economy. In general, relative to
companies operating in Western economies, companies in Russian are
characterized by a lack of: (i) management with experience of operating in a
market economy; (ii) modern technology; and, (iii) a sufficient capital base
with which to develop and expand their operations. It is unclear what will
be the future effect on Russian companies, if any, of Russia's continued
attempts to move toward a more market-oriented economy. Russia's economy has
experienced severe economic recession, if not depression, since 1990 during
which time the economy has been characterized by high rates of inflation,
high rates of unemployment, declining gross domestic product, deficit
government spending, and a devaluing currency. The economic reform program
has involved major disruptions and dislocations in various sectors of the
economy, and those problems have been exacerbated by growing liquidity
problems. Further, Russian presently receives significant financial
assistance from a number of countries through various programs. To the
extent these programs are reduced or eliminated in the future, Russian
economic development may be adversely impacted.
The Russian securities markets are substantially smaller, less liquid
and significantly more volatile than the securities markets in the United
States. In addition, there is little historical data on these securities
markets because they are of recent origin. A substantial proportion of
securities transactions in Russia are privately negotiated outside of stock
exchanges and over-the-counter markets. A limited number of issuers
represent a disproportionately large percentage of market capitalization and
trading volume. Although evolving rapidly, even the largest of Russia's
stock exchanges are not well developed compared to Western stock exchanges.
The actual volume of exchange-based trading in Russia is low and active on-
market trading generally occurs only in the shares of a few private
companies. Most secondary market trading of equity securities occurs through
over-the-counter trading facilitated by a growing number of licensed brokers.
Shares are traded on the over-the-counter market primarily by the management
of enterprises, investment funds, short-term speculators and foreign
investors. The securities of Russian companies are mostly traded over-the-
counter and, despite the large number of stock exchanges, there is still no
organized public market for such securities. This may increase the
difficulty of valuing the Portfolio's investments. No established secondary
markets may exist for many of the securities in which the Portfolio may
invest. Reduced secondary market liquidity may have an adverse effect on
market price and the Portfolio's ability to dispose of particular instruments
when necessary to meet its liquidity requirements or in response to specific
economic events such as a deterioration in the creditworthiness of the
issuer. Reduced secondary market liquidity for securities may also make it
more difficult for the Portfolio to obtain accurate market quotations for
purposes of valuing its portfolio and calculating its net asset value.
Market quotations are generally available on many emerging country securities
only from a limited number of dealers and may not necessarily represent firm
bids of those dealers or prices for actual sales.
Because of the recent formation of the securities markets as well as
the underdeveloped state of the banking and telecommunications systems,
settlement, clearing and registration transactions are subject to significant
risks not normally associated with investments in the United States and other
more developed markets. Ownership of shares (except where shares are held
through depositories that meet the requirements of the 1940 Act) is defined
according to entries in the company's share register and normally evidenced
by extracts from the register or in certain limited cases by formal share
certificates. However, there is not a central registration system and these
services are carried out by the companies themselves or by registrars located
throughout Russia. These registrars are not necessarily subject to effective
state supervision and its possible for the Portfolio to lose its registration
through fraud, negligence and even mere oversight. The laws and regulations
in Russia affecting Western investment business continue to evolve in an
unpredictable manner. Russian laws and regulations, particularly those
involving taxation, foreign investment and trade, title to property or
securities, and transfer of title, applicable to the Portfolio's activities
are relatively new and can change quickly and unpredictably in a manner far
more volatile than in the United States or other developed market economies.
Although basic commercial laws are in place, they are often unclear or
contradictory and subject to varying interpretation, and may at any time be
amended, modified, repealed or replaced in a manner adverse to the interest
of the Portfolio. There is still lacking a cohesive body of law and
precedents normally encountered in business environments. Foreign investment
in Russian companies is, in certain cases, legally restricted. Sometimes
these restrictions are contained in constitutional documents of an enterprise
which are not publicly available. Russian foreign investment legislation
currently guarantees the right of foreign investors to transfer abroad income
received on investments such as profits, dividends and interest payments.
This right is subject to settlement of all applicable taxes and duties.
However, more recent legislation governing currency regulation and control
guarantees the right to export interest, dividends and other income on
investments, but does not expressly permit the repatriation of capital from
the realization of investments. Current practice is to recognize the right
to repatriation of capital. Authorities currently do not attempt to restrict
repatriation beyond the extent of the earlier law. No guarantee can be made,
however, that amounts representing realization of capital of income will be
capable of being remitted. If, for any reason, the Portfolio were unable to
distribute an amount equal to substantially all of its investment company
taxable income (as defined for U.S. tax purposes) within applicable time
periods, the Portfolio would not qualify for the favorable U.S. federal
income tax treatment afforded to regulated investment companies, or, even if
it did so qualify, it might become liable for income and excise taxes on
undistributed income.
Russian courts lack experience in commercial dispute resolution and
many of the procedural remedies for enforcement and protection of legal
rights typically found in Western jurisdictions are not available in Russia.
There remains uncertainty as to the extent to which local parties and
entities, including Russian state authorities, will recognize the contractual
and other rights of the parties with which they deal. Accordingly, there
will be difficulty and uncertainty in the Portfolio's ability to protect and
enforce its rights against Russian state and private entities. There is also
no assurance that the Russian courts will recognize or acknowledge that the
Portfolio has acquired title to any property or securities in which the
Portfolio invests, or that the Portfolio is the owner of any property or
security held in the name of a nominee which has acquired such property or
security on behalf of the Portfolio, because there is at present in Russia no
reliable system or legal framework regarding the registration of titles.
There can be no assurance that this difficulty in protecting and enforcing
rights in Russia will not have a material adverse effect on the Portfolio and
its operations. Difficulties are likely to be encountered enforcing
judgments of foreign courts within Russia or of Russian courts in foreign
jurisdictions due to the limited number of countries which have signed
treaties for mutual recognition of court judgments with Russia.
Defensive Purposes
Each Portfolio may invest up to 20% of its respective net assets in
cash or cash items. In addition, for temporary or defensive purposes, the
Portfolio may invest in cash or cash items without limitation. The "cash
items" in which the Portfolio may invest, include short-term obligations such
as rated commercial paper and variable amount master demand notes; United
States dollar-denominated time and savings deposits (including certificates
of deposit); bankers' acceptances; obligations of the United States
Government or its agencies or instrumentalities; repurchase agreements
collateralized by eligible investments of a Portfolio; securities of other
mutual funds which invest primarily in debt obligations with remaining
maturities of 13 months or less (which investments also are subject to the
advisory fee); and other similar high-quality short-term United States
dollar-denominated obligations.
INVESTMENT RESTRICTIONS
The Fund has adopted the following restrictions relating to the
investment of the assets of the Portfolios.
Each Portfolio is subject to certain "fundamental" investment
restrictions which may not be changed without the affirmative vote of a
majority of the outstanding voting securities of each Portfolio affected by
the change. With respect to the submission of a change in an investment
restriction to the holders of the Fund's outstanding voting securities, such
matter shall be deemed to have been effectively acted upon with respect to a
particular Portfolio if a majority of the outstanding voting securities of
such Portfolio vote for the approval of such matter, notwithstanding (1) that
such matter has not been approved by the holders of a majority of the
outstanding voting securities of any other Portfolio affected by such matter,
and (2) that such matter has not been approved by the vote of a majority of
the outstanding voting securities of the Fund. For this purpose and under
the Investment Company Act of 1940, a majority of the outstanding voting
shares of each Portfolio means the lesser of (i) 67% of the voting shares
represented at a meeting which more than 50% of the outstanding voting shares
are represented or (ii) more than 50% of the outstanding voting shares. An
investment restriction which is not fundamental may be changed by a vote of
the Board of Directors without further shareholder approval. Except as
otherwise noted, each of the investment restrictions below is fundamental.
The fundamental investment restrictions were most recently considered at a
Special Meeting of Shareholders held on April 17, 2000.
Fundamental Restrictions
1. The Portfolios will not borrow money or issue senior securities
except as permitted under the Investment Company Act of 1940, as
amended, and as interpreted or modified from time to time by any
regulatory authority having jurisdiction.
2. The Portfolios will not concentrate their investments in a
particular industry, except that:
(a) with respect to Money Market Portfolio, this limitation does not
apply to investments in domestic banks;
(b) under normal market conditions, Mortgage Securities Portfolio
will concentrate its investments in the mortgage and mortgage-
finance industry. Mortgage Securities Portfolio will not
concentrate its investments in any other particular industry;
(c) under normal market conditions, Real Estate Securities Portfolio
will concentrate its investments in the real estate or real
estate related industry. Real Estate Portfolio will not
concentrate its investments in any other particular industry;
(d) Index 500 Portfolio may concentrate its investments in a
particular industry if the S&P 500 Index is so concentrated; and
(e) Index 400 Mid-Cap Portfolio may concentrate its investments in a
particular industry if the S&P 400 Mid-Cap Index is so
concentrated.
For purposes of this limitation, the U.S. Government, and state or
municipal governments and their political subdivisions, are not
considered members of any industry. Whether a Portfolio is
concentrating in an industry shall be determined in accordance with
the Investment Company Act of 1940, as amended, and as interpreted
or modified from time to time by any regulatory authority having
jurisdiction.
3. The Portfolios will not purchase or sell real estate unless acquired
as a result of ownership of securities or other instruments, but
this shall not prevent the Portfolios from investing in securities
or other instruments backed by real estate investments therein or in
securities of companies that deal in real estate or mortgages.
4. The Portfolios will not purchase physical commodities or contracts
relating to physical commodities.
5. The Portfolios may not make loans except as permitted under the
Investment Company Act of 1940, as amended, and as interpreted or
modified from time to time by any regulatory authority having
jurisdiction.
6. The Portfolios may not act as an underwriter of securities, except
to the extent the Fund may be deemed to be an underwriter in
connection with the disposition of Portfolio securities.
Non-Fundamental Restrictions
The Fund has adopted a number of non-fundamental policies which appear below.
7. The Portfolios will not acquire any new securities while borrowings,
including borrowings through reverse repurchase agreements, exceed
5% of total assets.
8. The Portfolios will use futures contracts and options on futures
contracts only (a) for "bona fide hedging purposes" (as defined in
regulations of the Commodity Futures Trading Commission) or (b) for
other purposes so long as the aggregate initial margins and premiums
required in connection with non-hedging positions do not exceed 5%
of the liquidation value of the Portfolio.
9. The Portfolios may mortgage, pledge or hypothecate their assets only
to secure permitted borrowings. Collateral arrangements with
respect to futures contracts, options thereon and certain options
transactions are not considered pledges for purposes of this
limitation.
10. The Portfolios may not make short sales of securities, other than
short sales "against the box."
11. The Portfolios may not purchase securities on margin, but it may
obtain such short-term credits as may be necessary for the clearance
of securities transactions and it may make margin deposits in
connection with futures contracts.
12. The Portfolios will not invest more than 15% (10% in the case of
Money Market Portfolio) of their net assets in illiquid securities.
13. The total market value of securities against which a Portfolio may
write call or put options will not exceed 2% of the Portfolios'
total assets. In addition, a Portfolio will not commit more than 5%
of its total assets to premiums when purchasing put or call options.
If a percentage restriction described above or in the Fund's Prospectus
is adhered to at the time of an investment, a later increase or decrease in
the investment's percentage of the value of a Portfolio's total assets
resulting from a change in such values or assets will not constitute a
violation of the percentage restriction.
Additional Restrictions
The Money Market Portfolio is subject to the investment restrictions of
Rule 2a-7 under the Investment Company Act of 1940, as amended (the "1940
Act"), in addition to its other policies and restrictions discussed below.
Pursuant to Rule 2a-7, the Fund is required to invest exclusively in
securities that mature within 397 days from the date of purchase and to
maintain an average weighted maturity of not more than 90 days. Rule 2a-7
also requires that all investments by the Portfolio be limited to United
States dollar-denominated investments that (a) present "minimal credit risk"
and (b) are at the time of acquisition "Eligible Securities." Eligible
Securities include, among others, securities that are rated by two Nationally
Recognized Statistical Rating Organizations ("NRSROs") in one of the two
highest categories for short-term debt obligations, such as A-1 or A-2 by
S&P, or Prime-1 or Prime-2 by Moody's.
Rule 2a-7 also requires, among other things, that the Money Market
Portfolio may not invest, other than in U.S. "Government Securities" (as
defined in the 1940 Act), (a) more than 5% of its total assets in Second Tier
Securities (i.e., Eligible Securities that are not rated by two NRSROs in the
highest category such as A-1 and Prime-1 and (b) more than the greater of 1%
of its total assets or $1,000,000 in Second Tier Securities of any one
issuer. The present practice is not to purchase any Second Tier Securities.
PORTFOLIO TURNOVER
Portfolio turnover is the ratio of the lesser of annual purchases or
sales of portfolio securities to the average monthly value of portfolio
securities, not including short-term securities. A 100% portfolio turnover
rate would occur, for example, if the lesser of the value of purchases or
sales of portfolio securities for a particular year were equal to the average
monthly value of the portfolio securities owned during such year.
Each Portfolio has a different expected annual rate of portfolio
turnover. A high rate of turnover in a Portfolio generally involves
correspondingly greater brokerage commission expenses, which must be borne
directly by the Portfolio. Turnover rates may vary greatly from year to year
and within a particular year and may also be affected by cash requirements
for redemptions of each Portfolio's shares and by requirements which enable
the Fund to receive favorable tax treatment. The portfolio turnover rates
associated with each Portfolio will, of course, be affected by the level of
purchases and redemptions of shares of each Portfolio. However, because rate
of portfolio turnover is not a limiting factor, particular holdings may be
sold at any time, if in the opinion of Advantus Capital such a sale is
advisable.
The Money Market Portfolio, consistent with its investment objective,
will attempt to maximize yield through trading. This may involve selling
instruments and purchasing different instruments to take advantage of
disparities of yields in different segments of the high grade money market or
among particular instruments within the same segment of the market. Since
the Portfolio's assets will be invested in securities with short maturities
and the Portfolio will manage its assets as described above, the Portfolio's
holdings of money market instruments will turn over several times a year.
However, this does not generally increase the Portfolio's brokerage costs,
since brokerage commissions as such are not usually paid in connection with
the purchase or sale of the instruments in which the Portfolio invests since
such securities will be purchased on a net basis.
For each of the last three calendar years, the portfolio turnover rates
for the various Portfolios were as follows:
Portfolio Turnover Rate
Portfolio 1999 1998 1997
Growth 65.3% 66.4% 120.1%
Bond 140.8 252.1 200.0
Money Market N/A N/A N/A
Asset Allocation 97.0 129.6 140.2
Mortgage Securities 79.4 116.7 106.4
Index 500 25.6 30.2 8.3
Capital Appreciation 114.1 82.7 74.0
International Stock 34.7 22.4 12.5
Small Company Growth 105.1 75.5 63.8
Maturing Government Bond -
2002 Portfolio 21.1 35.2 36.9
2006 Portfolio 19.8 21.6 3.1
2010 Portfolio 28.4 28.2 39.3
Value Stock 131.2 88.9 115.4
Small Company Value 101.5 70.2 13.0
Global Bond 287.4 285.3 120.5
Index 400 Mid-Cap 76.6 85.4 4.9
Macro-Cap Value 103.4 164.0 36.7
Micro-Cap Growth 108.5 67.4 28.9
Real Estate Securities 106.3 54.0 N/A
DIRECTORS AND EXECUTIVE OFFICERS
Under Minnesota law, the Board of Directors of the Fund has overall
responsibility for managing the Fund in good faith and in a manner reasonably
believed to be in the best interests of the Fund. The names, addresses,
principal occupations, and other affiliations of directors and executive
officers of the Fund are given below:
Position with Principal Occupation and other
Name and Address the Funds Affiliations (past 5 years)
William N. Westhoff* President and President, Treasurer and
Director,
Advantus Capital Director Advantus Capital Management,
Inc.;
Management, Inc. Senior Vice President and
Treasurer,
400 Robert Street North Minnesota Life Insurance
Company;
St. Paul, Minnesota 55101 Vice President and Director,
Robert Street Energy, Inc.;
President, MCM Funding 1997-1,
Inc.; President, MCM Funding
1998-1, Inc.; Senior Vice
President, Global Investments,
American Express Financial
Corporation, Minneapolis,
Minnesota, from August 1994 to
October 1997
Frederick P. Feuerherm* Vice President, Vice President, Assistant
Secretary and
Advantus Capital Director and Director, Advantus Capital
Management, Inc. Treasurer Management, Inc.; Vice
President,
400 Robert Street North Minnesota Life Insurance
Company;
St. Paul, Minnesota 55101 Vice President and Director,
MIMLIC Funding, Inc.; Vice
President and Assistant
Secretary, MCM Funding 1997-1,
Inc.; Vice President and
Assistant Secretary, MCM Funding
1998-1, Inc.
Ralph D. Ebbott Director Retired, Vice President and
Treasurer
409 Birchwood Avenue of Minnesota Mining and
White Bear Lake, Manufacturing Company
Minnesota 55101 (industrial and consumer
products) through June 1989
Charles E. Arner Director Retired, Vice Chairman of The
First
E-1430 First National National Bank of Saint Paul from
Bank Building November 1983 through June 1984;
332 Minnesota Street Chairman and Chief Executive
Officer
St. Paul, Minnesota 55101 of The First National Bank of
Saint Paul from October 1980
through November 1983
Ellen S. Berscheid Director Regents' Professor of Psychology
at the
University of Minnesota University of Minnesota
N309 Elliott Hall
Minneapolis, Minnesota 55455
Michael J. Radmer Secretary Partner with the law firm of
Dorsey & Whitney LLP Dorsey & Whitney LLP
220 South Sixth Street
Minneapolis, Minnesota 55402
_________________________
* Denotes directors of the Funds who are "interested persons" (as defined
under the Investment Company Act of 1940) of the Funds.
_________________________
The Fund has both an Audit Committee and a Nominations Committee, the
members of which are all directors who are not "interested persons" of the
Fund. Ms. Berscheid and Messrs. Arner and Ebbott comprise the members of
both committees.
Legal fees and expenses are paid to the law firm of which Michael J.
Radmer is a partner. No compensation is paid by the Fund to any of its
officers or directors who is affiliated with Advantus Capital Management,
Inc. ("Advantus Capital"). Each director of the Fund who is not affiliated
with Advantus Capital is also a director of thirteen other investment
companies of which Advantus Capital is the investment adviser (the "Fund
Complex"). As of the date hereof, such directors receive compensation in
connection with all such investment companies which, in the aggregate, is
equal to $8,000 per year and $2,000 per meeting attended (and reimbursement
of travel expenses to attend directors' meetings). The portion of such
compensation borne by the Fund is a pro rata portion based on the ratio that
the Fund's total net assets bears to the total net assets of the Fund
Complex. During the fiscal year ended December 31, 1999, each Director not
affiliated with Advantus Capital was compensated by the Fund in accordance
with the following table:
Name of
Director
Aggregate
Compensation
from
the Fund
Pension or
Retirement
Benefits
Accrued as
Part of Fund
Expenses
Estimated
Annual
Benefits Upon
Retirement
Total
Compensation
From Fund and
Fund Complex
Paid to
Directors
Charles E.
Arner
$16,303
n/a
n/a
$20,000
Ellen S.
Berscheid
$16,303
n/a
n/a
$20,000
Ralph D.
Ebbott
$16,303
n/a
n/a
$20,000
As of December 31, 1999, the directors and executive officers of the
Fund did not own any shares of the Fund.
DIRECTOR LIABILITY
Under Minnesota law, the Board of Directors of the Fund owes certain
fiduciary duties to the Fund and to its shareholders. Minnesota law provides
that a director "shall discharge the duties of the position of director in
good faith, in a manner the director reasonably believes to be in the best
interest of the corporation, and with the care an ordinarily prudent person
in a like position would exercise under similar circumstances." Fiduciary
duties of a director of a Minnesota corporation include, therefore, both a
duty of "loyalty" (to act in good faith and act in a manner reasonably
believed to be in the best interests of the corporation) and a duty of "care"
(to act with the care an ordinarily prudent person in a like position would
exercise under similar circumstances). Minnesota law also authorizes
corporations to eliminate or limit the personal liability of a director to
the corporation or its shareholders for monetary damages for breach of the
fiduciary duty of "care." Minnesota law does not, however, permit a
corporation to eliminate or limit the liability of a director (i) for any
breach of the directors' duty of "loyalty" to the corporation or its
shareholders, (ii) for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law, (iii) for authorizing a
dividend, stock repurchase or redemption or other distribution in violation
of Minnesota law or for violation of certain provisions of Minnesota
securities laws, or (iv) for any transaction from which the director derived
an improper personal benefit. The Articles of Incorporation of the Fund
limit the liability of directors to the fullest extent permitted by Minnesota
statutes, except to the extent that such liability cannot be limited as
provided in the Investment Company Act of 1940 (which prohibits any
provisions which purport to limit the liability of directors arising from
such directors' willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of their role as directors).
Minnesota law does not eliminate the duty of "care" imposed upon a
director. It only authorizes a corporation to eliminate monetary liability
for violations of that duty. Minnesota law, further, does not permit
elimination or limitation of liability of "officers" to the corporation for
breach of their duties as officers (including the liability of directors who
serve as officers for breach of their duties as officers). Minnesota law
does not permit elimination or limitation of the availability of equitable
relief, such as injunctive or recessionary relief. Further, Minnesota law
does not permit elimination or limitation of a director's liability under the
Securities Act of 1933 or the Securities Exchange Act of 1934, and it is
uncertain whether and to what extent the elimination of monetary liability
would extend to violations of duties imposed on directors by the Investment
Company Act of 1940 and the rules and regulations adopted under such Act.
INVESTMENT ADVISORY AND OTHER SERVICES
General
Advantus Capital Management, Inc. ("Advantus Capital") has been the
investment adviser and manager of the Fund and its Portfolios since May 1,
1997. Advantus Capital acts as investment adviser to the Portfolios pursuant
to a written agreement that will be periodically considered for approval by
the directors or shareholders of the Fund. The address of Advantus Capital
is 400 Robert Street North, St. Paul, Minnesota 55101.
The Fund and Advantus Capital have obtained an exemptive order from the
Securities and Exchange Commission which permits Advantus Capital to employ a
"manager of managers" strategy in connection with its management of the Fund.
The exemptive order permits Advantus Capital, subject to certain conditions,
to select new investment sub-advisers with the approval of the Fund's Board
of Directors, but without obtaining shareholder approval. The order also
permits Advantus Capital to change the terms of agreements with the
investment sub-advisers or continue the employment of an investment sub-
adviser after an event which would otherwise cause the automatic termination
of services. Shareholders would be notified of any investment sub-adviser
changes. Shareholders have the right to terminate arrangements with an
investment sub-adviser by vote of a majority of the outstanding shares of a
Portfolio. In the case of a Portfolio which employs more than one investment
sub-adviser, the order also permits the Fund to disclose such investment sub-
advisers' fees only in the aggregate in its registration statement. Advantus
Capital has the ultimate responsibility for the investment performance of
each Portfolio employing investment sub-advisers due to its responsibility to
oversee the investment sub-advisers and recommend their hiring, termination
and replacement.
Credit Suisse Asset Management, LLC ("CSAM") serves as investment sub-
adviser to the Fund's Capital Appreciation Portfolio and Small Company Growth
Portfolio pursuant to an investment sub-advisory agreement with Advantus
Capital. Templeton Investment Counsel, Inc. serves as investment sub-adviser
to the Fund's International Stock Portfolio pursuant to an investment sub-
advisory agreement with Advantus Capital. Julius Baer Investment Management
Inc. ("Julius Baer") serves as investment sub-adviser to the Fund's Global
Bond Portfolio, pursuant to an investment sub-advisory agreement with
Advantus Capital. Julius Baer determines the Portfolio's allocation between
foreign and domestic securities and selects and manages the Portfolio's
foreign investments (Advantus Capital selects and manages domestic
investments). J.P. Morgan Investment Management Inc. serves as investment
sub-adviser to the Fund's Macro-Cap Value Portfolio pursuant to an investment
sub-advisory agreement with Advantus Capital. Wall Street Associates serves
as investment sub-adviser to the Fund's Micro-Cap Growth Portfolio pursuant
to an investment sub-advisory agreement with Advantus Capital. State Street
Research & Management Company ("State Street Research") serves as investment
sub-adviser to the Fund's Small Company Value Portfolio pursuant to an
investment sub-advisory agreement with Advantus Capital.
Control and Management of Advantus Capital
Advantus Capital was incorporated in Minnesota in June 1994, and is a
wholly-owned subsidiary of Minnesota Life Insurance Company ("Minnesota
Life"). Minnesota Life is a third-tier subsidiary of a mutual insurance
holding company called Minnesota Mutual Companies, Inc. Minnesota Life was
organized in 1880, and has assets of more than $16 billion. William N.
Westhoff, President and a Director of the Fund, is President, Treasurer and
Director of Advantus Capital. Frederick P. Feuerherm, Vice President,
Treasurer and a Director of the Fund, is a Vice President, Assistant
Secretary and Director of Advantus Capital.
Investment Advisory Agreement
Advantus Capital acts as investment adviser and manager of the Fund
under an Investment Advisory Agreement dated May 1, 2000 (the "Investment
Advisory Agreement"), which became effective the same date, and was approved
by shareholders on April 17, 2000. The Investment Advisory Agreement was
last approved by the Board of Directors (including a majority of the
directors who are not parties to the contract, or interested persons of any
such party) on February 10, 2000. Prior to May 1, 1997, the Fund obtained
advisory services from MIMLIC Asset Management Company ("MIMLIC Management"),
formerly the parent company of Advantus Capital. Advantus Capital commenced
its business in June 1994, and provides investment advisory services to
eleven other Advantus funds and various private accounts.
The Investment Advisory Agreement, will terminate automatically in the
event of assignment. In addition, the Investment Advisory Agreement is
terminable at any time, without penalty, by the Board of Directors of the
Fund or by vote of a majority of the Fund's outstanding voting securities on
60 days' written notice to Advantus Capital, and by Advantus Capital on 60
days' written notice to the Fund. Unless sooner terminated, the Investment
Advisory Agreement shall continue in effect for more than two years after its
execution only so long as such continuance is specifically approved at least
annually either by the Board of Directors of the Fund or by a vote of a
majority of the outstanding voting securities, provided that in either event
such continuance is also approved by the vote of a majority of the directors
who are not interested persons of any party to the Investment Advisory
Agreement, cast in person at a meeting called for the purpose of voting on
such approval. The required shareholder approval of any continuance of the
Investment Advisory Agreement shall be effective with respect to any
Portfolio if a majority of the outstanding voting securities of the class of
capital stock of that Portfolio votes to approve such continuance,
notwithstanding that such continuance may not have been approved by a
majority of the outstanding voting securities of the Fund.
If the shareholders of a class of capital stock of any Portfolio fail
to approve any continuance of the Investment Advisory Agreement, Advantus
Capital will continue to act as investment adviser with respect to such
Portfolio pending the required approval of its continuance, or a new contract
with Advantus Capital or a different investment adviser or other definitive
action; provided that the compensation received by Advantus Capital in
respect of such Portfolio during such period will be no more than its actual
costs incurred in furnishing investment advisory and management services to
such Portfolio or the amount it would have received under the Investment
Advisory Agreement in respect of such Portfolio, whichever is less.
The Investment Advisory Agreement may be amended by the parties only if
such amendment is specifically approved by the vote of a majority of the
outstanding voting securities of the Fund and by the vote of a majority of
the directors of the Fund who are not interested persons of any party to the
Investment Advisory Agreement cast in person at a meeting called for the
purpose of voting on such approval. The required shareholder approval shall
be effective with respect to any Portfolio if a majority of the outstanding
voting securities of the class of capital stock of that Portfolio vote to
approve the amendment, notwithstanding that the amendment may not have been
approved by a majority of the outstanding voting securities of the Fund.
Pursuant to the Investment Advisory Agreement, the Fund pays Advantus
Capital an advisory fee equal on an annual basis to a percentage of a
Portfolio's average daily net assets as set forth in the following table:
The Fund pays Advantus Capital monthly fees calculated on an annual basis for
each Portfolio. Advantus Capital uses a portion of the applicable fees to
pay sub-advisers. The annual advisory fees paid to Advantus Capital for each
of the Portfolios is as follows:
Advisory Fee Paid Prior
to May 1, 2000
(as a percentage of
Portfolio average daily net assets)1
Growth Portfolio 0.45% of assets to $1
billion; and
0.40% of assets exceeding $1
billion
Bond Portfolio 0.30% of assets to $500
million;
0.25% of assets exceeding
$500 million to $1 billion;
and
0.20% of assets exceeding $1
billion
Money Market Portfolio 0.25% of assets to $1billion;
and
0.20% of assets exceeding $1
billion
Asset Allocation Portfolio 0.35% of assets to $1
billion; and
0.30% of assets exceeding $1
billion
Mortgage Securities Portfolio 0.30% of assets to $1
billion; and
0.25% of assets exceeding $1
billion
Index 500 Portfolio 0.15% of assets to $250
million;
0.10% of assets exceeding
$250 million to $1 billion;
and
0.075% of assets exceeding $1
billion
Capital Appreciation Portfolio 0.50% of assets to $1
billion; and
0.45% of assets exceeding $1
billion1
International Stock Portfolio 0.60% of assets
to $250 million;
0.55% of assets exceeding
$250 million to $500 million;
0.50% of assets exceeding
$500 million to $1 billion;
and
0.45% of assets exceeding $1
billion2
Small Company Growth 0.65% of assets to $1
billion; and
Portfolio 0.60% of assets exceeding $1
billion3
Maturing Government Bond Portfolios 0.25%
Value Stock Portfolio 0.50% of assets to $500
million;
0.45% of assets exceeding
$500 million to $1 billion;
and
0.40% of assets exceeding $1
billion
Small Company Value Portfolio 0.70% of assets to $1
billion; and
0.65% of assets exceeding $1
billion4
Global Bond Portfolio 0.60% of assets to $1
billion; and
0.55% of assets exceeding $1
billion5
Index 400 Mid-Cap Portfolio 0.15% of assets to $250
million;
0.10% of assets exceeding
$250 million to $1 billion;
and
0.075% of assets exceeding $1
billion
Macro-Cap Value Portfolio 0.50%6
Micro-Cap Growth Portfolio 0.95%7
Real Estate Securities Portfolio 0.60% of assets to $1
billion; and
0.55% of assets exceeding $1
billion
1 Advantus Capital uses a portion of these fees to pay CSAM an annual sub-
advisers fee equal to 0.50% of total assets between $0 and $500 million;
0.45% of total assets between $500 million and $1 billion; 0.35% of total
assets between $1 billion and $2 billion; and 0.30% of total assets exceeding
$2 billion. The term "assets" includes all assets advised or sub-advised by
CSAM for Advantus Capital or its affiliates, in addition to the assets of the
Portfolio. The fee rate is applied to all assets back to the first dollar in
the Portfolio.
2 Advantus Capital uses a portion of these fees to pay Templeton Counsel an
annual sub-advisers fee equal to 0.70% of total assets between $0 and $10
million; 0.65% of total assets exceeding $10 million to $25 million; 0.55% of
assets exceeding $25 million to $50 million; 0.50% of assets exceeding $50
million to $100 million; and 0.40% of assets exceeding $100 million. For the
purpose of establishing the appropriate breakpoints at which the Portfolio's
sub-advisory fee shall be calculated, the Portfolio will benefit from the
aggregation of the monthly market value of any non-mutual fund account of
Minnesota Life or any affiliate thereof, advised or sub-advised by Templeton
Counsel or any advisory affiliate thereof as well as the average daily net
assets of any U.S. registered mutual fund advised by Advantus and sub-advised
by Templeton Counsel or any advisory affiliate. For fee-stacking purposes,
the asset classes so managed with the highest fee schedules shall be counted
first as assets of this Portfolio in order to determine this Portfolio's
appropriate starting breakpoint when Franklin Advisors, Inc., an affiliate of
Templeton Counsel, provides other sub-advisory services to Advantus Capital,
covering small company domestic equities in an amount in excess of $100
million and Minnesota Life, offers as investment options in its registered
variable insurance contracts the Templeton Developing Markets Securities Fund
and any other two funds in the Franklin Templeton Variable Insurance Products
Trust.
3 Advantus Capital uses a portion of these fees to pay CSAM an annual sub-
advisers fee equal to 0.65% of total assets between $0 and $500 million;
0.60% of total assets between $500 million and $1 billion; 0.50% of total
assets between $1 billion and $2 billion; and 0.45% of total assets exceeding
$2 billion. The term "assets" includes all assets advised or sub-advised by
CSAM for Advantus Capital or its affiliates, in addition to the assets of the
Portfolio. The fee rate is applied to all assets back to the first dollar in
the Portfolio.
4 Advantus Capital uses a portion of these fees to pay State Street Research
an annual sub-advisers fee equal to 0.65% on the first $500 million of
assets; 0.60% on the next $500 million of assets; and 0.50% of assets in
excess of $1 billion. The term "assets" includes all 'small company value'
assets sub-advised by State Street Research for Advantus Capital or its
affiliates, in addition to the assets of the Portfolio.
5 Advantus Capital uses a portion of these fees to pay JBIM an annual sub-
advisers fee equal to .030% of the Portfolio's average daily net assets.
6 Advantus Capital uses a portion of these fees to pay J.P Morgan an annual
sub-advisers fee equal to .45% of the Portfolio's average daily net assets.
7 Advantus Capital uses a portion of these fees to pay WSA an annual sub-
advisers fee equal to .85% of the Portfolio's average daily net assets.
The fees paid by the Fund during the fiscal years ended December 31,
1999, 1998 and 1997 (before absorption of certain expenses, described below)
were as follows:
Advisory Fees Paid
Portfolio 1999 1998 1997
Growth Portfolio $2,494,891 $1,933,104 $1,466,591
Bond Portfolio 905,784 797,554 673,785
Money Market Portfolio 715,791 365,699 353,186
Asset Allocation Portfolio 3,331,000 2,789,366 2,284,255
Mortgage Securities Portfolio 664,424 558,926 413,651
Index 500 Portfolio 2,380,660 1,883,032 1,171,693
Capital Appreciation Portfolio 2,859,868 2,474,808 1,879,870
International Stock Portfolio 2,264,526 2,179,226 1,856,022
Small Company Growth Portfolio 1,449,287 1,377,138 1,223,927
Maturing Government Bond -
2002 Portfolio 19,643 10,114 1,959
2006 Portfolio 16,349 12,908 8,471
2010 Portfolio 13,438 10,545 6,719
Value Stock Portfolio 1,511,048 1,593,193 1,171,946
Small Company Value Portfolio 77,509 47,485 9,775
Global Bond Portfolio 188,285 160,962 41,149
Index 400 Mid-Cap Portfolio 61,826 26,300 5,014
Macro-Cap Value Portfolio 113,418 47,602 7,048
Micro-Cap Growth Portfolio 171,857 60,544 15,671
Real Estate Securities Portfolio 41,354 23,859 N/A
Under the Investment Advisory Agreement, Advantus Capital furnishes the
Fund office space and all necessary office facilities, equipment and
personnel for servicing the investments of the Fund. The Fund pays all its
costs and expenses which are not assumed by Advantus Capital. These Fund
expenses include, by way of example, but not by way of limitation, all
expenses incurred in the operation of the Fund including, among others,
interest, taxes, brokerage fees and commissions, fees of the directors who
are not employees of Advantus Capital or any of its affiliates, expenses of
directors' and shareholders' meetings, including the cost of printing and
mailing proxies, expenses of insurance premiums for fidelity and other
coverage, association membership dues, charges of custodians, auditing and
legal expenses. The Fund will also pay the fees and bear the expense of
registering and maintaining the registration of the Fund and its shares with
the Securities and Exchange Commission and registering or qualifying its
shares under state or other securities laws and the expense of preparing and
mailing prospectuses and reports to shareholders. Advantus Capital shall
bear all advertising and promotional expenses in connection with the
distribution of the Fund's shares, including paying for the printing of
Prospectuses and Statements of Additional Information for new shareholders
and the costs of sales literature. Advantus Capital also bears all costs
under its agreement with Wilshire Associates for the use by Advantus Capital,
in connection with the Index 500 Portfolio, of Wilshire Associates'
proprietary index fund statistical sampling technique.
Prior to May 1, 2000, Minnesota Life had voluntarily agreed to absorb
all fees and expenses that exceed .65% of average daily net assets for the
Growth Portfolio, Bond Portfolio, Money Market Portfolio, Asset Allocation
Portfolio and Mortgage Securities Portfolio, .55% of average daily net assets
for the Index 500 Portfolio and Index 400 Mid-Cap Portfolio, .90% of average
daily net assets for the Capital Appreciation Portfolio, Small Company Growth
Portfolio, Value Stock Portfolio, Small Company Value Portfolio and Real
Estate Securities Portfolio, .40% of average daily net assets for each of the
three Maturing Government Bond Portfolios, 1.60% of average daily net assets
of Global Bond Portfolio, .85% of average daily net assets of Macro-Cap Value
Portfolio, and 1.25% of average daily net assets of Micro-Cap Growth
Portfolio. In addition, Minnesota Life had voluntarily agreed to absorb
expenses, excluding investment advisory fees, that exceed 1.00% for
International Stock Portfolio. Effective May 1, 2000, Advantus Capital has
voluntarily agreed to absorb all fees and expenses that exceed, for each
Portfolio, the percentage of average daily net assets set forth above. For
each of the last three calendar years, the expenses voluntarily absorbed by
Minnesota Life for the various Portfolios were as follows:
Expenses Voluntarily Absorbed
Portfolio 1999 1998 1997
Growth Portfolio -0- $ -0- $ -0-
Bond Portfolio -0- -0- -0-
Money Market Portfolio -0- -0- -0-
Asset Allocation Portfolio -0- -0- -0-
Mortgage Securities Portfolio -0- -0- -0-
Index 500 Portfolio -0- -0- -0-
Capital Appreciation Portfolio -0- -0- -0-
International Stock Portfolio -0- -0- -0-
Small Company Growth Portfolio -0- -0- -0-
Maturing Government Bond -
2002 Portfolio 53,336 37,949 36,833
2006 Portfolio 56,178 37,165 37,425
2010 Portfolio 55,419 39,052 38,967
Value Stock Portfolio -0- -0- -0-
Small Company Value Portfolio 67,886 58,848 11,517
International Bond Portfolio -0- -0- -0-
Index 400 Mid-Cap Portfolio 70,044 52,946 14,670
Macro-Cap Value Portfolio 102,703 114,468 22,940
Micro-Cap Growth Portfolio 50,020 46,960 11,102
Real Estate Securities Portfolio 63,511 31,736 N/A
There is no specified or minimum period of time during which Advantus
Capital has agreed to continue its voluntary absorption of these expenses,
and Advantus Capital may in its discretion cease its absorption of expenses
at any time. Should Advantus Capital cease absorbing expenses the effect
would be to increase substantially Fund expenses and thereby reduce
investment return.
Each Portfolio will bear all expenses that may be incurred with respect
to its individual operation, including but not limited to transaction
expenses, advisory fees, brokerage, interest, taxes and the charges of the
custodian. The Fund will pay all other expenses not attributable to a
specific Portfolio, but those expenses will be allocated among the Portfolios
on the basis of the size of their respective net assets unless otherwise
allocated by the Board of Directors of the Fund.
Sub-Adviser - CSAM
Credit Suisse Asset Management, LLC ("CSAM") has been retained under an
investment sub-advisory agreement to provide investment advice and, in
general, to conduct the management and investment program of the Capital
Appreciation Portfolio, subject to the general control of the Board of
Directors of the Fund. CSAM is a registered investment adviser under the
Investment Advisers Act of 1940.
CSAM, located at 153 East 53rd Street, New York, New York 10022, serves
as an investment sub-adviser to the Portfolio pursuant to a written
agreement. CSAM is an indirect wholly-owned U.S. subsidiary of Credit Suisse
Group ("Credit Suisse"). Credit Suisse is a global financial services
company, providing a comprehensive range of banking and insurance products.
Active on every continent and in all major financial centers, Credit Suisse
comprises five business units - Credit Suisse Asset Management (asset
management); Credit Suisse First Boston (investment banking); Credit Suisse
Private Banking (private banking); Credit Suisse (retail banking); and
Winterthur (insurance). Credit Suisse has approximately 62,000 people
worldwide. The principal business address of Credit Suisse is Paradeplatz 8,
CH 8070, Zurich, Switzerland. CSAM, together with its predecessor firms, has
been engaged in the investment advisory business for over 60 years.
Investment Sub-Advisory Agreement - CSAM
CSAM acts as investment sub-adviser to the Fund's Capital Appreciation
Portfolio under an Investment Sub-Advisory Agreement (the "CSAM Capital
Appreciation Agreement") with Advantus Capital dated May 1, 2000, which
became effective the same date. Prior to May 1, 2000, the Capital
Appreciation Portfolio was managed by Winslow Capital Management, Inc. of
Minneapolis, Minnesota. The CSAM Agreement will terminate automatically upon
the termination of the Investment Advisory Agreement and in the event of its
assignment. In addition, the CSAM Agreement is terminable at any time,
without penalty, by the Board of Directors of the Fund, by Advantus Capital
on 60 days' written notice to CSAM, and by CSAM on 60 days' written notice to
Advantus Capital. Unless sooner terminated, the CSAM Agreement shall
continue in effect from year to year if approved at least annually either by
the Board of Directors of the Fund, provided that in either event such
continuance is also approved by the vote of a majority of the Directors who
are not interested persons of any party to the CSAM Agreement, cast in person
at a meeting called for the purpose of voting on such approval.
In payment for the investment sub-advisory services to be rendered by
CSAM for the Capital Appreciation the Portfolio, the Adviser pays to CSAM, a
fee computed at an annual rate which shall be a percentage of the average
daily value of the net assets of the Portfolio. The fee is accrued daily and
shall be based on the net asset value of all of the issued and outstanding
shares of the Portfolio as determined as of the close of each business day
pursuant to the Articles of Incorporation, Bylaws and currently effective
Prospectus and Statement of Additional Information of the Fund. The fee is
payable in arrears on the last day of each calendar month.
The amount of such annual fee, as applied to the average daily value of
the net assets of the Portfolio shall be applied as follows: total assets
between $0 and $500 million, 0.50%; total assets between $500 million and $1
billion, 0.45%; total assets between $1 billion and $2 billion, 0.35%; total
assets exceeding $2 billion, 0.30%. For the purpose of applying the
breakpoints in the fee calculation, the term "assets" shall include all
assets advised or sub-advised by the Sub-Adviser for the Adviser in addition
to those assets of the Portfolio. The assets shall be calculated quarterly
based upon the aggregate assets on March 31st, June 30th, September 30th and
December 31st of each calendar year (or portion thereof) that the CSAM
Capital Appreciation Agreement is effective, with the fee rate determined on
each such date being applicable to the following period and applied to all
assets back to the first dollar in the Portfolio.
Sub-Adviser - Templeton Counsel
Templeton Investment Counsel, Inc. (hereinafter "Templeton Counsel"), a
Florida corporation with principal offices at 500 East Broward Boulevard, Ft.
Lauderdale, Florida 33394, has been retained under an investment sub-advisory
agreement to provide investment advice and, in general, to conduct the
management investment program of International Stock Portfolio, subject to
the general control of the Board of Directors of the Fund. Templeton Counsel
is an indirect, wholly-owned subsidiary of Templeton Worldwide, Inc., Ft.
Lauderdale, Florida, which in turn is a wholly-owned subsidiary of Franklin
Resources, Inc. ("Franklin").
Franklin is a large, diversified financial services organization.
Through its operating subsidiaries, Franklin provides a variety of investment
products and services to institutions and individuals throughout the United
States and abroad. One of the country's largest mutual fund organizations,
Franklin's business includes the provision of management, administrative and
distribution services to the Franklin Templeton Group of Funds, which is
distributed through a nationwide network of banks, broker-dealers, financial
planners and investment advisers. Franklin is headquartered in San Mateo,
California, and its common stock is listed on the New York Stock Exchange
under the ticker symbol BEN.
Investment Sub-Advisory Agreement - Templeton Counsel
Templeton Counsel acts as an investment sub-adviser to the Fund's
International Stock Portfolio under an Investment Sub-Advisory Agreement (the
"Templeton Agreement") with Advantus Capital dated May 1, 1997, which became
effective the same date, and was approved by shareholders of International
Stock Portfolio on April 24, 1997. The Templeton Agreement, as amended, was
last approved for continuance by the Board of Directors of the Fund,
including a majority of the Directors who are not a party to the Templeton
Agreement or interested persons of any such party, on February 10, 2000. The
Templeton Agreement will terminate automatically upon the termination of the
Investment Advisory Agreement and in the event of its assignment. In
addition, the Templeton Agreement is terminable at any time, without penalty,
by the Board of Directors of the Fund, by Advantus Capital or by a vote of
the majority of the International Stock Portfolio's outstanding voting
securities on 60 days' written notice to Templeton Counsel and by Templeton
Counsel on 60 days' written notice to Advantus Capital. Unless sooner
terminated, the Templeton Agreement shall continue in effect from year to
year if approved at least annually by the Board of Directors of the Fund or
by a vote of a majority of the outstanding voting securities of International
Stock Portfolio, provided that in either event such continuance is also
approved by the vote of a majority of the directors who are not interested
persons of any party to the Templeton Agreement, cast in person at a meeting
called for the purpose of voting on such approval.
From the advisory fee received from International Stock Portfolio,
Advantus Capital pays Templeton Counsel a sub-advisory fee equal to .70% on
the first $10 million of International Stock Portfolio's average daily net
assets, .65% on the next $15 million, .55% on the next $25 million, .50% on
the next $50 million, and .40% on the next $100 million and thereafter. For
the purpose of establishing the appropriate breakpoints at which the
Portfolio's sub-advisory fee shall be calculated, the Portfolio will benefit
from the aggregation of the monthly market value of any non-mutual fund
account of Minnesota Life or any affiliate thereof, advised or sub-advised by
Templeton Counsel or any advisory affiliate by Advantus and sub-advised by
Templeton Counsel or any advisory affiliate. For fee-stacking purposes, the
asset classes so managed with the highest fee schedules shall be counted
first as assets of this Portfolio in order to determine this Portfolio's
appropriate starting breakpoint when Franklin Advisors, Inc., and affiliate
of Templeton Counsel, provides other sub-advisory services to Advantus
Capital, covering small company domestic equities in an amount in excess of
$100 million and Minnesota Life, offers as investment options in its
registered variable insurance contracts the Templeton Developing Markets
Securities Fund and any other two funds in the Franklin Templeton Variable
Insurance Products Trust.
Sub-Adviser - JBIM
Julius Baer Investment Management Inc. ("JBIM"), with principal offices
at 330 Madison Avenue, New York, New York 10017, has been retained under an
investment sub-advisory agreement to provide investment advice and, in
general, to conduct the management investment program for the Global Bond
Portfolio's foreign securities and to determine the Portfolio's total
allocation of domestic and foreign securities, subject to the general control
of the Board of Directors of the Fund. JBIM is a majority owned subsidiary
of Julius Baer Securities, Inc., a registered broker-dealer and investment
adviser, which in turn is a wholly-owned subsidiary of Baer Holding Ltd.
Julius Baer Securities, Inc. owns 93% of the outstanding stock of JBIM and 7%
is owned by three employees of JBIM. JBIM has been registered as an
investment adviser since April 1983. Directly and through Julius Baer
Securities, Inc., JBIM provides investment management services to a wide
variety of individual and institutional clients, including registered
investment companies.
Investment Sub-Advisory Agreement - JBIM
JBIM acts as investment sub-adviser to the Fund's Global Bond Portfolio
under an Investment Sub-Advisory Agreement (the "JBIM Agreement") with
Advantus Capital dated May 1, 1998. The JBIM Agreement was last approved by
the Board of Directors of the Fund, including a majority of the Directors who
are not a party to the JBIM Agreement or interested persons of any such
party, on February 10, 2000.
The JBIM Agreement will terminate automatically upon the termination of
the Investment Advisory Agreement and in the event of its assignment. In
addition, the JBIM Agreement is terminable at any time, without penalty, by
the Board of Directors of the Fund, by Advantus Capital or by vote of a
majority of the Global Bond Portfolio's outstanding voting securities on 60
days' written notice to JBIM and by JBIM on 60 days' written notice to
Advantus Capital. Unless sooner terminated, the JBIM Agreement shall
continue in effect from year to year if approved at least annually either by
the Board of Directors of the Fund or by a vote of a majority of the
outstanding voting securities of the Global Bond Portfolio, provided that in
either event such continuance is also approved by the vote of a majority of
the Directors who are not interested persons of any party to the JBIM
Agreement, cast in person at a meeting called for the purpose of voting on
such approval.
From the advisory fee received from Global Bond Portfolio, Advantus
Capital pays JBIM a sub-advisory fee equal to .30% of Global Bond Portfolio's
average daily net assets.
Sub-Adviser - Morgan Investment
J.P. Morgan Investment Management Inc. ("Morgan Investment"), with
principal offices at 522 Fifth Avenue, New York, New York 10036, has been
retained under an investment sub-advisory agreement to provide investment
advice and, in general, to conduct the management investment program of the
Macro-Cap Value Portfolio, subject to the general control of the Board of
Directors of the Fund. Morgan Investment is a wholly-owned subsidiary of
J.P. Morgan & Co. Incorporated ("J.P. Morgan"), a bank holding company
organized under the laws of Delaware. Through offices in New York City and
abroad, J.P. Morgan, through Morgan Investment and other subsidiaries, offers
a wide range of services to governmental, institutional, corporate and
individual customers and acts as investment adviser to individual and
institutional clients.
Investment Sub-Advisory Agreement - Morgan Investment
Morgan Investment acts as investment sub-adviser to the Fund's Macro-
Cap Value Portfolio under an Investment Sub-Advisory Agreement (the "Morgan
Management Agreement") with Advantus Capital dated May 1, 1997, and became
effective after it was approved by shareholders on October 15, 1997. The
Morgan Management Agreement was last approved by Board of Directors of the
Fund, including a majority of the Directors who are not a party to the Morgan
Management Agreement or interested persons of any such party, on February 10,
2000.
The Morgan Management Agreement will terminate automatically upon the
termination of the Investment Advisory Agreement and in the event of its
assignment. In addition, the Morgan Management Agreement is terminable at
any time, without penalty, by the Board of Directors of the Fund, by Advantus
Capital or by vote of a majority of the Macro-Cap Value Portfolio's
outstanding voting securities on 60 days' written notice to Morgan Management
and by Morgan Management on 60 days' written notice to Advantus Capital.
Unless sooner terminated, the Morgan Management Agreement shall continue in
effect from year to year if approved at least annually either by the Board of
Directors of the Fund or by a vote of a majority of the outstanding voting
securities of the Macro-Cap Value Portfolio, provided that in either such
continuance is also approved by the vote of a majority of the Directors who
are not interested persons of any party to the Morgan Management Agreement,
cast in person at a meeting called for the purpose of voting on such
approval.
In payment for the investment sub-advisory services to be rendered by
Morgan Management to the Macro-Cap Portfolio, the Adviser pays to Morgan
Management a fee computed at an annual rate which shall be a percentage of
the average daily net assets of the Portfolio. The fee is accrued daily and
based on the net asset value of all of the issued and outstanding shares of
the Portfolio as determined as of the close of each business day pursuant to
the Articles of Incorporation, Bylaws and currently effective Prospectus and
Statement of Additional Information of the Fund. The fee is payable in
arrears on the last day of each calendar month. From the advisory fee
received from Macro-Cap Value Portfolio, Advantus Capital pays Morgan
Management a sub-advisory fee equal to .45% of Macro-Cap Value Portfolio's
average daily net assets.
Sub-Adviser - WSA
Wall Street Associates ("WSA"), a California corporation with principal
offices at La Jolla Financial Building, Suite 100, 1200 Prospect Street, La
Jolla, California 92037, has been retained under an investment sub-advisory
agreement to provide investment advice and, in general, to conduct the
management investment program of the Micro-Cap Growth Portfolio, subject to
the general control of the Board of Directors of the Fund. WSA, founded in
1987, provides investment advisory services for institutional clients and
high net worth individuals.
Investment Sub-Advisory Agreement - WSA
WSA acts as investment sub-adviser to the Fund's Micro-Cap Growth
Portfolio under an Investment Sub-Advisory Agreement (the "WSA Agreement")
with Advantus Capital dated May 1, 1997 and became effective after it was
approved by shareholders on September 15, 1997. The WSA Agreement was last
approved by the Board of Directors of the Fund, including a majority of the
Directors who are not a party to the WSA Agreement or interested persons of
any such party, on February 10, 2000.
The WSA Agreement will terminate automatically upon the termination of
the Investment Advisory Agreement and in the event of its assignment. In
addition, the WSA Agreement is terminable at any time, without penalty, by
the Board of Directors of the Fund, by Advantus Capital or by vote of a
majority of the Micro-Cap Growth Portfolio's outstanding voting securities on
60 days' written notice to WSA and by WSA on 60 days' written notice to
Advantus Capital. Unless sooner terminated, the WSA Agreement shall continue
in effect from year to year if approved at least annually either by the Board
of Directors of the Fund or by a vote of a majority of the outstanding voting
securities of the Micro-Cap Growth Portfolio, provided that in either event
such continuance is also approved by the vote of a majority of the Directors
who are not interested persons of any party to the WSA Agreement, cast in
person at a meeting called for the purpose of voting on such approval.
In payment for the investment sub-advisory services to be rendered by
WSA to the Micro-Cap Growth Portfolio, the Adviser pays to WSA, a fee
computed at an annual rate which is a percentage of the average daily net
assets of the Portfolio. The fee is accrued daily and based on the net asset
value of all of the issued and outstanding shares of the Portfolio as
determined as of the close of each business day pursuant to the Articles of
Incorporation, Bylaws and currently effective Prospectus and Statement of
Additional Information of the Fund. The fee is payable in arrears on the
last day of each calendar month. From the advisory fee received from Micro-
Cap Growth Portfolio, Advantus Capital pays WSA a sub-advisory fee equal to
.85% of Micro-Cap Growth Portfolio's average daily net assets.
Sub-Adviser - CSAM
Credit Suisse Asset Management, LLC ("CSAM") has been retained under an
investment sub-advisory agreement to provide investment advice and, in
general, to conduct the management and investment program of the Small
Company Growth Portfolio, subject to the general control of the Board of
Directors of the Fund. CSAM is a registered investment adviser under the
Investment Advisers Act of 1940.
CSAM, located at 153 East 53rd Street, New York, New York 10022, serves
as an investment sub-adviser to the Portfolio pursuant to a written
agreement. CSAM is an indirect wholly-owned U.S. subsidiary of Credit Suisse
Group ("Credit Suisse"). Credit Suisse is a global financial services
company, providing a comprehensive range of banking and insurance products.
Active on every continent and in all major financial centers, Credit Suisse
comprises five business units - Credit Suisse Asset Management (asset
management); Credit Suisse First Boston (investment banking); Credit Suisse
Private Banking (private banking); Credit Suisse (retail banking); and
Winterthur (insurance). Credit Suisse has approximately 62,000 people
worldwide. The principal business address of Credit Suisse is Paradeplatz 8,
CH 8070, Zurich, Switzerland. CSAM, together with its predecessor firms, has
been engaged in the investment advisory business for over 60 years.
Investment Sub-Advisory Agreement - CSAM
CSAM acts as investment sub-adviser to the Fund's Small Company Growth
Portfolio under an Investment Sub-Advisory Agreement (the "CSAM Small Company
Growth Agreement") with Advantus Capital dated March 7, 2000, which became
effective the same date. The CSAM Small Company Growth Agreement represents
a new agreement with this firm for the management of the Small Company Growth
Portfolio. Prior to that date, the Portfolio had been managed by the
Portfolio's advisor, Advantus Capital. The CSAM Small Company Growth
Agreement will terminate automatically upon the termination of the Investment
Advisory Agreement and in the event of its assignment. In addition, the CSAM
Small Company Growth Agreement is terminable at any time, without penalty, by
the Board of Directors of the Fund, by Advantus Capital or, and by CSAM on 60
days' written notice to Advantus Capital. Unless sooner terminated, the CSAM
Small Company Growth Agreement shall continue in effect from year to year if
approved at least annually either by the Board of Directors of the Fund,
provided that in either event such continuance is also approved by the vote
of a majority of the Directors who are not interested persons of any party to
the CSAM Agreement, cast in person at a meeting called for the purpose of
voting on such approval.
In payment for the investment sub-advisory services to be rendered by
CSAM to the Small Company Growth Portfolio, the Adviser pays to CSAM, a fee
computed at an annual rate which is a percentage of the average daily net
assets of the Portfolio. The fee is accrued daily and based on the net asset
value of all of the issued and outstanding shares of the Portfolio as
determined as of the close of each business day pursuant to the Articles of
Incorporation, Bylaws and currently effective Prospectus and Statement of
Additional Information of the Fund. The fee is payable in arrears on the
last day of each calendar month.
The amount of such annual fee, as applied to the average daily value of
the net assets of the Portfolio shall be applied as follows: total assets
between $0 and $500 million, 0.65%; total assets between $500 million and $1
billion, 0.60%; total assets between $1 billion and $2 billion, 0.50%; On all
assets in excess of $2 billion, 0.45%. For the purpose of the fee
calculation, the term "assets" for purposes of the schedule shall include all
assets advised or sub-advised by the Sub-Adviser for the Adviser in addition
to those assets of the Portfolio. The aggregation of assets for purposes of
the breakpoints shall be calculated quarterly based upon the aggregate assets
on March 31st, June 30th, September 30th and December 31st of each calendar
year (or portion thereof) that this Agreement is effective, with the fee rate
determined on each such date being applicable to the following period and
applied to all assets back to the first dollar in the Portfolio.
Sub-Adviser - State Street Research
State Street Research & Management Company ("State Street Research")
has been retained under an investment sub-advisory agreement to provide
investment advice and, in general, to conduct the management and investment
program of the Small Company Value Portfolio, subject to the general control
of the Board of Directors of the Fund. State Street is a registered
investment adviser under the Investment Advisers Act of 1940.
State Street Research, a Delaware corporation, with offices at One
Financial Center, Boston, Massachusetts 02111-2690, acts as the investment
sub-adviser to the Portfolio. State Street Research was founded by Paul
Cabot, Richard Saltonstall and Richard Paine to serve as investment adviser
to one of the nation's first mutual funds, presently known as State Street
Research Investment Trust, which they had formed in 1924. Their investment
management philosophy emphasized comprehensive fundamental reach and
analysis, including meetings with the management of companies under
consideration for investment. State Street Research's portfolio management
group has extensive investment industry experience managing equity and debt
securities. State Street Research is an indirect wholly-owned subsidiary of
Metropolitan Life Insurance Company.
Investment Sub-Advisory Agreement - State Street Research
State Street Research acts as investment sub-adviser to the Fund's
Small Company Value Portfolio under an Investment Sub-Advisory Agreement (the
"State Street Research Small Company Value Agreement") with Advantus Capital
dated March 7, 2000, which became effective the same date. The State Street
Research Small Company Value Agreement represents a new agreement with this
firm for the management of the Small Company Value Portfolio. Prior to March
1, 2000, the Small Company Value Portfolio was managed by Portfolio's
advisor, Advantus Capital. The State Street Research Small Company Value
Agreement will terminate automatically upon the termination of the Investment
Advisory Agreement and in the event of its assignment. In addition, the
State Street Research Small Company Value Agreement is terminable at any
time, without penalty, by the Board of Directors of the Fund, by Advantus
Capital on 60 days' written notice to State Street Research, and by State
Street Research on 60 days' written notice to Advantus Capital. Unless
sooner terminated, the State Street Research Agreement shall continue in
effect from year to year if approved at least annually either by the Board of
Directors of the Fund, provided that in either event such continuance is also
approved by the vote of a majority of the Directors who are not interested
persons of any party to the State Street Research Agreement, cast in person
at a meeting called for the purpose of voting on such approval.
In payment for the investment sub-advisory services to be rendered by
State Street Research to the Small Company Value Portfolio, the Adviser pays
to State Street Research, a fee computed at an annual rate which is a
percentage of the average daily net assets of the Portfolio. The fee is
accrued daily and shall be based on the net asset value of all of the issued
and outstanding shares of the Portfolio as determined as of the close of each
business day pursuant to the Articles of Incorporation, Bylaws and currently
effective Prospectus and Statement of Additional Information of the Fund.
The fee is payable in arrears on the last day of each calendar month.
The amount of such annual fee, as applied to the average daily net
assets of the Portfolio is: on the first $500 million, 0.65%; on the next
$500 million, 0.60%; on all assets in excess of $1 billion, 0.50%. For the
purpose of the fee calculation and the indicated breakpoints, the term
"assets" shall include all 'small company value' assets sub-advised by State
Street Research for Advantus Capital, in addition to the assets of the
Portfolio. The aggregation of those assets for purposes of the breakpoints,
shall be calculated quarterly based upon the aggregate assets on March 31st,
June 30th, September 30th, and December 31st of each calendar year (or
portion thereof) that the State Street Small Company Value Agreement is
effective.
Administrative Services
The Fund has entered into an agreement with Minnesota Life under which
Minnesota Life provides accounting, legal and other administrative services
to the Fund. Minnesota Life currently provides such services at a monthly
cost of $3,900 per Portfolio, except for International Stock Portfolio,
Global Bond Portfolio and Macro-Cap Value Portfolio which pay $2,800 per
Portfolio. During each of the last three calendar years the amounts paid by
each Portfolio to Minnesota Life for these services were as follows:
Portfolio 1999 1998 1997
Growth Portfolio $45,400 $30,000 $29,600
Bond Portfolio 45,400 30,000 29,600
Money Market Portfolio 45,400 30,000 29,600
Asset Allocation Portfolio 45,400 30,000 29,600
Mortgage Securities Portfolio 45,400 30,000 29,600
Index 500 Portfolio 45,400 30,000 29,600
Capital Appreciation Portfolio 45,400 30,000 29,600
International Stock Portfolio 33,300 30,000 29,600
Small Company Growth Portfolio 45,400 30,000 29,600
Maturing Government Bond -
2002 Portfolio 45,400 30,000 29,600
2006 Portfolio 45,400 30,000 29,600
2010 Portfolio 45,400 30,000 29,600
Value Stock Portfolio 45,400 30,000 29,600
Small Company Value Portfolio 45,400 30,000 8,750
International Bond Portfolio 33,300 30,000 8,750
Index 400 Mid-Cap Portfolio 45,400 30,000 8,750
Macro-Cap Value Portfolio 33,300 30,000 7,750
Micro-Cap Growth Portfolio 45,400 30,000 8,750
Real Estate Securities Portfolio 45,400 20,000 N/A
The Fund has also entered into a separate agreement with SEI
Investments Mutual Fund Services (SEI) pursuant to which SEI provides daily
accounting services for International Stock Portfolio, Global Bond Portfolio
and Macro-Cap Value Portfolio. Minnesota Life, pursuant to its
administrative services agreement with the Fund, provides these three
Portfolios with financial reporting services and generally oversees SEI's
performance of it services. Under the agreement with SEI, the cost to each
Portfolio for SEI's services is an annual fee equal to the greater of $45,000
or .08% of the Portfolio's first $150 million of net assets and .05% of its
net assets in excess of $150 million. During the last three calendar years,
the amounts paid by each Portfolio to SEI for these services were as follows:
Portfolio 1999 1998 1997
International Stock Portfolio $195,103 $176,673 $149,792
Global Bond Portfolio 44,649 66,208 14,000
Macro-Cap Value 46,021 61,031 11,250
Code of Ethics
Advantus Capital, Ascend Financial and the Fund, together with each of
the Fund's sub-advisers, has each adopted a Code of Ethics in accordance with
the Investment Company Act of 1940 and the rules and regulations thereunder.
The private investment activities of personnel covered by the Code of Ethics
are restricted in accordance with the Code's provisions, but, subject to such
provisions, personnel may invest in securities including securities that may
be purchased or held by the Fund.
Distribution Agreement
Ascend Financial Services, Inc. ("Ascend Financial") acts as the
underwriter of the Funds' shares, pursuant to a written agreement. The Board
of Directors of the Fund, including a majority of the directors who are not
parties to the contract, or interested persons of any such party, approved
the Fund's Underwriting and Distribution Agreement dated May 1, 2000 with
Ascend Financial (the "Distribution Agreement") on February 10, 2000. Under
the Distribution Agreement, Ascend Financial does not receive any
compensation for its services as principal underwriter for the Fund, except
for certain fees paid pursuant to the Fund's Rule 12b-1 Plan of Distribution.
See "Payment of Certain Distribution Expenses of the Fund," below.
The Distribution Agreement may be terminated by the Fund or Ascend
Financial at any time by the giving of 60 days' written notice, and
terminates automatically in the event of its assignment. Unless sooner
terminated, the Distribution Agreement shall continue in effect for more than
two years after its execution only so long as such continuance is
specifically approved at least annually by either the Board of Directors of
the Fund or by a vote of a majority of the outstanding voting securities,
provided that in either event such continuance is also approved by the vote
of a majority of the directors who are not parties to the Distribution
Agreement, or interested persons of such parties, cast in person at a meeting
called for the purpose of voting on such approval.
In the Distribution Agreement Ascend Financial undertakes to indemnify
the Fund against all costs of litigation and other legal proceedings, and
against any liability incurred by or imposed upon the Fund in any way arising
out of or in connection with the sale or distribution of the Fund's shares,
except to the extent that such liability is the result of information which
was obtainable by Ascend Financial only from persons affiliated with the Fund
but not with Ascend Financial.
Payment of Certain Distribution Expenses of the Fund
The Fund has adopted a Plan of Distribution (the "Plan") relating to
the payment of certain distribution and/or shareholder servicing expenses
pursuant to Rule 12b-1 under the Investment Company Act of 1940. Under the
Plan, each Portfolio of the Fund, with the exception of the Maturing
Government Bond Portfolio 2002, the Maturing Government Bond Portfolio 2006
and the Maturing Government Bond Portfolio 2010 (each of which is not part of
the Plan), pays a fee to Ascend Financial, or to life insurance companies
("Insurance Companies") whose variable insurance contracts ("Variable
Contracts") offer shares of the Fund, which, on an annual basis, is equal to
.25% of each Portfolio's average daily net assets, and is to be used to pay
certain expenses incurred in connection with servicing shareholder accounts
and to promote the distribution of the Fund's shares.
The distribution fees may be used by Ascend Financial for the purpose
of financing any activity, which is primarily intended to result in the sale
of shares of the Fund or Variable Contracts offering such shares.
Distribution-related payments made under the Plan may be used for, among
other things, the printing of prospectuses and reports used for sales
purposes, preparing and distributing sales literature and related expenses,
advertisements, education of Variable Contract owners or dealers and their
representatives, trail commissions, and other distribution-related expenses,
including a prorated portion of the overhead expenses of the Distributor or
the Insurance Companies which are attributable to the distribution of the
Variable Contracts. Payments under the Plan may also be used to pay
Insurance Companies, dealers or others for non-distribution services,
including, among other things, responding to inquiries from owners of
Variable Contracts regarding the Fund, printing and mailing Fund prospectuses
and other shareholder communications to existing Variable Contract owners,
direct communications with Variable Contract owners regarding Fund operations
and Portfolio composition and performance, furnishing personal services or
such other enhanced services as the Fund or a Variable Contract owner may
require, or maintaining customer accounts and records.
In addition, the Plan contains, among other things, provisions
complying with the requirements of Rule 12b-1 discussed below. In
particular, the Plan provides that (1) the Plan will not take effect until it
has been approved by a vote of a majority of the outstanding voting
securities of the Portfolios of the Fund covered by the Plan, except for the
voting securities attributable to the Maturing Government Bond Portfolio
2002, the Maturing Government Bond Portfolio 2006 and the Maturing Government
Bond Portfolio 2010 (each of which is not part of the Plan), and by a
majority vote of both the full Board of Directors of the Fund and those
directors who are not interested persons of the Fund and who have no direct
or indirect financial interest in the operation of the Plan or in any
agreements relating to it (the Independent Directors), (2) the Plan will
continue in effect from one year to another so long as its continuance is
specifically approved annually by a majority vote of both the full Board of
Directors and the Independent Directors, (3) the Plan may be terminated at
any time, without penalty, by vote of a majority of the Independent Directors
or by a vote of a majority of the outstanding voting securities of the Fund,
(4) the Plan may not be amended to increase materially the amount of the fees
payable thereunder unless the amendment is approved by a vote of a majority
of the outstanding voting securities of the Fund, and all material amendments
must be approved by a majority vote of both the full Board of Directors and
the Independent Directors, (5) while the Plan is in effect, the selection and
nomination of any new Independent Directors is committed to the discretion of
the Independent Directors then in office, and (6) the Fund's underwriter, the
Insurance Companies or others will prepare and furnish to the Board of
Directors, and the Board of Directors will review, at least quarterly,
written reports which set forth the amounts expended under the Plan and the
purposes for which those expenditures were made.
Rule 12b-1(b) provides that any payments made by an investment company
in connection with the distribution of its shares may only be made pursuant
to a written plan describing all material aspects of the proposed financing
of distribution and also requires that all agreements with any person
relating to implementation of the plan must be in writing. In addition, Rule
12b-1(b)(2) requires that such plan, together with any related agreements, be
approved by a vote of the Board of Directors and of the directors who are not
interested persons of the investment company and have no direct or indirect
financial interest in the operation of the plan or in any agreements related
to the plan, cast in person at a meeting called for the purpose of voting on
such plan or agreements. Rule 12b-1(b)(3) requires that the plan or
agreement provide, in substance: (1) that it shall continue in effect for a
period of more than one year from the date of its execution or adoption only
so long as such continuance is specifically approved at least annually in the
manner described in paragraph (b)(2) of Rule 12b-1; (2) that any person
authorized to direct the disposition of monies paid or payable by the
investment company pursuant to the plan or any related agreement shall
provide to the investment company's Board of Directors, and the directors
shall review, at least quarterly, a written report of the amounts so expended
and the purposes for which such expenditures were made; and (3) in the case
of a plan, that it may be terminated at any time by vote of a majority of the
members of the Board of Directors of the investment company who are not
interested persons of the investment company and have no direct or indirect
financial interest in the operation of the plan or in any agreements related
to the plan or by vote of a majority of the outstanding voting securities of
the investment company. Rule 12b-1(b)(4) requires that such plans may not be
amended to increase materially the amount to be spent for distribution
without shareholder approval and that all material amendments of the plan
must be approved in the manner described in paragraph (b)(2) of Rule 12b-1.
Rule 12b-1(c) provides that the investment company may rely upon Rule 12b-
1(b) only if selection and nomination of the investment company's
disinterested directors are committed to the discretion of such disinterested
directors. Rule 12b-1(e) provides that the investment company may implement
or continue a plan pursuant to Rule 12b-1(b) only if the directors who vote
to approve such implementation or continuation conclude, in the exercise of
reasonable business judgment and in light of their fiduciary duties under
state law, and under Sections 36(a) and (b) of the Investment Company Act of
1940, that there is a reasonable likelihood that the plan will benefit the
investment company and its shareholders. At the Board of Directors meeting
held February 10, 2000, the Board of Directors of the Fund so concluded.
The Plan of Distribution could be construed as "compensation plans"
because Ascend Financial is paid a fixed fee and is given discretion
concerning what expenses are payable under the Plan of Distribution. Under a
compensation plan, the fee to the distributor is not directly tied to
distribution expenses actually incurred by the distributor, thereby
permitting the distributor to receive a profit if amounts received exceed
expenses. Ascend Financial may spend more or less for the distribution and
promotion of the Fund's shares than it receives as distribution fees pursuant
to the Plan of Distribution for the Portfolios covered by the Plan. However,
to the extent fees received exceed expenses, including indirect expense such
as overhead, Ascend Financial could be said to have received a profit.
In accordance with the Plan of Distribution, Ascend Financial has
entered into a Fund Shareholder Services Agreement with Minnesota Life
Insurance Company (Minnesota Life), dated May 1, 2000. This Agreement
provides that Minnesota Life will provide to the Fund, on behalf of Ascend
Financial, distribution and non-distribution related services, of the type
described above. Ascend Financial agrees to pay Minnesota Life an amount
equal, on an annual basis, to 0.25% of the average combined daily net assets
of all the designated Portfolios of the Fund which are attributable to the
Variable Contracts and are a part of the Plan of Distribution. This
Agreement was approved by a vote of the Board of Directors, including a
majority of the Independent Directors, on February 10, 2000.
Custodians
The assets of each Portfolio of the Fund are held in custody by an
independent custodian pursuant to a custodian agreement approved by the
Fund's Board of Directors.
Norwest Bank Minnesota, N.A., Sixth Street and Marquette Avenue,
Minneapolis, Minnesota 55479, is the custodian for the Money Market, Growth,
Asset Allocation, Index 500, Capital Appreciation, Small Company Growth,
Value Stock, Small Company Value, Index 400 Mid-Cap, Macro-Cap Value, Micro-
Cap Growth and Real Estate Securities Portfolios.
Bankers Trust Company, 280 Park Avenue, New York, New York 10017, is
the custodian for the Bond, Mortgage, Maturing Government Bond, International
Stock and Global Bond Portfolios.
Independent Auditors
KPMG LLP, 90 South Seventh Street, Minneapolis, Minnesota 55402, acts
as the Fund's independent auditors, providing audit services including audits
of the Fund's annual financial statements and assistance and consultation in
connection with SEC filings.
General Counsel
The Fund's independent general counsel is Dorsey & Whitney LLP.
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE
Adviser
Advantus Capital selects and (where applicable) negotiates commissions
with the brokers who execute the transactions for all Portfolios of the Fund,
except for those Portfolios which have entered into sub-advisory agreements.
The primary criteria for the selection of a broker is the ability of the
broker, in the opinion of Advantus Capital, to secure prompt execution of the
transactions on favorable terms, including the reasonableness of the
commission and considering the state of the market at the time. In selecting
a broker, Advantus Capital considers the quality and expertise of that
brokerage and any research services (as defined in the Securities Exchange
Act of 1934), and generally the Fund pays higher than the lowest commission
rates available. Such research services include advice, both directly and in
writing, as to the value of securities, the advisability of investing in,
purchasing or selling securities, and the availability of securities or
purchasers or sellers of securities, as well as analyses and reports
concerning issues, industries, securities, economic factors and trends,
portfolio strategy, and the performance of accounts. By allocating brokerage
business in order to obtain research services for Advantus Capital, the Fund
enables Advantus Capital to supplement its own investment research activities
and allows Advantus Capital to obtain the views and information of
individuals and research staffs of many different securities research firms
prior to making investment decisions for the Fund. To the extent such
commissions are directed to these other brokers who furnish research services
to Advantus Capital, Advantus Capital receives a benefit, not capable of
evaluation in dollar amounts, without providing any direct monetary benefit
to the Fund from these commissions.
There is no formula for the allocation by Advantus Capital of the
Fund's brokerage business to any broker-dealers for brokerage and research
services. However, Advantus Capital will authorize the Fund to pay an amount
of commission for effecting a securities transaction in excess of the amount
of commission another broker would have charged only if Advantus Capital
determines in good faith that such amount of commission is reasonable in
relation to the value of the brokerage and research services provided by such
broker viewed in terms of either that particular transaction or Advantus
Capital's overall responsibilities with respect to the accounts as to which
it exercises investment discretion.
To the extent research services are used by Advantus Capital in
rendering investment advice to the Fund, such services would tend to reduce
Advantus Capital's expenses. However, Advantus Capital does not believe that
an exact dollar amount can be assigned to these services. Research services
received by Advantus Capital from brokers or dealers executing transactions
for the Fund will be available also for the benefit of other portfolios
managed by Advantus Capital, and conversely, research services received by
Advantus Capital in respect of transactions for such other portfolios will be
available for the benefit of the Fund.
During the fiscal years ended December 31, 1999, 1998 and 1997,
brokerage commissions paid were:
Brokerage Commissions Paid
Portfolio 1999 1998 1997
Growth Portfolio 642,621 $538,168 $707,244
Bond Portfolio -- -- --
Money Market Portfolio -- -- --
Asset Allocation Portfolio 836,927 650,690 412,404
Mortgage Securities Portfolio -- -- --
Index 500 Portfolio 186,851 150,419 92,649
Capital Appreciation Portfolio 500,124 356,002 342,165
International Stock Portfolio 298,978 256,337 163,231
Small Company Growth Portfolio 238,273 217,936 168,318
Maturing Government Bond -
2002 Portfolio -- -- --
2006 Portfolio -- -- --
2010 Portfolio -- -- --
Value Stock Portfolio 620,615 488,264 494,532
Small Company Value Portfolio 35,368 19,653 5,739
Global Bond Portfolio -- -- --
Index 400 Mid-Cap Portfolio 31,118 12,882 3,192
Macro-Cap Value Portfolio 25,056 20,044 5,661
Micro-Cap Growth Portfolio 6,993 6,288 7,115
Real Estate Securities Portfolio 31,384 24,017 --
Most transactions in money market instruments will be purchases from
issuers of or dealers in money market instruments acting as principal. There
usually will be no brokerage commissions paid by the Fund for such purchases
since securities will be purchased on a net price basis. Trading does,
however, involve transaction costs. Transactions with dealers serving as
primary market makers reflect the spread between the bid and asked prices of
securities. Purchases of underwritten issues may be made which will reflect
a fee paid to the underwriter.
The Fund will not execute portfolio transactions through any affiliate,
except as described below. Advantus Capital believes that most research
services obtained by it generally benefit one or more of the investment
companies which it manages and also benefits accounts which it manages.
Normally research services obtained through managed funds and managed
accounts investing in common stocks would primarily benefit such funds and
accounts; similarly, services obtained from transactions in fixed income
securities would be of greater benefit to the managed funds and managed
accounts investing in debt securities.
In addition to providing investment management services to the Fund,
Advantus Capital provides investment advisory services for three insurance
companies, namely Minnesota Life and its subsidiary life insurance companies
and certain associated separate accounts. It also provides investment
advisory services to qualified pension and profit sharing plans,
corporations, partnerships, investment companies and various private
accounts. Frequently, investments deemed advisable for the Fund are also
deemed advisable for one or more of such accounts, so that Advantus Capital
may decide to purchase or sell the same security at or about the same time
for both the Fund and one of those accounts. In such circumstances, orders
for a purchase or sale of the same security for one or more of those accounts
may be combined with an order for the Fund, in which event the transactions
will be averaged as to price and normally allocated as nearly as practicable
in proportion to the amounts desired to be purchased or sold for each
account. While in some instances combined orders could adversely affect the
price or volume of a security, it is believed that the Fund's participation
in such transactions on balance will produce better net results for the Fund.
The Fund's acquisition during the fiscal year ended December 31, 1999,
of securities of its regular brokers or dealers or of the parent of those
brokers or dealers that derive more than 15 percent of gross revenue from
securities-related activities is presented below:
Value of Securities Owned
in the Portfolios at
Name of Issuer End of Fiscal Year
Morgan Stanley Dean Witter $17,910,000
Prudential Home Mortgage 14,210,000
GE Capital Corporation 10,611,000
Bear Stearns Mortgage, Inc. 4,498,000
Merrill Lynch & Company, Inc. 2,814,000
Paine Webber 2,328,000
Charles Schwab Corp. 1,662,000
Lehman Structured Securities 1,398,000
Lehman Brothers, Inc. 538,000
The Goldman Sachs Group, Inc. 235,000
Investment Technology Group, Inc. 43,000
Sub-Advisers
Except as indicated below, each of the investment advisory firms having
a sub-advisory relationship with Advantus Capital, in managing the affected
Portfolios, intends to follow the same brokerage practices as those described
above for Advantus Capital. Templeton Counsel, in managing the International
Stock Portfolio, follows the same basic brokerage practices as those
described above for Advantus Capital. In addition, in selecting brokers for
portfolio transactions, Templeton Counsel takes into account its past
experience as to brokers qualified to achieve "best execution," including the
ability to effect transactions at all where a large block is involved,
availability of the broker to stand ready to execute possibly difficult
transactions in the future, the financial strength and stability of the
broker, and whether the broker specializes in foreign securities held by the
International Stock Portfolio. Purchases and sales of portfolio securities
within the United States other than on a securities exchange are executed
with primary market makers acting as principal, except where, in the judgment
of Templeton Counsel, better prices and execution may be obtained on a
commission basis or from other sources.
PURCHASE AND REDEMPTION OF SHARES
Shares of the Fund are currently offered continuously at prices equal
to the respective net asset values of the Portfolios only to Minnesota Life,
and to certain of its life insurance affiliates, in connection with its
variable life insurance policies and variable annuity contracts. Ascend
Financial serves as the Fund's underwriter. It is possible that at some
later date the Fund may offer its shares to other investors and it reserves
the right to do so.
Shares of the Fund are sold and redeemed at their net asset value next
computed after a purchase or redemption order is received by the Fund.
Depending upon the net asset values at that time, the amount paid upon
redemption may be more or less than the cost of the shares redeemed. Payment
for shares redeemed will generally be made within seven days after receipt of
a proper notice of redemption. The right to redeem shares or to receive
payment with respect to any redemption may only be suspended for any period
during which: (a) trading on the New York Stock Exchange is restricted as
determined by the Securities and Exchange Commission or such exchange is
closed for other than weekends and holidays; (b) an emergency exists, as
determined by the Securities and Exchange Commission, as a result of which
disposal of Portfolio securities or determination of the net asset value of a
Portfolio is not reasonably practicable; and (c) the Securities and Exchange
Commission by order permits postponement for the protection of shareholders.
FUND SHARES AND VOTING RIGHTS
The authorized capital of the Fund consists of one trillion shares of
capital stock with a par value of $.01 per share; with authorized shares of
100,000,000,000 allocated to each Portfolio. The remaining shares may be
allocated by the Board of Directors to any new or existing Portfolios.
All shares of all Portfolios have equal voting rights, except that only
shares of a particular Portfolio are entitled to vote certain matters
pertaining only to that Portfolio. Pursuant to the Investment Company Act of
1940 (as amended) and the rules and regulations thereunder, certain matters
approved by a vote of all Fund shareholders may not be binding on a Portfolio
whose shareholders have not approved such matter.
Each issued and outstanding share is entitled to one vote and to
participate equally in dividends and distributions declared by the respective
Portfolio and in net assets of such Portfolio upon liquidation or dissolution
remaining after satisfaction of outstanding liabilities. The shares of each
Portfolio, when issued, are fully paid and non-assessable, have no
preemptive, conversion, or similar rights, and are freely transferable. Fund
shares do not have cumulative voting rights, which means that the holders of
more than half of the Fund shares voting for election of directors can elect
all of the directors if they so choose. In such event, the holders of the
remaining shares would not be able to elect any directors.
The Fund will not hold periodically scheduled shareholder meetings.
Minnesota corporate law does not require an annual meeting. Instead, it
provides for the Board of Directors to convene shareholder meetings when it
deems appropriate. In addition, if a regular meeting of shareholders has not
been held during the immediately preceding fifteen months, a shareholder or
shareholders holding three percent or more of the voting shares of a Fund may
demand a regular meeting of shareholders of the Fund by written notice of
demand given to the chief executive officer or the chief financial officer of
the Fund. Within thirty days after receipt of the demand by one of those
officers, the Board of Directors shall cause a regular meeting of
shareholders to be called and held no later than ninety days after receipt of
the demand, all at the expense of the Fund. A special meeting may also be
called at any time by the chief executive officer, two or more directors, or
a shareholder or shareholders holding ten percent of the voting shares of the
Fund. At a meeting, called for the purpose, shareholders may remove any
director by a vote of two-thirds of the outstanding shares. Additionally,
the Investment Company Act of 1940 requires shareholder votes for all
amendments to fundamental investment policies and restrictions, and for all
investment advisory contracts and amendments thereto.
NET ASSET VALUE
The net asset value of the shares of the Portfolios is computed once
daily, and, in the case of Money Market Portfolio, after the declaration of
the daily dividend, as of the primary closing time for business on the New
York Stock Exchange (as of the date hereof the primary close of trading is
3:00 p.m. (Central Time), but this time may be changed) on each day, Monday
through Friday, except (i) days on which changes in the value of such Fund's
portfolio securities will not materially affect the current net asset value
of such Fund's shares, (ii) days during which no such Fund's shares are
tendered for redemption and no order to purchase or sell such Fund's shares
is received by such Fund and (iii) customary national business holidays on
which the New York Stock Exchange is closed for trading (as of the date
hereof, New Year's Day, Martin Luther King Jr. Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day). The net asset value per share of each Portfolio is computed
by adding the sum of the value of the securities held by that Portfolio plus
any cash or other assets that it holds, subtracting all of its liabilities,
and dividing the result by the total number of shares outstanding in that
Portfolio at that time. Expenses, including the investment advisory fee
payable to Advantus Capital, are accrued daily.
Securities held by the Fund are valued at their market value.
Otherwise, such securities are valued at fair value as determined in good
faith by the Board of Directors, with calculations made by persons acting
pursuant to the direction of the Board. However, debt securities of the
International Stock Portfolio with maturities of 60 days or less when
acquired, or which subsequently are within 60 days of maturity, and all
securities in the Money Market Portfolio, are valued at amortized cost.
All instruments held by the Money Market Portfolio are valued on an
amortized cost basis. This involves valuing an instrument at its cost and
thereafter assuming a constant amortization to maturity of any discount or
premium, regardless of the impact of fluctuating interest rates on the market
value of the instrument. While this method provides certainty in valuation,
it may result in periods during which the value of an instrument in the
Portfolio, as determined by amortized cost, is higher or lower than the price
the Portfolio would receive if it sold the instrument. During periods of
declining interest rates, the daily yield on shares of the Portfolio computed
by dividing the annualized daily income of the Portfolio by the net asset
value computed as described above may tend to be higher than a like
computation made by a portfolio with identical investments utilizing a method
of valuation based upon market prices and estimates of market prices for all
of its securities.
The Money Market Portfolio values its portfolio securities at amortized
cost in accordance with Rule 2a-7 under the Investment Company Act of 1940,
as amended. Pursuant to Rule 2a-7, the Board of Directors of the Fund has
determined, in good faith based upon a full consideration of all material
factors, that it is in the best interests of the Money Market Portfolio and
its shareholders to maintain a stable net asset value per share for such
Portfolio of a constant $ 1.00 per share by virtue of the amortized cost
method of valuation. The Money Market Portfolio will continue to use this
method only so long as the Board of Directors believes that it fairly
reflects the market-based net asset value per share. In accordance with Rule
2a-7, the Board of Directors has undertaken, as a particular responsibility
within the overall duty of care owed to the Portfolio's shareholders, to
establish procedures reasonably designed, taking into account current market
conditions and the Portfolio's investment objective, to stabilize the
Portfolio's net asset value per share at a single value.
These procedures include the periodic determination of any deviation of
current net asset value per-share calculated using available market
quotations from the Portfolio's amortized cost price per-share, the periodic
review by the Board of the amount of any such deviation and the method used
to calculate any such deviation, the maintenance of records of such
determinations and the Board's review thereof, the prompt consideration by
the Board if any such deviation exceeds of 1%, and the taking of such
remedial action by the Board as it deems appropriate where it believes the
extent of any such deviation may result in material dilution or other unfair
results to investors or existing shareholders. Such remedial action may
include reverse share splits, redemptions in kind, selling portfolio
instruments prior to maturity to realize capital gains or losses, shortening
the average portfolio maturity, withholding dividends or utilizing a net
asset value per share as determined by using available market quotations.
The Portfolio will, in further compliance with Rule 2a-7, maintain a
dollar-weighted average Portfolio maturity not exceeding 90 days and will
limit its Portfolio investments to those United States dollar-denominated
instruments which the Board determines present minimal credit risks and which
are eligible securities. The Portfolio will limit its investments in the
securities of any one issuer to no more than 5% of Portfolio assets and it
will limit investment in securities of less than the highest rated categories
to 5% of Portfolio assets. Investment in the securities of any issuer of
less than the highest rated categories will be limited to the greater of 1%
of Portfolio assets or one million dollars. In addition, the Fund will
reassess promptly any security which is in default or downgraded from its
rating category to determine whether that security then presents minimal
credit risks and whether continuing to hold the securities is in the best
interests of the Portfolio in the Fund. In addition, the Fund will record,
maintain, and preserve a written copy of the above-described procedures and a
written record of the Board's considerations and actions taken in connection
with the discharge of its above-described responsibilities.
PERFORMANCE DATA
Current Yield Figures for Money Market Portfolio
Current annualized yield quotations for the Money Market Portfolio are
based on the Portfolio's net investment income for a seven-day or other
specified period and exclude any realized or unrealized gains or losses on
portfolio securities. Current annualized yield is computed by determining
the net change (exclusive of realized gains and losses from the sale of
securities and unrealized appreciation and depreciation) in the value of a
hypothetical account having a balance of one share at the beginning of the
specified period, dividing such net change in account value by the value of
the account at the beginning of the period, and annualizing this quotient on
a 365-day basis. The net change in account value reflects the value of any
additional shares purchased with dividends from the original share in the
account during the specified period, any dividends declared on such original
share and any such additional shares during the period, and expenses accrued
during the period. The Fund may also quote the effective yield of the Money
Market Portfolio for a seven-day or other specified period for which the
current annualized yield is computed by expressing the unannualized return on
a compounded, annualized basis. Purchasers of variable contracts issued by
Minnesota Life should recognize that the yield on the assets relating to such
a contract which are invested in shares of the Money Market Portfolio would
be lower than the Money Market Portfolio's yield for the same period since
charges assessed against such assets are not reflected in the Portfolio's
yield. The current yield and effective yield of the Money Market Portfolio
for the seven-day period ended December 31, 1999 were 5.20% and 5.34%,
respectively.
Current Yield Figures for Other Portfolios
Yield quotations for Portfolios other than the Money Market Portfolio
are determined by dividing the Portfolio's net investment income per share
for a 30-day period, excluding realized or unrealized gains or losses, by the
net asset value per share on the last day of the period. In computing net
investment income dividends are accrued daily based on the stated dividend
rate of each dividend-paying security, and interest reflects an amortization
of discount or premium on debt obligations (other than installment debt
obligations) based upon the market value of each obligation on the last day
of the preceding 30-day period. Undeclared earned income (net investment
income which at the end of the base period has not been declared as a
dividend but is expected to be declared shortly thereafter) is subtracted
from the net asset value per share on the last day of the period. An
annualized yield figure is determined under a formula which assumes that the
net investment income is earned and reinvested at a constant rate and
annualized at the end of a six-month period. The yield figures published by
the Fund will reflect Minnesota Life's voluntary absorption of certain Fund
expenses (as previously discussed in "Investment Advisory and Other Services
- Investment Advisory Agreement" above). For the 30-day period ended
December 31, 1999, the yields of the Portfolios are shown in the table below.
The figures in parentheses show what the yield would have been had Minnesota
Life not absorbed Fund expenses as described above.
Portfolio Yield
Growth Portfolio -.12% (-.12%)
Bond Portfolio 6.34 (6.34)
Money Market Portfolio N/A N/A
Asset Allocation Portfolio 1.98 (1.98)
Mortgage Securities Portfolio 7.20 (7.20)
Index 500 Portfolio .74 (.74)
Capital Appreciation Portfolio -.69 (-.69)
International Stock Portfolio .18 (.18)
Small Company Growth Portfolio -.69 (-.69)
Maturing Government Bond -
2002 Portfolio 6.47 (6.10)
2006 Portfolio 6.70 (6.11)
2010 Portfolio 6.68 (5.92)
Value Stock Portfolio .82 (.82)
Small Company Value Portfolio .90 (.49)
Global Bond Portfolio 7.45 (7.45)
Index 400 Mid-Cap Portfolio .54 (.42)
Macro-Cap Value Portfolio .63 (.63)
Micro-Cap Growth Portfolio -.88 (.88)
Real Estate Securities Portfolio 4.79 (3.97)
Total Return Figures For All Portfolios
Cumulative total return quotations for the Portfolios represent the
total return for the period since shares of the Portfolio became available
for sale pursuant to the Fund's registration statement. Cumulative total
return is equal to the percentage change between the net asset value of a
hypothetical $ 1,000 investment at the beginning of the period and the net
asset value of that same investment at the end of the period with dividend
and capital gain distributions treated as reinvested.
The cumulative total return figures published by the Fund will reflect
Minnesota Life's voluntary absorption of certain Fund expenses (as previously
discussed in "Investment Advisory and Other Services - Investment Advisory
Agreement" above). The cumulative total returns for the Portfolios for the
specified periods ended December 31, 1999 are shown in the table below. The
figures in parentheses show what the cumulative total returns would have been
had Minnesota Life not absorbed Fund expenses as described above.
From Inception Date of
to 12/31/99 Inception
Growth Portfolio 660.51% (651.29%) 12/3/85
Bond Portfolio 181.38 (178.82) 12/3/85
Money Market Portfolio 106.72 (100.18) 12/3/85
Asset Allocation Portfolio 425.56 (424.24) 12/3/85
Mortgage Securities Portfolio 167.52 (166.58) 5/1/87
Index 500 Portfolio 561.42 (559.27) 5/1/87
Capital Appreciation Portfolio 568.89 (559.46) 5/1/87
International Stock Portfolio 165.70 (165.52) 5/1/92
Small Company Growth Portfolio 178.31 (178.31) 5/3/93
Maturing Government Bond -
2002 Portfolio 50.94 (44.38) 5/2/94
2006 Portfolio 58.25 (49.44) 5/2/94
2010 Portfolio 62.09 (49.20) 5/2/94
Value Stock Portfolio 125.20 (124.54) 5/2/94
Small Company Value Portfolio -7.54 (-8.70) 10/1/97
Global Bond Portfolio 7.19 (7.19) 10/1/97
Index 400 Mid-Cap Portfolio 35.39 (34.24) 10/1/97
Macro-Cap Value Portfolio 28.31 (25.84) 10/15/97
Micro-Cap Growth Portfolio 144.93 (143.74) 10/1/97
Real Estate Securities Portfolio -18.21 (-19.80) 5/1/98
Yield quotations for Portfolios other than the Money Market Portfolio and all
quotations of cumulative total return figures will be accompanied by average
annual total return figures for a one year period and for the period since
shares of the Portfolio became available pursuant to the Fund's registration
statement. Average annual total return figures are the average annual
compounded rates of return required for an account with an initial investment
of $1,000 to equal the redemption value of the account at the end of the
period. The average annual total return figures published by the Fund will
reflect Minnesota Life's voluntary absorption of certain Fund expenses (as
discussed in "Investment Advisory and Other Services - Investment Advisory
Agreement" above).
The average annual rates of return for the Portfolios for the specified
periods ended December 31, 1999 are shown in the table below. The figures in
parentheses show what the average annual rates of return would have been had
Minnesota Life not absorbed Fund expenses as described above.
Year Ended Five Years Ten Years
From Inception Date of
12/31/99 Ended 12/31/99 Ended 12/31/99
to 12/31/99 Inception
Growth Portfolio 25.67% (25.67%) 26.88% (26.88%) 17.19% (17.19%)
15.49% (15.39%) 12/3/85
Bond Portfolio -2.73 (-2.73) 6.84 (6.84) 7.02 (7.00)
7.62 (7.55) 12/3/85
Money Market Portfolio 4.71 (4.71) 5.03 (5.03) 4.78 (4.70)
5.29 (5.05) 12/3/85
Asset Allocation Portfolio 15.17 (15.17) 18.97 (18.97) 13.61 (13.61)
12.50 (12.48) 12/3/85
Mortgage Securities Portfolio 1.99 (1.99) 8.06 (8.06) 7.73
(7.71) 8.07 (8.04) 5/1/87
Index 500 Portfolio 20.28 (20.28) 27.67 (27.67) 17.56 (17.55)
16.18 (16.15) 5/1/87
Capital Appreciation Portfolio 21.51 (21.51) 24.11 (24.11) 17.11
(17.08) 16.17 (16.04) 5/1/87
International Stock Portfolio 21.43 (21.43) 14.67 (14.67) N/A
N/A 13.58 (13.57) 5/1/92
Small Company Growth
Portfolio 45.63 (45.63) 17.44 (17.44) N/A N/A
16.59 (16.59) 5/3/93
Maturing Government Bond-
2002 Portfolio -.48 (-1.00) 8.52 7.75 N/A N/A
7.53 (6.69) 5/2/94
2006 Portfolio -7.81 (-8.64) 9.58 8.62 N/A N/A
8.43 (7.34) 5/2/94
2010 Portfolio -11.54 (-12.45) 10.20 8.92 N/A N/A
8.89 (7.31) 5/2/94
Value Stock Portfolio .27 (.27) 16.57 16.57 N/A N/A
15.39 (15.33) 5/2/94
Small Company Value
Portfolio -3.07 (-3.61) N/A N/A N/A N/A
-3.42 (-3.96) 10/1/97
Global Bond Portfolio -7.81 (-7.81) N/A N/A N/A N/A
3.13 (3.13) 10/1/97
Index 400 Mid-Cap Portfolio 15.96 (15.62) N/A N/A N/A
N/A 14.40 (13.98) 10/1/97
Macro-Cap Value Portfolio 7.17 (6.68) N/A N/A N/A N/A
11.92 (10.94) 10/15/97
Micro-Cap Growth Portfolio 148.77 (148.45) N/A N/A N/A N/A
48.85 (48.53) 10/1/97
Real Estate Securities Portfolio -3.89 -5.18 N/A N/A N/A
N/A -11.33 (-12.37) 5/1/98
Purchasers of variable contracts issued by Minnesota Life should
recognize that the yield, cumulative total return and average annual total
return on the assets relating to such a contract which are invested in shares
of any of the above Portfolios would be lower than the yield, cumulative total
return and average annual total return of such Portfolio for the same period
since charges assessed against such assets are not reflected in the
Portfolios' quotations.
Predictability of Return
Anticipated Value at Maturity. The maturity values of zero-coupon bonds
are specified at the time the bonds are issued, and this feature, combined
with the ability to calculate yield to maturity, has made these instruments
popular investment vehicles for investors seeking reliable investments to meet
long-term financial goals.
Each Maturing Government Bond Portfolio consists primarily of zero-
coupon bonds but is actively managed to accommodate contract owner activity
and to take advantage of perceived market opportunities. Because of this
active management approach, each Maturing Government Bond Portfolio does not
guarantee that a certain price per share will be attained by the time a
Portfolio is liquidated. Instead, the Fund attempts to track the price
behavior of a directly held zero coupon bond by:
(1) Maintaining a weighted average maturity within each Maturing
Government Bond Portfolio's target maturity year;
(2) Investing at least 90% of assets in securities that mature within
one year of that Portfolio's target maturity year [for example, a
Portfolio with a maturity of ten years will be 90% composed of
securities having remaining maturities of nine, ten or eleven years
(rather than having half its securities with five-year maturities
and half with fifteen-year maturities];
(3) Investing a substantial portion of assets in Treasury STRIPS (the
most liquid Treasury zero);
(4) Under normal conditions, maintaining a nominal cash balance;
(5) Executing portfolio transactions necessary to accommodate net
contract owner purchases or redemptions on a daily basis; and
(6) Whenever feasible, contacting several U.S. government securities
dealers for each intended transaction in an effort to obtain the
best price on each transaction.
These measures enable Advantus Capital to calculate an anticipated value
at maturity (AVM) for each share of a Maturing Government Bond Portfolio,
calculated as of the date of purchase of such share, that approximates the
price per share that such share will achieve by the weighted average maturity
date of its Portfolio. The AVM calculation for each Maturing Government Bond
Portfolio is as follows:
AVM = P(l + AGR/2)2T
where P = the Portfolio's current price per share; T = the Portfolio's
weighted average term to maturity in years; and AGR = the anticipated growth
rate.
This calculation assumes that the share owner will reinvest all dividend
and capital gain distributions. It also assumes an expense ratio and a
portfolio composition that remain constant for the life of the Maturing
Government Bond Portfolio. Because expenses and composition do not remain
constant, however, the Fund may calculate an AVM for each Maturing Government
Bond Portfolio on any day on which the Fund values its securities. Such an
AVM is applicable only to shares purchased on that date.
In addition to the measures described above, which Advantus Capital
believes are adequate to assure close correspondence between the price
behavior of each Portfolio and the price behavior of directly held zero-coupon
bonds with comparable maturities, the Fund expects that each Portfolio will
invest at least 90% of its net assets in zero-coupon bonds until it is within
four years of its target maturity year and at least 80% of its net assets in
zero-coupon securities within two to four years of its target maturity year.
This expectation may be altered if the market supply of zero-coupon securities
diminishes unexpectedly.
Anticipated Growth Rate. The Fund may also calculate an anticipated
growth rate (AGR) for each Maturing Government Bond Portfolio on any day on
which the Fund values its securities. AGR is a calculation of the anticipated
annualized rate of growth for a Portfolio share, calculated from the date of
purchase of such share to the Portfolio's target maturity date. As is the
case with calculations of AVM, the AGR calculation assumes that the investor
will reinvest all dividends and capital gain distributions and that each
Maturing Government Bond Portfolio expense ratio and portfolio composition
will remain constant. Each Maturing Government Bond Portfolio AGR changes
from day to day (i.e., a particular AGR calculation is applicable only to
shares purchased on that date), due primarily to changes in interest rates
and, to a lesser extent, to changes in portfolio composition and other factors
that affect the value of the Portfolio's investments.
The Fund expects that a share owner who holds specific shares until a
Portfolio's weighted average maturity date, and who reinvests all dividends
and capital gain distributions, will realize an investment return and maturity
value on those shares that do not differ substantially from the AGR and AVM
calculated on the day such shares were purchased. The AGR and AVM calculated
with respect to shares purchased on any other date, however, may be materially
different.
TAXES
The Fund and each Portfolio qualified for the year ended December 31,
1999, and intends to continue to qualify as a "regulated investment company"
under the provisions of Subchapter M of the Internal Revenue Code, as amended
(the "Code"). As a result of changes included in the Tax Reform Act of 1986,
each Portfolio of the Fund is treated as a separate entity for federal income
tax purposes. If each Portfolio of the Fund qualifies as a "regulated
investment company" and complies with the provisions of the Code relieving
regulated investment companies which distribute substantially all of their net
income (both ordinary income and capital gain) from federal income tax, each
Portfolio of the Fund will be relieved of such tax on the amounts distributed.
To qualify for treatment as a regulated investment company, each
Portfolio must, among other things, derive in each taxable year at least 90%
of its gross income from dividends, interest payments with respect to
securities, and gains (without deduction for losses) from the sale or other
disposition of securities.
Each Portfolio of the Fund with outstanding shares which were purchased
to provide the Portfolio's initial capital (in an amount in excess of that
specified in the Code) and which are not attributable to any of the contracts
is subject to a non-deductible excise tax equal to 4 percent of the excess, if
any, of the amount required to be distributed pursuant to the Code for each
calendar year over the amount actually distributed. Currently, only the
Maturing Government Bond 2002 Portfolio, Maturing Government Bond 2006
Portfolio, Small Company Value Portfolio, Index 400 Mid-Cap Portfolio, Macro-
Cap Value Portfolio, Micro-Cap Growth Portfolio, Global Bond Portfolio and
Real Estate Securities Portfolio are subject to these distribution
requirements. In order to avoid the imposition of this excise tax, each
Portfolio generally must declare dividends by the end of a calendar year
representing 98 percent of that Portfolio's ordinary income for the calendar
year and 98 percent of its capital gain net income (both long-term and short-
term capital gains) for the twelve-month period ending October 31 of the
calendar year.
The foregoing is a general summary of applicable provisions of the Code
and Treasury Regulations now in effect and as currently interpreted by the
courts and the Internal Revenue Service. The Code and these Regulations, as
well as current interpretations thereof, may be changed at any time by
legislative, judicial or administrative action.
As the sole shareholder of the Fund will be Minnesota Life and the
separate accounts of Minnesota Life, this statement does not discuss federal
income tax consequences to the shareholder. For tax information with respect
to an owner of a contract issued in connection with the separate accounts, see
the Prospectus for those contracts.
THE STANDARD & POOR'S LICENSE
Standard & Poor's ("S&P") is a division of the McGraw-Hill Companies,
Inc. S&P has trademark rights to the marks "Standard & Poor'sr," "S&Pr," "S&P
500r, "S&P 400r," "Standard & Poor's 500," "Standard & Poor's MidCap 400," and
"500" and has licensed the use of such marks by the Fund, the Index 500
Portfolio and the Index 400 Mid-Cap Portfolio.
The Index 500 Portfolio and the Index 400 Mid-Cap Portfolio
(collectively, the "Portfolios") are not sponsored, endorsed, sold or promoted
by S&P. S&P makes no representation or warranty, express or implied, to the
owners of the Portfolios or any member of the public regarding the
advisability of investing in securities generally or in the Portfolios
particularly or the ability of the S&P 500 Index or the S&P MidCap 400 Index
to track general stock market performance. S&P's only relationship to the
Portfolios is the licensing of certain trademarks and trade names of S&P and
of the S&P 500 Index and the S&P MidCap 400 Index which are determined,
composed and calculated by S&P without regard to the Fund. S&P has no
obligation to take the needs of the Portfolios or the owners of the Fund into
consideration in determining, composing or calculating the S&P 500 Index or
the S&P MidCap 400 Index. S&P is not responsible for and has not participated
in the determination of the net asset value or public offering price of the
Portfolios nor is S&P a distributor of the Fund. S&P has no obligation or
liability in connection with the administration, marketing or trading of the
Portfolios.
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P
500 INDEX OR THE S&P MIDCAP 400 INDEX OR ANY DATA INCLUDED THEREIN, NOR DOES
S&P HAVE ANY LIABILITY FOR ANY ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN.
S&P MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE RESULTS TO BE OBTAINED BY
THE PORTFOLIOS, OWNERS OF THE FUND, OR ANY OTHER PERSON OR ENTITY FROM THE USE
OF THE S&P 500 INDEX, THE S&P MIDCAP 400 INDEX OR ANY DATA INCLUDED THEREIN.
S&P MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL
WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH
RESPECT TO THE S&P 500 INDEX, THE S&P 400 MIDCAP INDEX OR ANY DATA INCLUDED
THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL S&P HAVE
ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES
(INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
FINANCIAL STATEMENTS
The Fund's financial statements for the year ended December 31, 1999,
including the financial highlights for each of the respective periods
presented, appearing in the Fund's Annual Report to Shareholders, and the
report thereon of the Fund's independent auditors, KPMG LLP, also appearing
therein, are incorporated by reference in this Statement of Additional
Information.
APPENDIX A - MORTGAGE-RELATED SECURITIES
Mortgage-related securities represent an ownership interest in a pool of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. The mortgagor's monthly
payments to his lending institution are "passed-through" to investors such as
the Fund. Most insurers or services provide guarantees of payments,
regardless of whether or not the mortgagor actually makes the payment. The
guarantees made by issuers or servicers are backed by various forms of credit,
insurance and collateral.
Underlying Mortgages
Pools consist of whole mortgage loans or participations in loans. The
majority of these loans are made to purchasers of 1-4 family homes. Some of
these loans are made to purchasers of mobile homes. The terms and
characteristics of the mortgage instruments are generally uniform within a
pool buy may vary among pools. For example, in addition to fixed-rate fixed-
term mortgages, the fund may purchase pools of variable rate mortgages,
growing equity mortgages, graduated payment mortgages and other types.
All servicers apply standards for qualification to local lending
institutions which originate mortgages for the pools. Servicers also
establish credit standards and underwriting criteria for individual mortgages
included in the pools. In addition, many mortgages included in pools are
insured through private mortgage insurance companies.
Liquidity and Marketability
Since the inception of the mortgage-related pass-through security in
1970, the market for these securities has expanded considerably. The size of
the primary issuance market and active participation in the secondary market
by securities dealers and many types of investors makes government and
government-related pass-through pools highly liquid. The recently introduced
private conventional pools of mortgages (pooled by commercial banks, savings
and loans institutions and others, with no relationship with government and
government-related entities) have also achieved broad market acceptance and
consequently an active secondary market has emerged. However, the market for
conventional pools is smaller and less liquid than the market for the
government and government-related mortgage pools. The Fund may purchase some
mortgage-related securities through private placements, in which case only a
limited secondary market exists, and the security is considered illiquid.
Average Life
The average life of pass-through pools varies with the maturities of the
underlying mortgage instruments. In addition, a pool's term may be shortened
by unscheduled or early payments of principal and interest on the underlying
mortgages. The occurrence of mortgage prepayments is affected by factors
including the level of interest rates, general economic conditions, the
location and age of the mortgage and other social and demographic conditions.
As prepayment rates of individual pools vary widely, it is not possible
to accurately predict the average life of a particular pool. For pools of
fixed-rate 30-year mortgages, common industry practice is to assume that
prepayments will result in a 12-year average life. Pools of mortgages with
other maturities or different characteristics will have varying assumptions
for average life. The assumed average life of pools of mortgages having terms
of less than 30 years is less than 12 years, but typically not less than 5
years.
Yield Calculations
Yields on pass-through securities are typically quoted by investment
dealers and vendors based on the maturity of the underlying instruments and
the associated average life assumption. In periods of falling interest rates
the rate of prepayment tends to increase, thereby shortening the actual
average life of a pool of mortgage-related securities. Conversely, in periods
of rising rates and the rate of prepayment tends to decrease, thereby
lengthening the actual average life of the pool. Historically, actual average
life has been consistent with the 12-year assumption referred to above.
Actual prepayment experience may cause the yield to differ from the
assumed average life yield. Reinvestment of prepayments may occur at higher
or lower interest rates than the original investment, thus affecting the yield
of the Fund. The compounding effect from reinvestments of monthly payments
received by the Fund will increase the yield to shareholders compared to bonds
that pay interest semi-annually.
APPENDIX B - BOND AND COMMERCIAL PAPER RATINGS
Bond Ratings
Moody's Investors Service, Inc. describes its six highest ratings for
corporate bonds and mortgage-related securities as follows:
Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such issues.
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.
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.
Bonds which are rated Baa are considered medium grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
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.
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.
Moody's Investors Service, Inc. also applies numerical modifiers, 1, 2,
and 3, in each of these generic rating classifications. The modifier 1
indicates that the security 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 issue ranks in the lower end of its generic rating
category.
Standard & Poor's Corporation describes its six highest ratings for
corporate bonds and mortgage-related securities as follows:
AAA. Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely strong.
AA. Debt rated "AA" has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in small degree.
A. Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
BBB. Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to pay interest and repay
principal for debt in this category than in higher rated categories.
BB. Debt rated "BB" has less near-term vulnerability to default than
other speculative grade debt. However, it faces major ongoing uncertainties
or exposure to adverse business, financial, or economic conditions that could
lead to inadequate capacity to meet timely interest and principal payments.
B. Debt rated "B" has a greater vulnerability to default but currently
has the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
Standard & Poor's Corporation applies indicators "+", no character, and
"-" to the above rating categories. The indicators show relative standing
within the major rating categories.
Commercial Paper Ratings
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's Investors Service, Inc. Among the factors considered by Moody's
Investors Service, Inc. in assigning the ratings are the following: (1)
evaluation of the management of the issuer, (2) economic evaluation of the
issuer's industry or industries and an appraisal of speculative-type risks
which may be inherent in certain areas; (3) evaluation of the issuer's
products in relation to competition and customer acceptance; (4) liquidity;
(5) amount and quality of long-term debt; (6) trend of earnings over a period
of ten years; (7) financial strength of a parent company and the relationships
which exist with the issuer; an (8) recognition by the management of
obligations which may be present or may arise as a result of public interest
questions and preparations to meet such obligations.
The rating A-1 is the highest rating assigned by Standard & Poor's
Corporation to commercial paper which is considered by Standard & Poor's
Corporation to have the following characteristics:
Liquidity ratios of the issuer are adequate to meet cash redemptions.
Long-term senior debt is rated "A" or better. The issuer has access to at
least two additional channels of borrowing. Basic earnings and cash flow have
an upward trend with allowance made for unusual circumstances. Typically, the
issuer's industry is well established and the issuer has a strong position
within the industry. The reliability and quality of management are
unquestioned.
APPENDIX C - FUTURES CONTRACTS
Example of Futures Contract Sale
The Fund would engage in a futures contract sale to maintain the income
advantage from continued holding of a long-term security while endeavoring to
avoid part or all of the loss in market value that would otherwise accompany a
decline in long-term securities prices. Assume that the market value of a
certain security in the Fund's portfolio tends to move in concert with the
futures market prices of long-term United States Treasury bonds ("Treasury
bonds"). The Fund wishes to fix the current market value of this portfolio
security until some point in the future. Assume the portfolio security has a
market value of $100, and the Fund believes that, because of an anticipated
rise in interest rates, the value will decline to $95. The Fund might enter
into futures contract sales of Treasury bonds for a price of $98. If the
market value of the portfolio security does indeed decline from $100 to $95,
the futures market price for the Treasury bonds might also decline from $98 to
$93.
In that case, the $5 loss in the market value of the portfolio security
would be offset by the $5 gain realized by closing out the futures contract
sale. Of course, the futures market price of Treasury bonds might decline to
more than $93 or to less than $93 because of the imperfect correlation between
cash and futures prices mentioned above.
The Fund could be wrong in its forecast of interest rates and the
futures market price could rise above $98. In this case, the market value of
the portfolio securities, including the portfolio security being protected,
would increase. The benefit of this increase would be reduced by the loss
realized on closing out the futures contract sale.
If interest rate levels did not change prior to settlement date, the
Fund, in the above example, would incur a loss of $2 if it delivered the
portfolio security on the settlement date (which loss might be reduced by an
offsetting transaction prior to the settlement date). In each transaction,
nominal transaction expenses would also be incurred.
Example of Futures Contract Purchase
The Fund would engage in a futures contract purchase when it is not
fully invested in long-term securities but wishes to defer for a time the
purchase of long-term securities in light of the availability of advantageous
interim investments, e.g., short-term securities whose yields are greater than
those available on long-term securities. The Fund's basic motivation would be
to maintain for a time the income advantage from investing in the short-term
securities; the Fund would be endeavoring at the same time to eliminate the
effect of all or part of the increases in market price of the long-term
securities that the Fund may purchase.
For example, assume that the market price of a long-term security that
the Fund may purchase, currently yielding 10%, tends to move in concert with
futures market prices of Treasury bonds. The Fund wishes to fix the current
market price (and thus 10% yield) of the long-term security until the time
(four months away in this example) when it may purchase the security.
Assuming the long-term security has a market price of $100, and the Fund
believes that, because of an anticipated fall in interest rates, the price
will have risen to $105 (and the yield will have dropped to about 9-1/2%) in
four months, the Fund might enter into futures contracts purchases of Treasury
bonds for a price of $98. At the same time, the Fund would assign a pool of
investments in short-term securities that are either maturing in four months
or earmarked for sale in four months, for purchase of the long-term security
at an assumed market price of $100. Assume these short-term securities are
yielding 15%. If the market price of the long-term bond does indeed rise from
$100 to $105, the futures market price for Treasury bonds might also rise from
$98 to $103. In that case, the $5 increase in the price that the Fund pays
for the long-term security would be offset by the $5 gain realized by closing
out the futures contract purchase.
The Fund could be wrong in its forecast of interest rates; long-term
interest rates might rise to above 10%, and the futures market price could
fall below $98. If short-term rates at the same time fall to 10% or below, it
is possible that the Fund would continue with its purchase program for long-
term securities. The market prices of available long-term securities would
have decreased. The benefit of this price decrease, and thus yield increase,
will be reduced by the loss realized on closing out the futures contract
purchase.
If, however, short-term rates remained above available long-term rates,
it is possible that the Fund would discontinue its purchase program for long-
term securities. The yields on short-term securities in the portfolio,
including those originally in the pool assigned to the particular long-term
security, would remain higher than yields on long-term bonds. The benefit of
this continued incremental income will be reduced by the loss realized on
closing out the futures contract purchase.
In each transaction, nominal transaction expenses would also be
incurred.
Tax Treatment
The amount of any gain or loss realized by the Fund on closing out a
futures contract may result in a capital gain or loss for federal income tax
purposes. Generally, futures contracts held by the Fund at the close of the
Fund's taxable year will be treated for federal income tax purposes as sold
for their fair market value on the last business day of such year. Forty
percent of any gain or loss resulting from such constructive sale will be
treated as short-term capital gain or loss and 60 percent of such gain or loss
will be treated as long-term capital gain or loss. The amount of any capital
gain or loss actually realized by the Fund in a subsequent sale or other
disposition of these futures contracts will be adjusted to reflect any capital
gain or loss taken into account by the Fund in a prior year as a result of the
constructive sale of the contract. Notwithstanding the rules described above,
with respect to futures contracts which are part of futures contract sales,
and in certain other situations, the Fund may make an election which may have
the effect of exempting all or a part of those identified future contracts
from being treated for federal income tax purposes as sold on the last
business day of the Fund's taxable year; all or part of any gain or loss
otherwise realized by the Fund on any closing transaction may be deferred
until all of the Fund's positions with respect to the futures contract sales
are closed; and, all or part of any gain or loss may be treated as short-term
capital gain or loss.
Under the Federal income tax provisions applicable to regulated
investment companies, at least 90% of the Fund's annual gross income must be
derived from dividends, interest, payments with respect to loans of
securities, and gains from the sale or other disposition of securities
("qualifying income"). Under the Internal Revenue Code of 1986, as amended
(the "Code"), the Fund may include gains from forward contracts in determining
qualifying income. In addition, in order that the Fund continue to qualify as
a regulated investment company for Federal income tax purposes, less than 30%
of its gross income for any year must be derived from gains realized on the
sale or other disposition of securities held by the Fund for less than three
months. For this purpose, the Fund will treat gains realized on the closing
out of futures contracts as gains derived from the sale of securities. This
treatment could, under certain circumstances, require the Fund to defer the
closing out of futures contracts until after three months from the date the
fund acquired the contracts, even if it would be more advantageous to close
out the contracts prior to that time. However, under the Code, a special rule
is provided with respect to certain hedging transactions which has the effect
of allowing the Fund to engage in such short-term transactions in limited
circumstances. Any gains realized by the Fund as a result of the constructive
sales of futures contacts held by the Fund at the end of its taxable year, as
described in the preceding paragraph, will in all instances be treated as
derived from the sale of securities held for three months or more, regardless
of the actual period for which the Fund has held the futures contracts at the
end of the year.
APPENDIX D - BRADY BONDS
Brady Bonds are debt securities issued under the framework of the Brady
Plan, an initiative announced by U.S. Treasury Secretary Nicholas F. Brady in
1989 as a mechanism for debtor nations to restructure their outstanding
external indebtedness. The Brady Plan contemplates, among other things, the
adoption by debtor nations of certain economic reforms and the exchange of
commercial bank debt. Under the Brady Plan framework, a debtor nation
negotiates with its existing bank lenders as well as the World Bank and/or the
IMF. 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 replenish reserves
used to reduce outstanding bank debt. Under these loan agreements or other
arrangements with the World Bank or the IMF, debtor nations have been required
to agree to the implementation of certain domestic monetary and fiscal
reforms. The Brady Plan only sets forth general guiding principles for
economic reform and debt reduction, emphasizing that solutions must be
negotiated on a case-by-case basis between debtor nations and their creditors.
Brady Bonds have been issued only recently, and accordingly do not have a long
payment history. Agreements implemented under the Brady Plan to date are
designed to achieve debt and debt-service reduction through specific options
negotiated by a debtor nation with its creditors. As a result, the financial
packages offered by each country differ. The types of options have included
the exchange of outstanding commercial bank debt for bonds issued at 100% of
face value of such debt, and bonds bearing an interest rate which increases
over time and the advancement of the new money for bonds. The principal of
certain Brady Bonds has been collateralized by Treasury zero coupon bonds with
a maturity equal to the final maturity of such Brady Bonds. Collateral
purchases are financed by the IMF, the World Bank and the debtor nations'
reserves. In addition, the first two or three interest payments on certain
types of Brady Bonds may be collateralized by cash or securities agreed upon
by creditors.
ii
74
78
A-2
B-2
C-3
D-1
