LEGG MASON EQUITY FUNDS
LEGG MASON VALUE TRUST, INC.
LEGG MASON TOTAL RETURN TRUST, INC.
LEGG MASON SPECIAL INVESTMENT TRUST, INC.
LEGG MASON INVESTORS TRUST, INC.:
Legg Mason American Leading Companies Trust
Legg Mason Balanced Trust
Legg Mason U.S. Small-Capitalization Value Trust
Legg Mason Financial Services Fund
CLASS A SHARES, PRIMARY CLASS SHARES and NAVIGATOR CLASS SHARES
STATEMENT OF ADDITIONAL INFORMATION
July 31, 2000
This Statement of Additional Information is not a prospectus. It should
be read in conjunction with the Prospectus for Primary Class and Class A shares
or the Prospectus for Navigator Class shares of Value Trust, Total Return Trust,
Special Investment Trust, American Leading Companies Trust, Balanced Trust,
Small-Cap Value Trust and Financial Services Fund (both dated July 31, 2000), as
appropriate, which have been filed with the Securities and Exchange Commission
("SEC"). The funds' annual reports are incorporated by reference into this
Statement of Additional Information. A copy of either of the Prospectuses or the
annual reports may be obtained without charge from the funds' distributor, Legg
Mason Wood Walker, Incorporated ("Legg Mason") (address and telephone numbers
listed below).
Legg Mason Wood Walker,
Incorporated
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100 Light Street
Baltimore, Maryland 21202
(410) 539-0000 (800) 822-5544
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TABLE OF CONTENTS
Page
DESCRIPTION OF THE FUNDS......................................................3
FUND POLICIES.................................................................3
INVESTMENT STRATEGIES AND RISKS...............................................6
ADDITIONAL TAX INFORMATION...................................................31
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION...............................35
VALUATION OF FUND SHARES.....................................................37
PERFORMANCE INFORMATION......................................................38
TAX-DEFERRED QUALIFIED PLANS - PRIMARY CLASS AND CLASS A SHARES.............48
MANAGEMENT OF THE FUNDS......................................................50
THE FUNDS' INVESTMENT ADVISER/MANAGER........................................55
PORTFOLIO TRANSACTIONS AND BROKERAGE.........................................59
THE FUNDS' DISTRIBUTOR.......................................................63
CAPITAL STOCK INFORMATION....................................................66
THE FUNDS' CUSTODIAN AND TRANSFER AND DIVIDEND-DISBURSING AGENT..............67
THE FUNDS' LEGAL COUNSEL.....................................................67
THE FUNDS' INDEPENDENT ACCOUNTANTS/AUDITORS..................................67
FINANCIAL STATEMENTS.........................................................67
RATINGS OF SECURITIES.......................................................A-1
No person has been authorized to give any information or to make any
representations not contained in the Prospectuses or this Statement of
Additional Information in connection with the offerings made by the Prospectuses
and, if given or made, such information or representations must not be relied
upon as having been authorized by any fund or its distributor. The Prospectuses
and the Statement of Additional Information do not constitute offerings by any
fund or by the distributor in any jurisdiction in which such offerings may not
lawfully be made.
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DESCRIPTION OF THE FUNDS
Legg Mason Value Trust, Inc. ("Value Trust"), Legg Mason Total Return
Trust, Inc. ("Total Return Trust"), Legg Mason Special Investment Trust, Inc.
("Special Investment Trust") and Legg Mason Investors Trust, Inc. ("Investors
Trust") are each diversified open-end management investment companies that were
established as Maryland corporations on January 20, 1982, May 22, 1985, October
31, 1985, and May 5, 1993, respectively. Legg Mason American Leading Companies
Trust ("American Leading Companies"), Legg Mason Balanced Trust ("Balanced
Trust"), Legg Mason U.S. Small-Capitalization Value Trust ("Small-Cap Value
Trust"), and Legg Mason Financial Services Fund ("Financial Services Fund") are
separate series of Investors Trust.
FUND POLICIES
VALUE TRUST'S investment objective is to seek long-term growth of
capital. TOTAL RETURN TRUST'S investment objective is to seek capital
appreciation and current income in order to achieve an attractive total
investment return consistent with reasonable risk. SPECIAL INVESTMENT TRUST'S
investment objective is to seek capital appreciation. AMERICAN LEADING
COMPANIES' investment objective is to seek long-term capital appreciation and
current income consistent with prudent investment risk. BALANCED TRUST'S
investment objective is to seek long-term capital appreciation and current
income in order to achieve an attractive total investment return consistent with
reasonable risk. SMALL-CAP VALUE TRUST'S investment objective is to seek
long-term capital appreciation. FINANCIAL SERVICES FUND'S investment objective
is to seek long-term growth of capital.
The investment objective of each fund is fundamental, meaning it cannot
be changed except by a vote of fund shareholders. Each fund has adopted the
following fundamental investment limitations that cannot be changed except by
vote of its shareholders:
Value Trust, Total Return Trust and Special Investment Trust each may
not:
1. Borrow money, except from banks or through reverse repurchase
agreements for temporary purposes, in an aggregate amount not
to exceed 10% of the value of the total assets of the
respective fund at the time of borrowing; provided that
borrowings, including reverse repurchase agreements, in excess
of 5% of such value will be only from banks (although not a
fundamental policy subject to shareholder approval, each fund
will not purchase securities if borrowings, including reverse
purchase agreements, exceed 5% of its total assets);
2. With respect to 75% of total assets, invest more than 5% of
its total assets (taken at market value) in securities of any
one issuer, other than the U.S. Government, or its agencies
and instrumentalities, or purchase more than 10% of the voting
securities of any one issuer;
3. Purchase securities on "margin", except for short-term credits
necessary for clearance of portfolio transactions and except
that each fund may make margin deposits in connection with the
use of futures contracts and options on futures contracts;
4. Invest 25% or more of its total assets (taken at market value)
in any one industry;
5. Purchase or sell commodities and commodity contracts, but this
limitation shall not prevent each fund from purchasing or
selling options and futures contracts;
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6. Underwrite the securities of other issuers, except insofar as
each fund may be deemed an underwriter under the Securities
Act of 1933, as amended ("1933 Act"), in disposing of a
portfolio security;
7. Make loans, except loans of portfolio securities and except to
the extent that the purchase of a portion of an issue of
publicly distributed notes, bonds or other evidences of
indebtedness or deposits with banks and other financial
institutions may be considered loans;
8. Purchase or sell real estate, except that each fund may invest
in securities collateralized by real estate or interests
therein or in securities issued by companies that invest in
real estate or interests therein (as a non-fundamental policy
changeable without a shareholder vote, each fund will not
purchase or sell interests in real estate limited
partnerships);
9. Make short sales of securities or maintain a short position,
except that each fund may (a) make short sales and maintain
short positions in connection with its use of options, futures
contracts and options on futures contracts and (b) sell short
"against the box"; or
10. Issue senior securities, except as permitted under the
Investment Company Act of 1940, as amended ("1940 Act").
American Leading Companies, Balanced Trust and Small-Cap Value Trust
each may not:
1. Borrow money, except from banks or through reverse repurchase
agreements for temporary purposes in an aggregate amount not
to exceed 5% of the value of its total assets at the time of
borrowings. (Although not a fundamental policy subject to
shareholder approval, the fund will repay any money borrowed
before any portfolio securities are purchased);
2. Issue senior securities, except as permitted under the 1940
Act;
3. Engage in the business of underwriting the securities of other
issuers except insofar as the fund may be deemed an
underwriter under the 1933 Act in disposing of a portfolio
security;
4. Buy or hold any real estate; provided, however, that
instruments secured by real estate or interests therein are
not subject to this limitation;
5. With respect to 75% of its total assets, invest more than 5%
of its total assets (taken at market value) in securities of
any one issuer, other than the U.S. Government, its agencies
and instrumentalities, or purchase more than 10% of the voting
securities of any one issuer;
6. Purchase or sell any commodities or commodities contracts,
except that the fund may purchase or sell currencies, interest
rate and currency futures contracts, options on currencies,
securities, and securities indexes and options on interest
rate and currency futures contracts;
7. Make loans, except loans of portfolio securities and except to
the extent the purchase of notes, bonds or other evidences of
indebtedness, the entry into repurchase agreements, or
deposits with banks and other financial institutions may be
considered loans; or
8. Purchase any security if, as a result thereof, 25% or more of
its total assets would be invested in the securities of
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issuers having their principal business activities in the same
industry. This limitation does not apply to securities issued
or guaranteed by the U.S. Government, its agencies or
instrumentalities and repurchase agreements with respect
thereto.
Financial Services Fund may not:
1. Borrow money, except (a) from a bank, provided that
immediately after such borrowing there is an asset coverage of
300% for all borrowings of the fund; or (b) from a bank or
other persons for temporary purposes only, provided that such
temporary borrowings are in an amount not exceeding 5% of the
fund's total assets at the time when the borrowing is made;
2. Act as underwriter of securities issued by other persons. This
limitation is not applicable to the extent that, in connection
with the disposition of portfolio securities (including
restricted securities), the fund may be deemed an underwriter
under certain federal securities laws;
3. Purchase, hold or deal in real estate. This limitation is not
applicable to investments in securities which are secured by
or represent interests in real estate or to securities issued
by companies, including real estate investment trusts, that
invest in real estate or interests in real estate. This
limitation does not preclude the fund from investing in
mortgage-related securities or investing directly in
mortgages;
4. Purchase, hold or deal in commodities or commodities futures
contracts, except that the fund may purchase or sell forward
currency contracts;
5. Make loans to other persons, except (a) by loaning portfolio
securities, (b) by engaging in repurchase agreements, (c) by
purchasing nonpublicly offered debt securities, or (d) through
direct investments in mortgages. For purposes of this
limitation, the term "loans" shall not include the purchase of
a portion of an issue of publicly distributed bonds,
debentures or other securities;
6. Purchase securities or evidences of interest thereon on
"margin." This limitation is not applicable to short term
credit obtained by the fund for the clearance of purchases and
sales or redemption of securities, or to arrangements with
respect to transactions involving options, futures contracts,
short sales and other permitted investments and techniques
(including foreign exchange contracts);
7. Invest more than 25% of its total assets in a particular
industry other than the financial services industry;
8. Purchase the securities of any issuer if such purchase at the
time thereof would cause less than 75% of the value of its
total assets to be invested in cash and cash items (including
receivables), securities issued by the U.S. government, its
agencies or instrumentalities and repurchase agreements with
respect thereto, securities of other investment companies,
other securities for the purposes of this calculation limited
in respect of any one issuer to an amount not greater in value
than 5% of the value of the total assets of the fund and to
not more than 10% of the outstanding voting securities of such
issuer; or
9. Issue senior securities, except as permitted under the 1940
Act.
The foregoing limitations may be changed with respect to a fund by "the
vote of a majority of the outstanding voting securities" of that fund, a term
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defined in the 1940 Act to mean the vote (a) of 67% or more of the voting
securities present at a meeting, if the holders of more than 50% of the
outstanding voting securities of the fund are present, or (b) of more than 50%
of the outstanding voting securities of the fund, whichever is less.
For purposes of the diversification requirements described above,
Financial Services Fund will treat both the corporate borrower and the financial
intermediary as issuers of a loan participation interest. Investments by the
fund in collateralized mortgage obligations that are deemed to be investment
companies under the 1940 Act will be included in the limitation on investments
in other investment companies described below under "Investment Strategies and
Risks--Investment Companies".
AMERICAN LEADING COMPANIES, BALANCED TRUST AND SMALL-CAP VALUE TRUST:
The following are some of the non-fundamental limitations which
American Leading Companies, Balanced Trust and Small-Cap Value Trust currently
observe. Each fund may not:
1. Buy securities on "margin," except for short-term credits
necessary for clearance of portfolio transactions and except
that the fund may make margin deposits in connection with the
use of permitted currency futures contracts and options on
currency futures contracts; or
2. Make short sales of securities or maintain a short position,
except that the fund may sell short "against the box." This
limit does not apply to short sales and short positions in
connection with its use of options, futures contracts and
options on futures contracts (no fund intends to make short
sales in excess of 5% of its net assets during the coming
year).
In addition, as a non-fundamental limitation, American Leading
Companies may not purchase or sell interest rate and currency futures contracts,
options on currencies, securities, and securities indexes and options on
interest rate and currency futures contracts, provided, however, that the fund
may sell covered call options on securities and may purchase options to the
extent necessary to close out its position in one or more call options.
Except as otherwise stated, if a fundamental or non-fundamental
percentage limitation set forth above is complied with at the time an investment
is made, a later increase or decrease in percentage resulting from a change in
value of portfolio securities, in the net asset value of a fund or in the number
of securities an issuer has outstanding, will not be considered to be outside
the limitation. Each fund will monitor the level of borrowing and illiquid
securities in its portfolio and will make necessary adjustments to maintain the
required asset coverage and adequate liquidity.
Unless otherwise stated, the funds' investment policies and limitations
are not fundamental and can be changed without shareholder approval.
INVESTMENT STRATEGIES AND RISKS
THE FOLLOWING INFORMATION APPLIES TO VALUE TRUST, TOTAL RETURN TRUST, SPECIAL
INVESTMENT TRUST, AMERICAN LEADING COMPANIES, BALANCED TRUST, SMALL-CAP VALUE
TRUST, AND FINANCIAL SERVICES FUND, UNLESS OTHERWISE INDICATED:
This section supplements the information in the Prospectuses concerning
the investments the funds may make and the techniques they may use. Each fund,
unless otherwise stated, may employ several investment strategies, including:
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Foreign Securities
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Each fund may invest in foreign securities. Investment in foreign
securities presents certain risks, including those resulting from fluctuations
in currency exchange rates, revaluation of currencies, future political and
economic developments and the possible imposition of currency exchange blockages
or other foreign governmental laws or restrictions, reduced availability of
public information concerning issuers, and the fact that foreign issuers are not
generally subject to uniform accounting, auditing and financial reporting
standards or other regulatory practices and requirements comparable to those
applicable to domestic issuers. These risks are intensified when investing in
countries with developing economies and securities markets, also known as
"emerging markets." Moreover, securities of many foreign issuers may be less
liquid and their prices more volatile than those of comparable domestic issuers
and transactions in foreign securities may be subject to less efficient
settlement practices, including extended clearance and settlement periods.
Issuers may be less liquid and their prices more volatile than those of
comparable domestic issuers. In addition, with respect to certain foreign
countries, there is the possibility of expropriation, confiscatory taxation,
withholding taxes and limitations on the use or removal of funds or other
assets.
The costs associated with investment in foreign issuers, including
withholding taxes, brokerage commissions and custodial fees, are higher than
those associated with investment in domestic issuers. In addition, foreign
securities transactions may be subject to difficulties associated with the
settlement of such transactions. Delays in settlement could result in temporary
periods when assets of a fund are uninvested and no return is earned thereon.
The inability of a fund to make intended security purchases due to settlement
problems could cause a fund to miss attractive investment opportunities.
Inability to dispose of a portfolio security due to settlement problems could
result in losses to a fund due to subsequent declines in value of the portfolio
security or, if a fund has entered into a contract to sell the security, could
result in liability to the purchaser.
Since each fund may invest in securities denominated in currencies
other than the U.S. dollar and since each fund may hold foreign currencies, a
fund may be affected favorably or unfavorably by exchange control regulations or
changes in the exchange rates between such currencies and the U.S. dollar.
Changes in the currency exchange rates may influence the value of each fund's
shares, and also may affect the value of dividends and interest earned by that
fund and gains and losses realized by that fund. Exchange rates are determined
by the forces of supply and demand in the foreign exchange markets. These forces
are affected by the international balance of payments, other economic and
financial conditions, government intervention, speculation and other factors.
In addition to purchasing foreign securities, each fund may invest in
American Depository Receipts ("ADRs"). Generally, ADRs, in registered form, are
denominated in U.S. dollars and are designed for use in the domestic market.
Usually issued by a U.S. bank or trust company, ADRs are receipts that
demonstrate ownership of the underlying securities. For purposes of each fund's
investment policies and limitations, ADRs are considered to have the same
classification as the securities underlying them. ADRs may be sponsored or
unsponsored; issuers of securities underlying unsponsored ADRs are not
contractually obligated to disclose material information in the U.S.
Accordingly, there may be less information available about such issuers than
there is with respect to domestic companies and issuers of securities underlying
sponsored ADRs. Each fund may also invest in Global Depository Receipts
("GDRs"), which are receipts, often denominated in U.S. dollars, issued by
either a U.S. or non-U.S. bank evidencing its ownership of the underlying
foreign securities.
Although not a fundamental policy subject to shareholder vote, Legg
Mason Funds Management, Inc. ("LMFM"), currently anticipates that Value Trust,
Total Return Trust, Special Investment Trust and American Leading Companies will
each invest no more than 25% of its total assets in foreign securities. Grey
Seifert & Co., Inc. ("Grey Seifert") currently anticipates that Financial
Services Fund will not invest more than 25% of its total assets in foreign
securities, not including investments through ADRs. Bartlett & Co. ("Bartlett")
currently anticipates that Balanced Trust will not invest more than 10% of its
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total assets in foreign securities, either directly or through ADRs or GDRs.
Small-Cap Value Trust does not currently intend to invest in foreign securities.
Each fund (except Small-Cap Value Trust) may invest in securities of
issuers based in emerging markets (including, but not limited to, countries in
Asia, Latin America, the Indian Sub-continent, Southern and Eastern Europe, the
Middle East, and Africa). The risks of foreign investment are greater for
investments in emerging markets.
Many emerging market countries have experienced substantial, and in
some periods extremely high, rates of inflation for many years. Inflation and
rapid fluctuations in inflation rates have had, and may continue to have, very
negative effects on the economies and securities markets of certain emerging
markets. Economies in emerging markets generally are dependent heavily upon
international trade and, accordingly, have been and may continue to be affected
adversely by economic conditions, trade barriers, exchange controls, managed
adjustments in relative currency values and other protectionist measures imposed
or negotiated by the countries with which they trade.
Over the last quarter of a century, inflation in many emerging market
countries has been significantly higher than the world average. While some
emerging market countries have sought to develop a number of corrective
mechanisms to reduce inflation or mitigate its effects, inflation may continue
to have significant effects both on emerging market economies and their
securities markets. In addition, many of the currencies of emerging market
countries have experienced steady devaluations relative to the U.S. dollar, and
major devaluations have occurred in certain countries.
Because of the high levels of foreign-denominated debt owed by many
emerging market countries, fluctuating exchange rates can significantly affect
the debt service obligations of those countries. This could, in turn, affect
local interest rates, profit margins and exports which are a major source of
foreign exchange earnings. Although it might be theoretically possible to hedge
for anticipated income and gains, the ongoing and indeterminate nature of the
foregoing risks (and the costs associated with hedging transactions) makes it
virtually impossible to hedge effectively against such risks.
To the extent an emerging market country faces a liquidity crisis with
respect to its foreign exchange reserves, it may increase restrictions on the
outflow of any foreign exchange. Repatriation is ultimately dependent on the
ability of a fund to liquidate its investments and convert the local currency
proceeds obtained from such liquidation into U.S. dollars. Where this conversion
must be done through official channels (usually the central bank or certain
authorized commercial banks), the ability to obtain U.S. dollars is dependent on
the availability of such U.S. dollars through those channels, and if available,
upon the willingness of those channels to allocate those U.S. dollars to a fund.
In such a case, a fund's ability to obtain U.S. dollars may be adversely
affected by any increased restrictions imposed on the outflow of foreign
exchange. If a fund is unable to repatriate any amounts due to exchange
controls, it may be required to accept an obligation payable at some future date
by the central bank or other governmental entity of the jurisdiction involved.
If such conversion can legally be done outside official channels, either
directly or indirectly, a fund's ability to obtain U.S. dollars may not be
affected as much by any increased restrictions except to the extent of the price
which may be required to be paid for the U.S. dollars.
Many emerging market countries have little experience with the
corporate form of business organization and may not have well-developed
corporation and business laws or concepts of fiduciary duty in the business
context.
The securities markets of emerging markets are substantially smaller,
less developed, less liquid and more volatile than the securities markets of the
U.S. and other more developed countries. Disclosure and regulatory standards in
many respects are less stringent than in the U.S. and other major markets. There
also may be a lower level of monitoring and regulation of emerging markets and
the activities of investors in such markets; enforcement of existing regulations
has been extremely limited. Investing in the securities of companies in emerging
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markets may entail special risks relating to the potential political and
economic instability and the risks of expropriation, nationalization,
confiscation or the imposition of restrictions on foreign investment,
convertibility of currencies into U.S. dollars and on repatriation of capital
invested. In the event of such expropriation, nationalization or other
confiscation by any country, a fund could lose its entire investment in any such
country.
Most Latin American countries have experienced substantial, and in some
periods extremely high, rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates and corresponding currency devaluations have had
and may continue to have negative effects on the economies and securities
markets of certain Latin American countries.
Some emerging markets have different settlement and clearance
procedures. In certain markets there have been times when settlements have been
unable to keep pace with the volume of securities transactions, making it
difficult to conduct such transactions. The inability of the fund to make
intended securities purchases due to settlement problems could cause the fund to
miss attractive investment opportunities. Inability to dispose of a portfolio
security caused by settlement problems could result either in losses to a fund
due to subsequent declines in the value of the portfolio security or, if a fund
has entered into a contract to sell the security, in possible liability to the
purchaser.
The risk also exists that an emergency situation may arise in one or
more emerging markets as a result of which trading of securities may cease or
may be substantially curtailed and prices for a fund's portfolio securities in
such markets may not be readily available.
ILLIQUID AND RESTRICTED INVESTMENTS
Value Trust and Total Return Trust each may invest up to 10% of its net
assets in illiquid investments. American Leading Companies, Balanced Trust,
Special Investment Trust, Small-Cap Value Trust and Financial Services Fund each
may invest up to 15% of its net assets in illiquid investments. For this
purpose, "illiquid investments" are those that cannot be disposed of within
seven days for approximately the price at which the fund values the security.
Illiquid investments include repurchase agreements with terms of greater than
seven days, and restricted investments other than those the adviser to a fund
has determined are liquid pursuant to guidelines established by each fund's
Board of Directors and securities involved in swap, cap, floor and collar
transactions, and over-the-counter ("OTC") options and their underlying
collateral. Due to the absence of an active trading market, a fund may have
difficulty valuing or disposing of illiquid investments promptly. Judgment plays
a greater role in valuing illiquid securities than for those for which a more
active market exists.
Restricted securities may be sold only in privately negotiated
transactions, pursuant to a registration statement filed under the 1933 Act or
pursuant to an exemption from registration, such as Rule 144 or Rule 144A. A
fund may be required to pay part or all of the costs of such registration, and a
considerable period may elapse between the time a decision is made to sell a
restricted security and the time the registration statement becomes effective.
SEC regulations permit the sale of certain restricted securities to
qualified institutional buyers. The investment adviser to a fund, acting
pursuant to guidelines established by such fund's Board of Directors, may
determine that certain restricted securities qualified for trading on this newly
developing market are liquid. If the market does not develop as anticipated, or
qualified institutional investors become uninterested for a time, restricted
securities in a fund's portfolio may adversely affect that fund's liquidity.
The assets used as cover for OTC options written by a fund will be
considered illiquid unless the OTC options are sold to qualified dealers who
agree that the fund may repurchase any OTC option it writes at a maximum price
to be calculated by a formula set forth in the option agreement. The cover for
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an OTC option written subject to this procedure would be considered illiquid
only to the extent that the maximum repurchase price under the formula exceeds
the intrinsic value of the option.
DEBT SECURITIES
The prices of debt securities fluctuate in response to perceptions of
the issuer's creditworthiness and also tend to vary inversely with market
interest rates. The value of such securities is likely to decline in times of
rising interest rates. Conversely, when rates fall, the value of these
investments is likely to rise. The longer the time to maturity the greater are
such variations.
Generally, debt securities rated below BBB by Standard & Poor's
("S&P"), or below Baa by Moody's Investors Service, Inc. ("Moody's"), and
unrated securities of comparable quality, offer a higher current yield than that
provided by higher grade issues, but also involve higher risks. Debt securities
rated C by Moody's and S&P are bonds on which no interest is being paid and
which can be regarded as having extremely poor prospects of ever attaining any
real investment standing. Changes in economic conditions or developments
regarding the individual issuer are more likely to cause price volatility and
weaken the capacity of such securities to make principal and interest payments
than is the case for higher grade debt securities. However, debt securities,
regardless of their ratings, generally have a higher priority in the issuer's
capital structure than do equity securities. If an investment grade security
purchased by Value Trust, Total Return Trust, Special Investment Trust or
Financial Services Fund is subsequently given a rating below investment grade,
each fund's adviser will consider that fact in determining whether to retain
that security in that fund's portfolio, but is not required to dispose of it.
The ratings of S&P and Moody's represent the opinions of those agencies. Such
ratings are relative and subjective, and are not absolute standards of quality.
Unrated debt securities are not necessarily of lower quality than rated
securities, but they may not be attractive to as many buyers. A description of
the ratings assigned to corporate debt obligations by Moody's and S&P is
included in Appendix A.
Lower-rated debt securities are especially affected by adverse changes
in the industries in which the issuers are engaged and by changes in the
financial condition of the issuers. Highly leveraged issuers may also experience
financial stress during period of rising interest rates. Lower-rated debt
securities are also sometimes referred to as "junk bonds."
The market for lower-rated debt securities has expanded rapidly in
recent years. This growth has paralleled a long economic expansion. At certain
times in the past, the prices of many lower-rated debt securities declined,
indicating concerns that issuers of such securities might experience financial
difficulties. At those times, the yields on lower-rated debt securities rose
dramatically reflecting the risk that holders of such securities could lose a
substantial portion of their value as a result of the issuer's financial
restructuring or default. There can be no assurance that such declines will not
recur.
The market for lower-rated debt securities is generally thinner and
less active than that for higher quality debt securities, which may limit a
fund's ability to sell such securities at fair value. Judgment plays a greater
role in pricing such securities than is the case for securities having more
active markets. Adverse publicity and investor perceptions, whether or not based
on fundamental analysis, may also decrease the values and liquidity of
lower-rated debt securities, especially in a thinly traded market.
In addition to ratings assigned to individual bond issues, each adviser
will analyze interest rate trends and developments that may affect individual
issuers, including factors such as liquidity, profitability and asset quality.
The yields on bonds and other debt securities in which a fund invests are
dependent on a variety of factors, including general money market conditions,
general conditions in the bond market, the financial conditions of the issuer,
the size of the offering, the maturity of the obligation and its rating. There
may be a wide variation in the quality of bonds, both within a particular
classification and between classifications. A bond issuer's obligations are
subject to the provisions of bankruptcy, insolvency and other laws affecting the
rights and remedies of bond holders or other creditors of an issuer; litigation
or other conditions may also adversely affect the power or ability of bond
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issuers to meet their obligations for the payment of principal and interest.
Regardless of rating levels, all debt securities considered for purchase
(whether rated or unrated) are analyzed by each fund's adviser to determine, to
the extent possible, that the planned investment is sound.
If a security rated A or above at the time of purchase by American
Leading Companies is subsequently downgraded to a rating below A, the fund's
adviser will consider that fact in determining whether to dispose of the
security, but will dispose of it if necessary to insure that no more than 5% of
net assets are invested in debt securities rated below A. If one rating agency
has rated a security A or better and another agency has rated it below A, the
fund's adviser may rely on the higher rating in determining to purchase or
retain the security on behalf of American Leading Companies. Bonds rated A may
be given a "+" or "-" by the rating agency. The fund considers bonds denominated
A, A+ or A- to be included in the rating A.
Financial Services Fund may invest in the debt securities of
governmental or corporate issuers in any rating category of the recognized
rating services, including issues that are in default, and may invest in unrated
debt obligations. Most foreign debt obligations are not rated. Corporate debt
securities may pay fixed or variable rates of interest. These securities may be
convertible into preferred or common equity, or may be bought as part of a unit
containing common stock. Debt securities and securities convertible into common
stock need not necessarily be of a certain grade as determined by rating
agencies such as S&P or Moody's; however, the fund's adviser does consider such
ratings in determining whether the security is an appropriate investment for the
fund.
Financial Services Fund may invest in securities which are in lower
rating categories or are unrated if the adviser determines that the securities
provide the opportunity of meeting the fund's objective without presenting
excessive risk. The adviser will consider all factors which it deems
appropriate, including ratings, in making investment decisions for the fund and
will attempt to minimize investment risks through diversification, investment
analysis and monitoring of general economic conditions and trends. While the
adviser may refer to ratings, it does not rely exclusively on ratings, but makes
its own independent and ongoing review of credit quality.
PREFERRED STOCK
Each fund may purchase preferred stock as a substitute for debt
securities of the same issuer when, in the opinion of its adviser, the preferred
stock is more attractively priced in light of the risks involved. Preferred
stock pays dividends at a specified rate and generally has preference over
common stock in the payment of dividends and the liquidation of the issuer's
assets but is junior to the debt securities of the issuer in those same
respects. Unlike interest payments on debt securities, dividends on preferred
stock are generally payable at the discretion of the issuer's board of
directors. Shareholders may suffer a loss of value if dividends are not paid.
The market prices of preferred stocks are subject to changes in interest rates
and are more sensitive to changes in the issuer's creditworthiness than are the
prices of debt securities. Under normal circumstances, preferred stock does not
carry voting rights.
CONVERTIBLE SECURITIES
A convertible security is a bond, debenture, note, preferred stock or
other security that may be converted into or exchanged for a prescribed amount
of common stock of the same or a different issuer within a particular period of
time at a specified price or formula. A convertible security entitles the holder
to receive interest paid or accrued on debt or the dividend paid on preferred
stock until the convertible security matures or is redeemed, converted or
exchanged. Before conversion, convertible securities ordinarily provide a stream
of income with generally higher yields than those of common stocks of the same
or similar issuers, but lower than the yield of non-convertible debt.
Convertible securities are usually subordinated to comparable-tier
nonconvertible securities but rank senior to common stock in a corporation's
capital structure.
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The value of a convertible security is a function of (1) its yield in
comparison with the yields of other securities of comparable maturity and
quality that do not have a conversion privilege and (2) its worth, at market
value, if converted into the underlying common stock. The price of a convertible
security often reflects variations in the price of the underlying common stock
in a way that non-convertible debt does not. A convertible security may be
subject to redemption at the option of the issuer at a price established in the
convertible security's governing instrument, which may be less than the ultimate
conversion value.
Many convertible securities are rated below investment grade or, if
unrated, are considered of comparable quality. American Leading Companies does
not intend to purchase any convertible securities rated below BB by S&P or below
Ba by Moody's or, if unrated, deemed by the fund's adviser to be of comparable
quality. Moody's describes securities rated Ba as having "speculative elements;
their future cannot be considered 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."
CORPORATE DEBT SECURITIES
Corporate debt securities are bonds or notes issued by corporations and
other business organizations, including business trusts, in order to finance
their credit needs. Corporate debt securities include commercial paper which
consists of short-term (usually from 1 to 270 days) unsecured promissory notes
issued by corporations in order to finance their current operations.
Corporate debt securities may pay fixed or variable rates of interest,
or interest at a rate contingent upon some other factor, such as the price of
some commodity. These securities may be convertible into preferred or common
equity, or may be bought as part of a unit containing common stock. In selecting
corporate debt securities for a fund, the fund's adviser reviews and monitors
the creditworthiness of each issuer and issue. The adviser also analyzes
interest rate trends and specific developments which it believes may affect
individual issuers.
Financial Services Fund may invest in foreign corporate debt securities
denominated in U.S. dollars or foreign currencies. Foreign debt securities
include Yankee dollar obligations (U.S. dollar denominated securities issued by
foreign corporations and traded on U.S. markets) and Eurodollar obligations
(U.S. dollar denominated securities issued by foreign corporations and traded on
foreign markets).
WHEN-ISSUED SECURITIES
Each fund may enter into commitments to purchase securities on a
when-issued basis. Such securities are often the most efficiently priced and
have the best liquidity in the bond market. When a fund purchases securities on
a when-issued basis, it assumes the risks of ownership at the time of the
purchase, not at the time of receipt. However, the fund does not have to pay for
the obligations until they are delivered to it, and no interest accrues to the
fund until they are delivered. This is normally seven to 15 days later, but
could be longer. Use of this practice would have a leveraging effect on a fund.
American Leading Companies does not currently expect that its
commitment to purchase when-issued securities will at any time exceed, in the
aggregate, 5% of its net assets.
When a fund commits to purchase a when-issued security, it will
establish a segregated account with its custodian and maintain cash or
appropriate liquid securities in an amount at least equal in value to that
fund's commitments to purchase when-issued securities.
A fund may sell the securities underlying a when-issued purchase, which
may result in capital gains or losses.
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Indexed Securities (all funds except Financial Services Fund)
------------------
Indexed securities are securities whose prices are indexed to the
prices of securities indices, currencies or other financial statistics. Indexed
securities typically are debt securities or deposits whose value at maturity
and/or coupon rate is determined by reference to a specific instrument or
statistic. The performance of indexed securities fluctuates (either directly or
inversely, depending upon the instrument) with the performance of the index,
security, currency or other instrument to which they are indexed and may also be
influenced by interest rate changes in the U.S. and abroad. At the same time,
indexed securities are subject to the credit risks associated with the issuer of
the security, and their value may substantially decline if the issuer's
creditworthiness deteriorates. Recent issuers of indexed securities have
included banks, corporations and certain U.S. government agencies. The U.S.
Treasury recently began issuing securities whose principal value is indexed to
the Consumer Price Index (also known as "Treasury Inflation-Indexed
Securities"). A fund will only purchase indexed securities of issuers which its
adviser determines present minimal credit risks and will monitor the issuer's
creditworthiness during the time the indexed security is held. The adviser will
use its judgment in determining whether indexed securities should be treated as
short-term instruments, bonds, stock or as a separate asset class for purposes
of each fund's investment allocations, depending on the individual
characteristics of the securities. Each fund currently does not intend to invest
more than 5% of its net assets in indexed securities. Indexed securities may
fluctuate according to a multiple of changes in the underlying instrument and,
in that respect, have a leverage-like effect on a fund.
Senior Securities
-----------------
The 1940 Act prohibits the issuance of senior securities by a
registered open-end fund with one exception. Each fund may borrow from banks
provided that immediately after any such borrowing there is an asset coverage of
at least 300% for all borrowings of the fund. Borrowing for temporary purposes
only and in an amount not exceeding 5% of the value of the total assets of a
fund at the time the borrowing is made is not deemed to be an issuance of a
senior security.
There are various investment techniques which may give rise to an
obligation of a fund to pay in the future about which the SEC has stated it
would not raise senior security concerns, provided the fund maintains segregated
assets in an amount that covers the future payment obligation. Such investment
techniques include, among other things, when-issued securities, forward
contracts and repurchase agreements.
THE FOLLOWING INFORMATION APPLIES TO SPECIAL INVESTMENT TRUST AND SMALL-CAP
VALUE TRUST:
Small and Mid-Sized Company Stocks
----------------------------------
The advisers for Special Investment Trust and Small-Cap Value Trust
believe that the comparative lack of attention by investment analysts and
institutional investors to small and mid-sized companies may result in
opportunities to purchase the securities of such companies at attractive prices
compared to historical or market price-earnings ratios, book value, return on
equity or long-term prospects. Each fund's policy of investing primarily in the
securities of smaller companies differs from the investment approach of many
other mutual funds, and investment in such securities involves special risks.
Among other things, the prices of securities of small and mid-sized companies
generally are more volatile than those of larger companies; the securities of
smaller companies generally are less liquid; and smaller companies generally are
more likely to be adversely affected by poor economic or market conditions.
It is anticipated that some of the portfolio securities of either
Special Investment Trust or Small-Cap Value Trust may not be widely traded, and
that a fund's position in such securities may be substantial in relation to the
market for such securities. Accordingly, it may be difficult for a fund to
dispose of such securities at prevailing market prices in order to meet
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redemptions. However, as a non-fundamental policy, Special Investment Trust and
Small-Cap Value Trust will not invest more than 15% of their respective net
assets in illiquid securities.
Investments in securities of companies with small market
capitalizations are generally considered to offer greater opportunity for
appreciation but also may involve greater risks than customarily are associated
with more established companies. The securities of small companies may be
subject to more abrupt fluctuations in market price than larger, more
established companies. Small companies may have limited product lines, markets
or financial resources, or they may be dependent upon a limited management
group. In addition to exhibiting greater volatility, small company stocks may,
to a degree, fluctuate independently of larger company stocks, i.e., small
company stocks may decline in price as the prices of large company stocks rise
or vice versa.
THE FOLLOWING INFORMATION APPLIES TO BALANCED TRUST AND FINANCIAL SERVICES FUND
(UNLESS OTHERWISE INDICATED):
Mortgage-Related Securities
---------------------------
Mortgage-related securities provide capital for mortgage loans made to
residential homeowners, including securities which represent interests in pools
of mortgage loans made by lenders such as savings and loan institutions,
mortgage bankers, commercial banks and others. Pools of mortgage loans are
assembled for sale to investors (such as the funds) by various governmental,
government-related and private organizations, such as dealers. The market value
of mortgage-related securities will fluctuate as a result of changes in interest
rates and mortgage rates.
Interests in pools of mortgage loans generally provide a monthly
payment which consists of both interest and principal payments. In effect, these
payments are a "pass-through" of the monthly payments made by the individual
borrowers on their residential mortgage loans, net of any fees paid to the
issuer or guarantor of such securities. Additional payments are caused by
repayments of principal resulting from the sale of the underlying residential
property, refinancing or foreclosure, net of fees or costs which may be
incurred. Some mortgage-related securities (such as securities issued by
Government National Mortgage Association ("GNMA")) are described as "modified
pass-through" because they entitle the holder to receive all interest and
principal payments owed on the mortgage pool, net of certain fees, regardless of
whether the mortgagor actually makes the payment.
Commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers and other secondary market issuers, such
as dealers, create pass-through pools of conventional residential mortgage
loans. Such issuers also may be the originators 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 with respect to such pools. However, timely
payment of interest and principal of these pools is supported by various forms
of insurance or guarantees, including individual loan, title, pool and hazard
insurance. There can be no assurance that the private insurers can meet their
obligations under the policies. A fund may buy mortgage-related securities
without insurance or guarantees if, through an examination of the loan
experience and practices of the persons creating the pools, the fund's adviser
determines that the securities are an appropriate investment for the fund.
Another type of security representing an interest in a pool of mortgage
loans is known as a collateralized mortgage obligation ("CMO"). CMOs represent
interests in a short-term, intermediate-term or long-term portion of a mortgage
pool. Each portion of the pool receives monthly interest payments, but the
principal repayments pass through to the short-term CMO first and the long-term
CMO last. A CMO permits an investor to more accurately predict the rate of
principal repayments. CMOs are issued by private issuers, such as
broker/dealers, and by government agencies, such as Fannie Mae and Freddie Mac.
Investments in CMOs are subject to the same risks as direct investments in the
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underlying mortgage-backed securities. In addition, in the event of a bankruptcy
or other default of a broker who issued the CMO held by a fund, the fund could
experience both delays in liquidating its position and losses. Each fund may
invest in CMOs in any rating category of the recognized rating services and may
invest in unrated CMOs. Each fund may also invest in "stripped" CMOs, which
represent only the income portion or the principal portion of the CMO. The
values of stripped CMOs are very sensitive to interest rate changes;
accordingly, these instruments present a greater risk of loss than conventional
mortgage-backed securities.
Each fund's adviser expects that governmental, government-related or
private entities may create mortgage loan pools offering pass-through
investments in addition to those described above. The mortgages underlying these
securities may be second mortgages or alternative mortgage instruments (for
example, mortgage instruments whose principal or interest payments may vary or
whose terms to maturity may differ from customary long-term fixed rate
mortgages). As new types of mortgage-related securities are developed and
offered to investors, each fund's adviser will, consistent with the fund's
investment objective and policies, consider making investments in such new types
of securities. The Prospectuses will be amended with any necessary additional
disclosure prior to a fund investing in such securities.
The average life of securities representing interests in pools of
mortgage loans is likely to be substantially less than the original maturity of
the mortgage pools as a result of prepayments or foreclosures of such mortgages.
Prepayments are passed through to the registered holder with the regular monthly
payments of principal and interest, and have the effect of reducing future
payments. To the extent the mortgages underlying a security representing an
interest in a pool of mortgages are prepaid, a fund may experience a loss (if
the price at which the respective security was acquired by the fund was at a
premium over par, which represents the price at which the security will be
redeemed upon prepayment) or a gain (if the price at which the respective
security was acquired by the fund was at a discount from par). In addition,
prepayments of such securities held by a fund will reduce the share price of the
fund to the extent the market value of the securities at the time of prepayment
exceeds their par value, and will increase the share price of the fund to the
extent the par value of the securities exceeds their market value at the time of
prepayment. Prepayments may occur with greater frequency in periods of declining
mortgage rates because, among other reasons, it may be possible for mortgagors
to refinance their outstanding mortgages at lower interest rates. When market
interest rates increase, the market values of mortgage-backed securities
decline. At the same time, however, mortgage refinancing slows, which lengthens
the effective maturities of these securities. As a result, the negative effect
of the rate increase on the market value of mortgage securities is usually more
pronounced than it is for other types of fixed-income securities.
Although the market for mortgage-related securities issued by private
organizations is becoming increasingly liquid, such securities may not be
readily marketable. A fund will not purchase mortgage-related securities for
which there is no established market (including CMOs and direct investments in
mortgages as described below) or any other investments which the fund's adviser
deems to be illiquid pursuant to criteria established by the fund's Board of
Directors if, as a result, more than 10% of the value of the fund's net assets
would be invested in such illiquid securities and investments.
Government-related organizations which issue mortgage-related
securities include GNMA, Fannie Mae and Freddie Mac. Securities issued by GNMA
and Fannie Mae are fully modified pass-through securities, i.e., the timely
payment of principal and interest is guaranteed by the issuer. Freddie Mac
securities are modified pass-through securities, i.e., the timely payment of
interest is guaranteed by Freddie Mac, principal is passed through as collected
but payment thereof is guaranteed not later than one year after it becomes
payable.
In determining the dollar-weighted average maturity of the fixed income
portion of the portfolio, Bartlett, investment adviser to Balanced Trust, will
follow industry practice in assigning an average life to the mortgage-related
securities of the fund unless the interest rate on the mortgages underlying such
securities is such that Bartlett believes a different prepayment rate is likely.
For example, where a GNMA has a high interest rate relative to the market, that
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GNMA is likely to have a shorter overall maturity than a GNMA with a market rate
coupon. Moreover, Bartlett may deem it appropriate to change the projected
average life for the fund's mortgage-related security as a result of
fluctuations in market interest rates and other factors.
Financial Services Fund may invest no more than 5% of its net assets in
mortgage-related securities.
Municipal Lease Obligations (Balanced Trust only)
---------------------------
The municipal obligations in which the fund may invest include
municipal leases and participation interests therein. These obligations, which
may take the form of a lease, an installment purchase or a conditional sales
contract, are issued by state and local governments and authorities to acquire
land and a wide variety of equipment and facilities, such as fire and sanitation
vehicles, telecommunications equipment and other capital assets. Rather than
holding such obligations directly, the fund may purchase a participation
interest in a municipal lease obligation from a bank or other third party. A
participation interest gives the fund a specified, undivided pro-rata interest
in the total amount of the obligation.
Municipal lease obligations have risks distinct from those associated
with general obligation or revenue bonds. State constitutions and statutes set
forth requirements that states or municipalities must meet to incur debt. These
may include voter referenda, interest rate limits or public sale requirements.
Leases, installment purchase or conditional sale contracts (which normally
provide for title to the leased asset to pass to the governmental issuer) have
evolved as a means for governmental issuers to acquire property and equipment
without meeting their constitutional and statutory requirements for the issuance
of debt. The debt-issuance limitations are deemed inapplicable because of the
inclusion in many leases and contracts of "non-appropriation" clauses providing
that the governmental user has no obligation to make future payments under the
lease or contract unless money is appropriated for such purpose by the
appropriate legislative body on a yearly or other periodic basis.
In determining the liquidity of a municipal lease obligation, the
fund's adviser will distinguish between simple or direct municipal leases and
municipal lease-backed securities, the latter of which may take the form of a
lease-backed revenue bond or other investment structure using a municipal
lease-purchase agreement as its base. While the former may present special
liquidity issues, the latter are based on a well established method of securing
payment of a municipal obligation. The fund's investment in municipal lease
obligations and participation interests therein will be treated as illiquid
unless the fund's adviser determines, pursuant to guidelines established by the
Board of Directors, that the security could be disposed of within seven days in
the normal course of business at approximately the amount at which the fund has
valued the security.
An issuer's obligations under its municipal obligations are subject to
the provisions of bankruptcy, insolvency and other laws affecting the rights and
remedies of creditors, such as the Bankruptcy Code, and laws that may be enacted
by Congress or state legislatures extending the time for payment of principal or
interest, or both, or imposing other constraints upon enforcement of such
obligations. There is also the possibility that as a result of litigation or
other conditions the power or ability of issuers to meet their obligations for
the payment of interest and principal on their municipal obligations may be
materially and adversely affected.
THE FOLLOWING INFORMATION APPLIES TO VALUE TRUST, TOTAL RETURN TRUST, SPECIAL
INVESTMENT TRUST, BALANCED TRUST AND SMALL-CAP VALUE TRUST: (SMALL-CAP VALUE
TRUST DOES NOT CURRENTLY INTEND TO INVEST IN FUTURES AND OPTIONS.) AS NOTED
BELOW, FINANCIAL SERVICES FUND MAY INVEST IN FORWARD CURRENCY CONTRACTS.
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Options, Futures and Other Strategies
-------------------------------------
GENERAL. Each fund may invest in certain options, futures contracts
(sometimes referred to as "futures"), options on futures contracts, forward
currency contracts, swaps, caps, floors, collars, indexed securities and other
derivative instruments (collectively, "Financial Instruments") to attempt to
enhance its income or yield or to attempt to hedge its investments. The
strategies described below may be used in an attempt to manage a fund's foreign
currency exposure (including exposure to the Euro) as well as other risks of a
fund's investments that can affect its net asset value. Each fund may utilize
futures contracts and options to a limited extent. Specifically, a fund may
enter into futures contracts and related options provided that not more than 5%
of its net assets are required as a futures contract deposit and/or premium; in
addition, a fund may not enter into futures contracts or related options if, as
a result, more than 20% of the fund's total assets would be so invested.
Generally, each fund may purchase and sell any type of Financial
Instrument. However, as an operating policy, a fund will only purchase or sell a
particular Financial Instrument if the fund is authorized to invest in the type
of asset by which the return on, or value of, the Financial Instrument is
primarily measured. Since each fund is authorized to invest in foreign
securities, each fund may purchase and sell foreign currency and Euro
derivatives. However, a fund will only invest in foreign currency derivatives in
connection with the fund's investment in securities denominated in that
currency.
Hedging strategies can be broadly categorized as "short hedges" and
"long hedges." A short hedge is a purchase or sale of a Financial Instrument
intended partially or fully to offset potential declines in the value of one or
more investments held in a fund's portfolio. Thus, in a short hedge a fund takes
a position in a Financial Instrument whose price is expected to move in the
opposite direction of the price of the investment being hedged.
Conversely, a long hedge is a purchase or sale of a Financial
Instrument intended partially or fully to offset potential increases in the
acquisition cost of one or more investments that a fund intends to acquire.
Thus, in a long hedge, a fund takes a position in a Financial Instrument whose
price is expected to move in the same direction as the price of the prospective
investment being hedged. A long hedge is sometimes referred to as an
anticipatory hedge. In an anticipatory hedge transaction, a fund does not own a
corresponding security and, therefore, the transaction does not relate to a
security the fund owns. Rather, it relates to a security that the fund intends
to acquire. If the fund does not complete the hedge by purchasing the security
it anticipated purchasing, the effect on the fund's portfolio is the same as if
the transaction were entered into for speculative purposes.
Financial Instruments on securities generally are used to attempt to
hedge against price movements in one or more particular securities positions
that a fund owns or intends to acquire. Financial Instruments on indices, in
contrast, generally are used to attempt to hedge against price movements in
market sectors in which a fund has invested or expects to invest. Financial
Instruments on debt securities may be used to hedge either individual securities
or broad debt market sectors.
The use of Financial Instruments is subject to applicable regulations
of the SEC, the several exchanges upon which they are traded and the Commodity
Futures Trading Commission (the "CFTC"). In addition, a fund's ability to use
Financial Instruments may be limited by tax considerations. See "Additional Tax
Information."
In addition to the instruments, strategies and risks described below,
the advisers expect to discover additional opportunities in connection with
Financial Instruments and other similar or related techniques. These new
opportunities may become available as the advisers develop new techniques, as
regulatory authorities broaden the range of permitted transactions and as new
Financial Instruments or other techniques are developed. The advisers may
utilize these opportunities to the extent that they are consistent with a fund's
investment objective and permitted by its investment limitations and applicable
regulatory authorities. A fund might not use any of these strategies, and there
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can be no assurance that any strategy used will succeed. The funds' Prospectuses
or this Statement of Additional Information will be supplemented to the extent
that new products or techniques involve materially different risks than those
described below or in the Prospectuses.
SPECIAL RISKS. The use of Financial Instruments involves special
considerations and risks, certain of which are described below. In general,
these techniques may increase the volatility of a fund and may involve a small
investment of cash relative to the magnitude of the risk assumed. Risks
pertaining to particular Financial Instruments are described in the sections
that follow.
(1) Successful use of most Financial Instruments depends upon an
adviser's ability to predict movements of the overall
securities, currency and interest rate markets, which requires
different skills than predicting changes in the prices of
individual securities. There can be no assurance that any
particular strategy will succeed, and use of Financial
Instruments could result in a loss, regardless of whether the
intent was to reduce risk or increase return.
(2) There might be imperfect correlation, or even no correlation,
between price movements of a Financial Instrument and price
movements of the investments being hedged. For example, if the
value of a Financial Instrument used in a short hedge
increased by less than the decline in value of the hedged
investment, the hedge would not be fully successful. Such a
lack of correlation might occur due to factors unrelated to
the value of the investments being hedged, such as speculative
or other pressures on the markets in which Financial
Instruments are traded. The effectiveness of hedges using
Financial Instruments on indices will depend on the degree of
correlation between price movements in the index and price
movements in the securities being hedged.
Because there is a limited number of types of exchange-traded options
and futures contracts, it is likely that the standardized contracts available
will not match a fund's current or anticipated investments exactly. A fund may
invest in options and futures contracts based on securities with different
issuers, maturities or other characteristics from the securities in which it
typically invests, which involves a risk that the options or futures position
will not track the performance of the fund's other investments.
Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instruments match a fund's
investments well. Options and futures prices are affected by such factors as
current and anticipated short-term interest rates, changes in volatility of the
underlying instrument, and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation may
also result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, or from imposition of daily price fluctuation
limits or trading halts. A fund may purchase or sell options and futures
contracts with a greater or lesser value than the securities it wishes to hedge
or intends to purchase in order to attempt to compensate for differences in
volatility between the contract and the securities, although this may not be
successful in all cases. If price changes in a fund's options or futures
positions are poorly correlated with its other investments, the positions may
fail to produce anticipated gains or result in losses that are not offset by
gains in other investments.
(3) If successful, the above-discussed strategies can reduce risk
of loss by wholly or partially offsetting the negative effect
of unfavorable price movements. However, such strategies can
also reduce opportunity for gain by offsetting the positive
effect of favorable price movements. For example, if a fund
entered into a short hedge because its adviser projected a
decline in the price of a security in the fund's portfolio,
and the price of that security increased instead, the gain
from that increase might be wholly or partially offset by a
decline in the price of the Financial Instrument. Moreover, if
the price of the Financial Instrument declined by more than
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the increase in the price of the security, the fund could
suffer a loss. In either such case, the fund would have been
in a better position had it not attempted to hedge at all.
(4) As described below, a fund might be required to maintain
assets as "cover," maintain segregated accounts or make margin
payments when it takes positions in Financial Instruments
involving obligations to third parties (i.e., Financial
Instruments other than purchased options). If a fund were
unable to close out its positions in such Financial
Instruments, it might be required to continue to maintain such
assets or accounts or make such payments until the position
expired or matured. These requirements might impair a fund's
ability to sell a portfolio security or make an investment at
a time when it would otherwise be favorable to do so, or
require that the fund sell a portfolio security at a
disadvantageous time.
(5) A fund's ability to close out a position in a Financial
Instrument prior to expiration or maturity depends on the
existence of a liquid secondary market or, in the absence of
such a market, the ability and willingness of the other party
to the transaction (the "counterparty") to enter into a
transaction closing out the position. Therefore, there is no
assurance that any position can be closed out at a time and
price that is favorable to a fund.
COVER. Transactions using Financial Instruments, other than purchased
options, expose a fund to an obligation to another party. A fund will not enter
into any such transactions unless it owns either (1) an offsetting ("covered")
position in securities, currencies or other options, futures contracts or
forward contracts, or (2) cash and liquid assets with a value, marked-to-market
daily, sufficient to cover its potential obligations to the extent not covered
as provided in (1) above. Each fund will comply with SEC guidelines regarding
cover for these instruments and will, if the guidelines so require, set aside
cash or liquid assets in an account with its custodian in the prescribed amount
as determined daily.
Assets used as cover or held in an account cannot be sold while the
position in the corresponding Financial Instrument is open, unless they are
replaced with other appropriate assets. As a result, the commitment of a large
portion of a fund's assets to cover in accounts could impede portfolio
management or the fund's ability to meet redemption requests or other current
obligations.
OPTIONS. A call option gives the purchaser the right to buy, and
obligates the writer to sell, the underlying investment at the agreed-upon price
during the option period. A put option gives the purchaser the right to sell,
and obligates the writer to buy, the underlying investment at the agreed-upon
price during the option period. Purchasers of options pay an amount, known as a
premium, to the option writer in exchange for the right under the option
contract.
The purchase of call options can serve as a long hedge, and the
purchase of put options can serve as a short hedge. Writing put or call options
can enable a fund to enhance income or yield by reason of the premiums paid by
the purchasers of such options. However, if the market price of the security
underlying a put option declines to less than the exercise price of the option,
minus the premium received, a fund would expect to suffer a loss.
Writing call options can serve as a limited short hedge, because
declines in the value of the hedged investment would be offset to the extent of
the premium received for writing the option. However, if the security or
currency appreciates to a price higher than the exercise price of the call
option, it can be expected that the option will be exercised and the fund will
be obligated to sell the security or currency at less than its market value. If
the call option is an OTC option, the securities or other assets used as cover
would be considered illiquid to the extent described under "Illiquid and
Restricted Investments."
Writing put options can serve as a limited long hedge because increases
in the value of the hedged investment would be offset to the extent of the
premium received for writing the option. However, if the security or currency
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depreciates to a price lower than the exercise price of the put option, it can
be expected that the put option will be exercised and the fund will be obligated
to purchase the security or currency at more than its market value. If the put
option is an OTC option, the securities or other assets used as cover would be
considered illiquid to the extent described under "Illiquid and Restricted
Investments."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options that expire unexercised have
no value.
Each fund may effectively terminate its right or obligation under an
option by entering into a closing transaction. For example, a fund may terminate
its obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, a fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a closing
sale transaction. Closing transactions permit a fund to realize profits or limit
losses on an option position prior to its exercise or expiration.
A type of put that a fund may purchase is an "optional delivery standby
commitment," which is entered into by parties selling debt securities to the
fund. An optional delivery standby commitment gives a fund the right to sell the
security back to the seller on specified terms. This right is provided as an
inducement to purchase the security.
RISKS OF OPTIONS ON SECURITIES. Options offer large amounts of
leverage, which will result in a fund's net asset value being more sensitive to
changes in the value of the related instrument. Each fund may purchase or write
both exchange-traded and OTC options. Exchange-traded options in the United
States are issued by a clearing organization affiliated with the exchange on
which the option is listed that, in effect, guarantees completion of every
exchange-traded option transaction. In contrast, OTC options are contracts
between a fund and its counterparty (usually a securities dealer or a bank) with
no clearing organization guarantee. Thus, when a fund purchases an OTC option,
it relies on the counterparty from whom it purchased the option to make or take
delivery of the underlying investment upon exercise of the option. Failure by
the counterparty to do so would result in the loss of any premium paid by a fund
as well as the loss of any expected benefit of the transaction.
Each fund's ability to establish and close out positions in
exchange-listed options depends on the existence of a liquid market. However,
there can be no assurance that such a market will exist at any particular time.
Closing transactions can be made for OTC options only by negotiating directly
with the counterparty, or by a transaction in the secondary market if any such
market exists. There can be no assurance that a fund will in fact be able to
close out an OTC option position at a favorable price prior to expiration. In
the event of insolvency of the counterparty, a fund might be unable to close out
an OTC option position at any time prior to its expiration.
If a fund were unable to effect a closing transaction for an option it
had purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered call option
written by a fund could cause material losses because the fund would be unable
to sell the investment used as cover for the written option until the option
expires or is exercised.
OPTIONS ON INDICES. Puts and calls on indices are similar to puts and
calls on securities or futures contracts except that all settlements are in cash
and gain or loss depends on changes in the index in question rather than on
price movements in individual securities or futures contracts. When a fund
writes a call on an index, it receives a premium and agrees that, prior to the
expiration date, the purchaser of the call, upon exercise of the call, will
receive from the fund an amount of cash if the closing level of the index upon
which the call is based is greater than the exercise price of the call. The
amount of cash is equal to the difference between the closing price of the index
and the exercise price of the call times a specified multiple ("multiplier"),
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which determines the total dollar value for each point of such difference. When
a fund buys a call on an index, it pays a premium and has the same rights as to
such call as are indicated above. When a fund buys a put on an index, it pays a
premium and has the right, prior to the expiration date, to require the seller
of the put, upon the fund's exercise of the put, to deliver to the fund an
amount of cash if the closing level of the index upon which the put is based is
less than the exercise price of the put, which amount of cash is determined by
the multiplier, as described above for calls. When a fund writes a put on an
index, it receives a premium and the purchaser of the put has the right, prior
to the expiration date, to require the fund to deliver to it an amount of cash
equal to the difference between the closing level of the index and exercise
price times the multiplier if the closing level is less than the exercise price.
RISKS OF OPTIONS ON INDICES. The risks of investment in options on
indices may be greater than options on securities. Because index options are
settled in cash, when a fund writes a call on an index it cannot provide in
advance for its potential settlement obligations by acquiring and holding the
underlying securities. A fund can offset some of the risk of writing a call
index option by holding a diversified portfolio of securities similar to those
on which the underlying index is based. However, a fund cannot, as a practical
matter, acquire and hold a portfolio containing exactly the same securities as
underlie the index and, as a result, bears a risk that the value of the
securities held will vary from the value of the index.
Even if a fund could assemble a portfolio that exactly reproduced the
composition of the underlying index, it still would not be fully covered from a
risk standpoint because of the "timing risk" inherent in writing index options.
When an index option is exercised, the amount of cash that the holder is
entitled to receive is determined by the difference between the exercise price
and the closing index level on the date when the option is exercised. As with
other kinds of options, a fund as the call writer will not learn that the fund
has been assigned until the next business day at the earliest. The time lag
between exercise and notice of assignment poses no risk for the writer of a
covered call on a specific underlying security, such as common stock, because
there the writer's obligation is to deliver the underlying security, not to pay
its value as of a fixed time in the past. So long as the writer already owns the
underlying security, it can satisfy its settlement obligations by simply
delivering it, and the risk that its value may have declined since the exercise
date is borne by the exercising holder. In contrast, even if the writer of an
index call holds securities that exactly match the composition of the underlying
index, it will not be able to satisfy its assignment obligations by delivering
those securities against payment of the exercise price. Instead, it will be
required to pay cash in an amount based on the closing index value on the
exercise date. By the time it learns that it has been assigned, the index may
have declined, with a corresponding decline in the value of its portfolio. This
"timing risk" is an inherent limitation on the ability of index call writers to
cover their risk exposure by holding securities positions.
If a fund has purchased an index option and exercises it before the
closing index value for that day is available, it runs the risk that the level
of the underlying index may subsequently change. If such a change causes the
exercised option to fall out-of-the-money, a fund will be required to pay the
difference between the closing index value and the exercise price of the option
(times the applicable multiplier) to the assigned writer.
OTC OPTIONS. Unlike exchange-traded options, which are standardized
with respect to the underlying instrument, expiration date, contract size, and
strike price, the terms of OTC options (options not traded on exchanges)
generally are established through negotiation with the other party to the option
contract. While this type of arrangement allows a fund great flexibility to
tailor the option to its needs, OTC options generally involve greater risk than
exchange-traded options, which are guaranteed by the clearing organization of
the exchanges where they are traded.
Generally, OTC foreign currency options used by each fund are
European-style options. This means that the option is only exercisable
immediately prior to its expiration. This is in contrast to American-style
options, which are exercisable at any time prior to the expiration date of the
option.
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FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. The purchase of
futures or call options on futures can serve as a long hedge, and the sale of
futures or the purchase of put options on futures can serve as a short hedge.
Writing call options on futures contracts can serve as a limited short hedge,
using a strategy similar to that used for writing call options on securities or
indices. Similarly, writing put options on futures contracts can serve as a
limited long hedge. Futures contracts and options on futures contracts can also
be purchased and sold to attempt to enhance income or yield.
In addition, futures strategies can be used to manage the average
duration of a fund's fixed-income portfolio. If an adviser wishes to shorten the
average duration of a fund's fixed-income portfolio, the fund may sell a debt
futures contract or a call option thereon, or purchase a put option on that
futures contract. If an adviser wishes to lengthen the average duration of a
fund's fixed-income portfolio, the fund may buy a debt futures contract or a
call option thereon, or sell a put option thereon.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract a fund is required to deposit "initial margin"
in an amount generally equal to 10% or less of the contract value. Margin must
also be deposited when writing a call or put option on a futures contract, in
accordance with applicable exchange rules. Unlike margin in securities
transactions, initial margin on futures contracts does not represent a
borrowing, but rather is in the nature of a performance bond or good-faith
deposit that is returned to the fund at the termination of the transaction if
all contractual obligations have been satisfied. Under certain circumstances,
such as periods of high volatility, a fund may be required by an exchange to
increase the level of its initial margin payment, and initial margin
requirements might be increased generally in the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking-to-market." Variation margin does not involve borrowing, but rather
represents a daily settlement of a fund's obligations to or from a futures
broker. When a fund purchases an option on a futures contract, the premium paid
plus transaction costs is all that is at risk. In contrast, when a fund
purchases or sells a futures contract or writes a call or put option thereon, it
is subject to daily variation margin calls that could be substantial in the
event of adverse price movements. If a fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous.
Purchasers and sellers of futures contracts and options on futures can
enter into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument purchased or sold. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
However, there can be no assurance that a liquid secondary market will exist for
a particular contract at a particular time. In such event, it may not be
possible to close a futures contract or options position.
Under certain circumstances, futures exchanges may establish daily
limits on the amount that the price of a futures contract or an option on a
futures contract can vary from the previous day's settlement price; once that
limit is reached, no trades may be made that day at a price beyond the limit.
Daily price limits do not limit potential losses because prices could move to
the daily limit for several consecutive days with little or no trading, thereby
preventing liquidation of unfavorable positions.
If a fund were unable to liquidate a futures contract or an option on a
futures position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The fund would
continue to be subject to market risk with respect to the position. In addition,
except in the case of purchased options, the fund would continue to be required
to make daily variation margin payments and might be required to maintain the
position being hedged by the future or option or to maintain cash or securities
in a segregated account.
RISKS OF FUTURES CONTRACTS AND OPTIONS THEREON. The ordinary spreads
between prices in the cash and futures markets (including the options on futures
market), due to differences in the natures of those markets, are subject to the
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following factors, which may create distortions. First, all participants in the
futures market are subject to margin deposit and maintenance requirements.
Rather than meeting additional margin deposit requirements, investors may close
futures contracts through offsetting transactions, which could distort the
normal relationship between the cash and futures markets. Second, the liquidity
of the futures market depends on participants entering into offsetting
transactions rather than making or taking delivery. To the extent participants
decide to make or take delivery, liquidity in the futures market could be
reduced, thus producing distortion. Third, from the point of view of
speculators, the deposit requirements in the futures market are less onerous
than margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may cause temporary price
distortions. Due to the possibility of distortion, a correct forecast of general
interest rate, currency exchange rate or stock market trends by an adviser may
still not result in a successful transaction. An adviser may be incorrect in its
expectations as to the extent of various interest rate, currency exchange rate
or stock market movements or the time span within which the movements take
place.
INDEX FUTURES. The risk of imperfect correlation between movements in
the price of index futures and movements in the price of the securities that are
the subject of the hedge increases as the composition of a fund's portfolio
diverges from the securities included in the applicable index. The price of the
index futures may move more than or less than the price of the securities being
hedged. If the price of the index futures moves less than the price of the
securities that are the subject of the hedge, the hedge will not be fully
effective, but if the price of the securities being hedged has moved in an
unfavorable direction, a fund would be in a better position than if it had not
hedged at all. If the price of the securities being hedged has moved in a
favorable direction, this advantage will be partially offset by the futures
contract. If the price of the futures contract moves more than the price of the
securities, a fund will experience either a loss or a gain on the futures
contract that will not be completely offset by movements in the price of the
securities that are the subject of the hedge. To compensate for the imperfect
correlation of movements in the price of the securities being hedged and
movements in the price of the index futures, a fund may buy or sell index
futures in a greater dollar amount than the dollar amount of the securities
being hedged if the historical volatility of the prices of such securities being
hedged is more than the historical volatility of the prices of the securities
included in the index. It is also possible that, where a fund has sold index
futures contracts to hedge against decline in the market, the market may advance
and the value of the securities held in the portfolio may decline. If this
occurred, the fund would lose money on the futures contract and also experience
a decline in value of its portfolio securities. However, while this could occur
for a very brief period or to a very small degree, over time the value of a
diversified portfolio of securities will tend to move in the same direction as
the market indices on which the futures contracts are based.
Where index futures are purchased to hedge against a possible increase
in the price of securities before a fund is able to invest in them in an orderly
fashion, it is possible that the market may decline instead. If the fund then
concludes not to invest in them at that time because of concern as to possible
further market decline or for other reasons, it will realize a loss on the
futures contract that is not offset by a reduction in the price of the
securities it had anticipated purchasing.
To the extent that a fund enters into futures contracts, options on
futures contracts and options on foreign currencies traded on a CFTC-regulated
exchange that are not for bona fide hedging purposes (as defined by the CFTC),
the aggregate initial margin and premiums required to establish these positions
(excluding the amount by which options are "in-the-money" at the time of
purchase) may not exceed 5% of the liquidation value of the fund's portfolio,
after taking into account unrealized profits and unrealized losses on any
contracts the fund has entered into. (In general, a call option on a futures
contract is "in-the-money" if the value of the underlying futures contract
exceeds the strike, i.e., exercise, price of the call; a put option on a futures
contract is "in-the-money" if the value of the underlying futures contract is
exceeded by the strike price of the put.) This policy does not limit to 5% the
percentage of a fund's assets that are at risk in futures contracts, options on
futures contracts and currency options.
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FOREIGN CURRENCY HEDGING STRATEGIES -- SPECIAL CONSIDERATIONS. Each
fund may use options and futures contracts on foreign currencies (including the
Euro), as described above and forward currency contracts, as described below, to
attempt to hedge against movements in the values of the foreign currencies in
which that fund's securities are denominated or to attempt to enhance income or
yield. Currency hedges can protect against price movements in a security that a
fund owns or intends to acquire that are attributable to changes in the value of
the currency in which it is denominated. Such hedges do not, however, protect
against price movements in the securities that are attributable to other causes.
Each fund might seek to hedge against changes in the value of a
particular currency when no Financial Instruments on that currency are available
or such Financial Instruments are more expensive than certain other Financial
Instruments. In such cases, the fund may seek to hedge against price movements
in that currency by entering into transactions using Financial Instruments on
another currency or a basket of currencies, the value of which the fund's
adviser believes will have a high degree of positive correlation to the value of
the currency being hedged. The risk that movements in the price of the Financial
Instrument will not correlate perfectly with movements in the price of the
currency subject to the hedging transaction is magnified when this strategy is
used.
The value of Financial Instruments on foreign currencies depends on the
value of the underlying currency relative to the U.S. dollar. Because foreign
currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such Financial
Instruments, a fund could be disadvantaged by having to deal in the odd lot
market (generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than for round
lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the Financial Instruments until they reopen.
Settlement of hedging transactions involving foreign currencies might
be required to take place within the country issuing the underlying currency.
Thus, a fund might be required to accept or make delivery of the underlying
foreign currency in accordance with any U.S. or foreign regulations regarding
the maintenance of foreign banking arrangements by U.S. residents and might be
required to pay any fees, taxes and charges associated with such delivery
assessed in the issuing country.
FORWARD CURRENCY CONTRACTS. Each fund, including Financial Services
Fund, may enter into forward currency contracts to purchase or sell foreign
currencies for a fixed amount of U.S. dollars or another foreign currency. A
forward currency contract involves an obligation to purchase or sell a specific
currency at a future date, which may be any fixed number of days (term) from the
date of the forward currency contract agreed upon by the parties, at a price set
at the time of the forward currency contract. These forward currency contracts
are traded directly between currency traders (usually large commercial banks)
and their customers.
Such transactions may serve as long hedges; for example, a fund may
purchase a forward currency contract to lock in the U.S. dollar price of a
security denominated in a foreign currency that the fund intends to acquire.
Forward currency contract transactions may also serve as short hedges; for
example, a fund may sell a forward currency contract to lock in the U.S. dollar
equivalent of the proceeds from the anticipated sale of a security, dividend or
interest payment denominated in a foreign currency.
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Each fund may also use forward currency contracts to hedge against a
decline in the value of existing investments denominated in foreign currency.
For example, if a fund owned securities denominated in Euros, it could enter
into a forward currency contract to sell Euros in return for U.S. dollars to
hedge against possible declines in the Euro's value. Such a hedge, sometimes
referred to as a "position hedge," would tend to offset both positive and
negative currency fluctuations, but would not offset changes in security values
caused by other factors. A fund could also hedge the position by selling another
currency expected to perform similarly to the Euro. This type of hedge,
sometimes referred to as a "proxy hedge," could offer advantages in terms of
cost, yield or efficiency, but generally would not hedge currency exposure as
effectively as a simple hedge into U.S. dollars. Proxy hedges may result in
losses if the currency used to hedge does not perform similarly to the currency
in which the hedged securities are denominated.
The cost to a fund of engaging in forward currency contracts varies
with factors such as the currency involved, the length of the contract period
and the market conditions then prevailing. Because forward currency contracts
are usually entered into on a principal basis, no fees or commissions are
involved. When a fund enters into a forward currency contract, it relies on the
counterparty to make or take delivery of the underlying currency at the maturity
of the contract. Failure by the counterparty to do so would result in the loss
of any expected benefit of the transaction.
As is the case with futures contracts, parties to forward currency
contracts can enter into offsetting closing transactions, similar to closing
transactions on futures contracts, by selling or purchasing, respectively, an
instrument identical to the instrument purchased or sold. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the counterparty. Thus, there can be no assurance
that a fund will in fact be able to close out a forward currency contract at a
favorable price prior to maturity. In addition, in the event of insolvency of
the counterparty, a fund might be unable to close out a forward currency
contract at any time prior to maturity. In either event, a fund would continue
to be subject to market risk with respect to the position, and would continue to
be required to maintain a position in securities denominated in the foreign
currency or to maintain cash or liquid assets in an account.
The precise matching of forward currency contract amounts and the value
of the securities involved generally will not be possible because the value of
such securities, measured in the foreign currency, will change after the forward
currency contract has been established. Thus, a fund might need to purchase or
sell foreign currencies in the spot (cash) market to the extent such foreign
currencies are not covered by forward currency contracts. The projection of
short-term currency market movements is extremely difficult, and the successful
execution of a short-term hedging strategy is highly uncertain.
Successful use of forward currency contracts depends on an adviser's
skill in analyzing and predicting currency values. Forward currency contracts
may substantially change a fund's exposure to changes in currency exchange rates
and could result in losses to the fund if currencies do not perform as the
fund's adviser anticipates. There is no assurance that an adviser's use of
forward currency contracts will be advantageous to the fund or that the adviser
will hedge at an appropriate time.
COMBINED POSITIONS. Each fund may purchase and write options in
combination with each other, or in combination with futures or forward
contracts, to adjust the risk and return characteristics of its overall
position. For example, a fund may purchase a put option and write a call option
on the same underlying instrument, in order to construct a combined position
whose risk and return characteristics are similar to selling a futures contract.
Another possible combined position would involve writing a call option at one
strike price and buying a call option at a lower price, in order to reduce the
risk of the written call option in the event of a substantial price increase.
Because combined options positions involve multiple trades, they result in
higher transaction costs and may be more difficult to open and close out.
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TURNOVER. Each fund's options and futures activities may affect its
turnover rate and brokerage commission payments. The exercise of calls or puts
written by a fund, and the sale or purchase of futures contracts, may cause it
to sell or purchase related investments, thus increasing its turnover rate. Once
a fund has received an exercise notice on an option it has written, it cannot
effect a closing transaction in order to terminate its obligation under the
option and must deliver or receive the underlying securities at the exercise
price. The exercise of puts purchased by a fund may also cause the sale of
related investments, also increasing turnover; although such exercise is within
the fund's control, holding a protective put might cause it to sell the related
investments for reasons that would not exist in the absence of the put. A fund
will pay a brokerage commission each time it buys or sells a put or call or
purchases or sells a futures contract. Such commissions may be higher than those
that would apply to direct purchases or sales.
SWAPS, CAPS, FLOORS AND COLLARS. Each fund may enter into swaps, caps,
floors and collars to preserve a return or a spread on a particular investment
or portion of its portfolio, to protect against any increase in the price of
securities the fund anticipates purchasing at a later date or to attempt to
enhance yield. A swap involves the exchange by a fund with another party of
their respective commitments to pay or receive cash flows, e.g., an exchange of
floating rate payments for fixed-rate payments. The purchase of a cap entitles
the purchaser, to the extent that a specified index exceeds a predetermined
value, to receive payments on a notional principal amount from the party selling
the cap. The purchase of a floor entitles the purchaser, to the extent that a
specified index falls below a predetermined value, to receive payments on a
notional principal amount from the party selling the floor. A collar combines
elements of buying a cap and selling a floor.
Swap agreements, including caps, floors and collars, can be
individually negotiated and structured to include exposure to a variety of
different types of investments or market factors. Depending on their structure,
swap agreements may increase or decrease the overall volatility of a fund's
investments and its share price and yield because, and to the extent, these
agreements affect the fund's exposure to long- or short-term interest rates (in
the United States or abroad), foreign currency values, mortgage-backed security
values, corporate borrowing rates or other factors such as security prices or
inflation rates.
Swap agreements will tend to shift a fund's investment exposure from
one type of investment to another. For example, if a fund agrees to exchange
payments in U.S. dollars for payments in foreign currency, the swap agreement
would tend to decrease the fund's exposure to U.S. interest rates and increase
its exposure to foreign currency and interest rates. Caps and floors have an
effect similar to buying or writing options.
The creditworthiness of firms with which a fund enters into swaps,
caps, floors or collars will be monitored by its adviser. If a firm's
creditworthiness declines, the value of the agreement would be likely to
decline, potentially resulting in losses. If a default occurs by the other party
to such transaction, the fund will have contractual remedies pursuant to the
agreements related to the transaction.
The net amount of the excess, if any, of a fund's obligations over its
entitlements with respect to each swap will be accrued on a daily basis and an
amount of cash or liquid assets having an aggregate net asset value at least
equal to the accrued excess will be maintained in an account with the fund's
custodian that satisfies the requirements of the 1940 Act. A fund will also
establish and maintain such accounts with respect to its total obligations under
any swaps that are not entered into on a net basis and with respect to any caps
or floors that are written by the fund. The advisers and the funds believe that
such obligations do not constitute senior securities under the 1940 Act and,
accordingly, will not treat them as being subject to a fund's borrowing
restrictions. Each fund understands that the position of the SEC is that assets
involved in swap transactions are illiquid and are, therefore, subject to the
limitations on investing in illiquid investments. See "Illiquid and Restricted
Investments."
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The cost to a fund of engaging in forward currency contracts varies
with factors such as the currencies involved, the length of the contract period
and the market conditions then prevailing. Because forward currency contracts
are usually entered into on a principal basis, no fees or commissions are
involved. Each fund will deal only with banks, broker/dealers or other financial
institutions which the adviser deems to be of high quality and to present
minimum credit risk. The use of forward currency contracts does not eliminate
fluctuations in the prices of the underlying securities each fund owns or
intends to acquire, but it does fix a rate of exchange in advance. In addition,
although forward currency contracts limit the risk of loss due to a decline in
the value of the hedged currencies, at the same time they limit any potential
gain that might result should the value of the currencies increase.
Although each fund values its assets daily in terms of U.S. dollars, it
does not intend to convert its holdings of foreign currencies into U.S. dollars
on a daily basis. Each fund may convert foreign currency from time to time, and
investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit
based on the difference between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to a
fund at one rate, while offering a lesser rate of exchange should the fund
desire to resell that currency to the dealer.
THE FOLLOWING INFORMATION APPLIES TO VALUE TRUST, TOTAL RETURN TRUST, SPECIAL
INVESTMENT TRUST, AMERICAN LEADING COMPANIES, BALANCED TRUST, SMALL-CAP VALUE
TRUST AND FINANCIAL SERVICES FUND, UNLESS OTHERWISE INDICATED:
Repurchase Agreements
---------------------
When cash is temporarily available, or for temporary defensive
purposes, each fund may invest without limit in repurchase agreements and money
market instruments, including high-quality short-term debt securities. A
repurchase agreement is an agreement under which either U.S. government
obligations or other high-quality liquid debt securities are acquired from a
securities dealer or bank subject to resale at an agreed-upon price and date.
The securities are held for each fund by a custodian bank as collateral until
resold and will be supplemented by additional collateral if necessary to
maintain a total value equal to or in excess of the value of the repurchase
agreement. Each fund bears a risk of loss in the event that the other party to a
repurchase agreement defaults on its obligations and the fund is delayed or
prevented from exercising its rights to dispose of the collateral securities,
which may decline in value in the interim. The funds will enter into repurchase
agreements only with financial institutions determined by each fund's adviser to
present minimal risk of default during the term of the agreement.
Repurchase agreements are usually for a term of one week or less, but
may be for longer periods. Repurchase agreements maturing in more than seven
days may be considered illiquid. A fund will not enter into repurchase
agreements of more than seven days' duration if more than 15% of its net assets
(with respect to American Leading Companies Trust, Special Investment Trust,
Balanced Trust, Financial Services Fund and Small-Cap Value Trust) or more than
10% of its net assets (with respect to Value Trust and Total Return Trust) would
be invested in such agreements and other illiquid investments. To the extent
that proceeds from any sale upon a default of the obligation to repurchase were
less than the repurchase price, a fund might suffer a loss. If bankruptcy
proceedings are commenced with respect to the seller of the security,
realization upon the collateral by a fund could be delayed or limited. However,
each fund's adviser monitors the creditworthiness of parties with which the fund
may enter into repurchase agreements to minimize the prospect of such parties
becoming involved in bankruptcy proceedings within the time frame contemplated
by the repurchase agreement.
When a fund enters into a repurchase agreement, it will obtain as
collateral from the other party securities equal in value to 102% of the amount
of the repurchase agreement (or 100%, if the securities obtained are U.S.
Treasury bills, notes or bonds). Such securities will be held for that fund by a
custodian bank or an approved securities depository or book-entry system.
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Loans of Portfolio Securities
-----------------------------
Each fund may lend portfolio securities to brokers or dealers in
corporate or government securities, banks or other recognized institutional
borrowers of securities, provided that cash or equivalent collateral, equal to
at least 100% of the market value of the securities loaned, is continuously
maintained by the borrower with the fund's custodian. During the time the
securities are on loan, the borrower will pay the fund an amount equivalent to
any dividends or interest paid on such securities, and the fund may invest the
cash collateral and earn income, or it may receive an agreed upon amount of
interest income from the borrower who has delivered equivalent collateral. These
loans are subject to termination at the option of the fund or the borrower. Each
fund may pay reasonable administrative and custodial fees in connection with a
loan and may pay a negotiated portion of the interest earned on the cash or
equivalent collateral to the borrower or placing broker. Each fund does not have
the right to vote securities on loan, but would terminate the loan and regain
the right to vote if that were considered important with respect to the
investment. The risks of securities lending are similar to those of repurchase
agreements. Each fund except Financial Services Fund presently does not intend
to lend more than 5% of its portfolio securities at any given time. For
Financial Services Fund, no loans will be made if, as a result, the aggregate
amount of such loans would exceed 25% of the fund's total assets.
U.S. Government Obligations and Related Securities
--------------------------------------------------
U.S. government obligations include a variety of securities that are
issued or guaranteed by the U.S. Treasury, by various agencies of the U.S.
Government or by various instrumentalities that have been established or
sponsored by the U.S. Government. U.S. Treasury securities and securities issued
by the GNMA and Small Business Administration are backed by the "full faith and
credit" of the U.S. Government. Other U.S. government obligations may or may not
be backed by the "full faith and credit" of the U.S. In the case of securities
not backed by the "full faith and credit" of the U.S., the investor must look
principally to the agency issuing or guaranteeing the obligation (such as the
Federal Farm Credit System, the Federal Home Loan Banks, Fannie Mae and Freddie
Mac) for ultimate repayment and may not be able to assert a claim against the
U.S. itself in the event the agency or instrumentality does not meet its
commitments.
Participation interests in U.S. government obligations are pro rata
interests in such obligations which are generally underwritten by government
securities dealers. Certificates of safekeeping for U.S. government obligations
are documentary receipts for such obligations. Both participation interests and
certificates of safekeeping are traded on exchanges and in the over-the-counter
market.
A fund may invest in U.S. government obligations and related
participation interests. In addition, a fund may invest in custodial receipts
that evidence ownership of future interest payments, principal payments or both
on certain U.S. government obligations. Such obligations are held in custody by
a bank on behalf of the owners. These custodial receipts are known by various
names, including Treasury Receipts, Treasury Investors Growth Receipts ("TIGRs")
and Certificates of Accrual on Treasury Securities ("CATS"). Custodial receipts
generally are not considered obligations of the U.S. government for purposes of
securities laws. A fund will consider all interest-only or principal-only fixed
income securities as illiquid.
U.S. government obligations also include stripped securities, which are
created by separating bonds issued or guaranteed by the U.S. Treasury into their
principal and interest components and selling each piece separately (commonly
referred to as IOs and POs). Stripped securities are more volatile than other
fixed income securities in their response to changes in market interest rates.
The value of some stripped securities moves in the same direction as interest
rates, further increasing their volatility.
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Municipal Obligations
---------------------
Municipal obligations are debt obligations issued by or on behalf of
states, territories and possessions of the United States and the District of
Columbia, and their political subdivisions, agencies, authorities and
instrumentalities and other qualifying issuers which pay interest that is, in
the opinion of bond counsel to the issuer, exempt from federal income tax. A
fund may invest no more than 5% of its net assets in municipal obligations
(including participation interests). Municipal obligations are issued to obtain
funds to construct, repair or improve various public facilities such as
airports, bridges, highways, hospitals, housing, schools, streets and water and
sewer works, to pay general operating expenses or to refinance outstanding
debts. They also may be issued to finance various private activities, including
the lending of funds to public or private institutions for construction of
housing, educational or medical facilities or the financing of privately owned
or operated facilities. Municipal obligations consist of tax-exempt bonds,
tax-exempt notes and tax-exempt commercial paper. Tax-exempt notes generally are
used to provide short term capital needs and generally have maturities of one
year or less. Tax-exempt commercial paper typically represents short-term,
unsecured, negotiable promissory notes.
The two principal classifications of municipal obligations are "general
obligation" and "revenue" bonds. General obligation bonds are backed by the
issuer's full credit and taxing power. Revenue bonds are backed by the revenues
of a specific project, facility or tax. Private activity bonds are a specific
type of revenue bond backed by the credit of the private issuer of the facility,
and therefore investments in these bonds have more potential risk that the
issuer will not be able to meet scheduled payments of principal and interest.
Zero Coupon and Pay-in-Kind Bonds (all funds except Financial Services Fund)
---------------------------------
Corporate debt securities and municipal obligations include so-called
"zero coupon" bonds and "pay-in-kind" bonds. A fund may invest no more than 5%
of its net assets in either zero coupon bonds or pay-in-kind bonds. Zero coupon
bonds are issued at a significant discount from their principal amount in lieu
of paying interest periodically. Pay-in-kind bonds allow the issuer, at its
option, to make current interest payments on the bonds either in cash or in
additional bonds. The value of zero coupon and pay-in-kind bonds is subject to
greater fluctuation in response to changes in market interest rates than bonds
which make regular payments of interest. Both of these types of bonds allow an
issuer to avoid the need to generate cash to meet current interest payments.
Accordingly, such bonds may involve greater credit risks than bonds which make
regular payments of interest. Even though zero coupon and pay-in-kind bonds do
not pay current interest in cash, a fund holding those bonds is required to
accrue interest income on such investments and may be required to distribute
that income at least annually to shareholders. Thus, a fund could be required at
times to liquidate other investments in order to satisfy its dividend
requirements.
Direct Investment in Mortgages
------------------------------
Mortgage-related securities include investments made directly in
mortgages secured by real estate. When a fund makes a direct investment in
mortgages, the fund, rather than a financial intermediary, becomes the mortgagee
with respect to such loans purchased by the fund. Direct investments in
mortgages 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 the
purchaser for acting as servicing agent. The vendor does not provide any
insurance or guarantees covering the repayment of principal or interest on the
mortgages. A fund will invest in such mortgages only if its adviser has
determined through an examination of the mortgage loans and their originators
that the purchase of the mortgages should not present a significant risk of loss
to the fund. Investments in whole loans may be illiquid. Whole loans also may
present a greater risk of prepayment, because the mortgages so acquired are not
diversified as interests in larger pools.
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<PAGE>
Floating and Variable Rate Obligations
--------------------------------------
Fixed income securities may be offered in the form of floating and
variable rate obligations. A fund may invest no more than 5% of its net assets
in floating and variable rate obligations, respectively. Floating rate
obligations have an interest rate which is fixed to a specified interest rate,
such as bank prime rate, and is automatically adjusted when the specified
interest rate changes. Variable rate obligations have an interest rate which is
adjusted at specified intervals to a specified interest rate. Periodic interest
rate adjustments help stabilize the obligations' market values.
A fund may purchase these obligations from the issuers or may purchase
participation interests in pools of these obligations from banks or other
financial institutions. Variable and floating rate obligations usually carry
demand features that permit a fund to sell the obligations back to the issuers
or to financial intermediaries at par value plus accrued interest upon short
notice at any time or prior to specific dates. The inability of the issuer or
financial intermediary to repurchase an obligation on demand could affect the
liquidity of a fund's portfolio. Frequently, obligations with demand features
are secured by letters of credit or comparable guarantees. Floating and variable
rate obligations which do not carry unconditional demand features that can be
exercised within seven days or less are deemed illiquid unless the Board
determines otherwise. The fund's investment in illiquid floating and variable
rate obligations would be limited to the extent that it is not permitted to
invest more than 10% of the value of its net assets in illiquid investments.
Investment Companies
--------------------
The funds are permitted to invest in other investment companies. Each
fund will not: (a) invest more than 10% of its total assets in securities of
other investment companies; (b) invest more than 5% of its total assets in
securities of any investment company; and (c) purchase more than 3% of the
outstanding voting stock of any investment company.
Investment in closed-end investment companies may involve the payment
of substantial premiums above the net asset value of such issuers' portfolio
securities. In addition, the total return on such investments in investment
companies will be reduced by their operating expenses and fees, including
advisory fees, which may be duplicative. A fund will invest in investment
companies, when, in its adviser's judgment, the potential benefits of such
investment justify the payment of any applicable premium or sales charge.
THE FOLLOWING INFORMATION APPLIES TO FINANCIAL SERVICES FUND ONLY:
Concentration
-------------
The fund will not invest more than 25% of its total assets in a
particular industry other than the financial services industry.
Securities in the Financial Services Industry
---------------------------------------------
Companies in the financial services industry include regional and money
center banks, securities brokerage firms, asset management companies, savings
banks and thrift institutions, specialty finance companies (e.g.,, credit card,
mortgage providers), insurance and insurance brokerage firms, government
sponsored agencies (e.g., Sallie Mae), financial conglomerates and foreign
banking and financial services companies.
The financial services industry is currently undergoing relatively
rapid change as existing distinctions between financial service segments become
less clear. For instance, recent business combinations in the U.S. have included
insurance, finance, banking and/or securities brokerage under single ownership.
Moreover, Congress recently repealed the federal laws generally separating
30
<PAGE>
commercial and investment banking, and the services offered by banks are likely
to expand. While providing diversification, expanded powers could expose banks
to well-established competitors, particularly as the historical distinctions
between banks and other financial institutions erode. Increased competition may
also result from the broadening of regional and national interstate banking
powers, which has already reduced the number of publicly traded regional banks.
Banks, savings and loan associations and finance companies are subject
to extensive governmental regulation which may limit both the amounts and types
of loans and other financial commitments they can make and the interest rates
and fees they can charge. The profitability of these groups is largely dependent
on the availability and cost of capital funds, and can fluctuate significantly
when interest rates change. In addition, general economic conditions are
important to the operations of these concerns, with exposure to credit losses
resulting from possible financial difficulties of borrowers potentially having
an adverse effect.
Finance companies can be highly dependent upon access to capital
markets and any impediments to such access, such as adverse overall economic
conditions or a negative perception in the capital markets of a finance
company's financial condition or prospects, could adversely affect its business.
Insurance companies are likewise subject to substantial governmental
regulation, predominately at the state level, and may be subject to severe price
competition. The performance of the fund's investments in insurance companies
will be subject to risk from several additional factors. The earnings of
insurance companies will be affected by, in addition to general economic
conditions, pricing (including severe pricing competition from time to time),
claims activity, and marketing competition. Particular insurance lines will also
be influenced by specific matters. Property and casualty insurer profits may be
affected by certain weather catastrophes and other disasters. Life and health
insurer profits may be affected by mortality and morbidity rates. Individual
companies may be exposed to material risk, including reserve inadequacy,
problems in investment portfolios (due to real estate or "junk" bond holdings,
for example), and the inability to collect from reinsurance carriers. Insurance
companies are subject to extensive governmental regulation, including the
imposition of maximum rate levels, which may not be adequate for some lines of
business. Proposed or potential anti-trust or tax law changes also may affect
adversely insurance companies' policy sales, tax obligations and profitability.
Companies engaged in stock brokerage, commodity brokerage, investment
banking, investment management, or related investment advisory services are
closely tied economically to the securities and commodities markets and can
suffer during a decline in either. These companies also are subject to the
regulatory environment and changes in regulations, pricing pressure, the
availability of funds to borrow and interest rates.
ADDITIONAL TAX INFORMATION
The following is a general summary of certain federal tax
considerations affecting each fund and its shareholders. Investors are urged to
consult their own tax advisers for more detailed information and for information
regarding any federal, state or local taxes that might apply to them.
General
-------
For federal tax purposes, each fund is treated as a separate
corporation. To continue to qualify for treatment as a regulated investment
company ("RIC") under the Internal Revenue Code of 1986, as amended ("Code"), a
fund must distribute annually to its shareholders at least 90% of its investment
company taxable income (generally, net investment income plus any net short-term
capital gain and any net gains from certain foreign currency transactions)
("Distribution Requirement") and must meet several additional requirements. For
each fund, these requirements include the following: (1) the fund must derive at
least 90% of its gross income each taxable year from dividends, interest,
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<PAGE>
payments with respect to securities loans and gains from the sale or other
disposition of securities or foreign currencies, or other income (including
gains from options, futures or forward contracts) derived with respect to its
business of investing in securities or those currencies ("Income Requirement");
(2) at the close of each quarter of the fund's taxable year, at least 50% of the
value of its total assets must be represented by cash and cash items, U.S.
government securities, securities of other RICs and other securities, with those
other securities limited, in respect of any one issuer, to an amount that does
not exceed 5% of the value of the fund's total assets and that does not
represent more than 10% of the issuer's outstanding voting securities; and (3)
at the close of each quarter of the fund's taxable year, not more than 25% of
the value of its total assets may be invested in the securities (other than U.S.
government securities or the securities of other RICs) of any one issuer.
By qualifying for treatment as a RIC, a fund (but not its shareholders)
will be relieved of federal income tax on the part of its investment company
taxable income and net capital gain (i.e., the excess of net long-term capital
gain over net short-term capital loss) that it distributes to its shareholders.
If any fund failed to qualify for that treatment for any taxable year, (1) it
would be taxed at corporate rates on the full amount of its taxable income for
that year without being able to deduct the distributions it makes to its
shareholders and (2) the shareholders would treat all those distributions,
including distributions of net capital gain, as dividends (that is, ordinary
income) to the extent of the fund's earnings and profits. In addition, the fund
could be required to recognize unrealized gains, pay substantial taxes and
interest and make substantial distributions before requalifying for RIC
treatment.
If fund shares are sold at a loss after being held for six months or
less, the loss will be treated as a long-term, instead of a short-term, capital
loss to the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for any dividend or other distribution, the investor will pay full
price for the shares and receive some portion of the price back as a taxable
distribution.
Each fund will be subject to a nondeductible 4% excise tax ("Excise
Tax") to the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gain net
income for the one-year period ending on October 31 of that year, plus certain
other amounts. For this and other purposes, dividends and other distributions
declared by a fund in December of any year and payable to its shareholders of
record on a date in that month will be deemed to have been paid by the fund and
received by the shareholders on December 31 if the fund pays the distributions
during the following January. Accordingly, those distributions will be taxed to
shareholders for the year in which that December 31 falls.
A portion of the dividends from each fund's investment company taxable
income (whether paid in cash or reinvested in fund shares) may be eligible for
the dividends-received deduction allowed to corporations. The eligible portion
for any fund may not exceed the aggregate dividends received by that fund from
domestic corporations. However, dividends received by a corporate shareholder
and deducted by it pursuant to the dividends-received deduction are subject
indirectly to the federal alternative minimum tax. Distributions of net capital
gain made by any fund do not qualify for the dividends-received deduction.
Foreign Securities
------------------
FOREIGN TAXES. Interest and dividends received by a fund, and gains
realized thereby, may be subject to income, withholding or other taxes imposed
by foreign countries and U.S. possessions ("foreign taxes") that would reduce
the total return on its securities. Tax conventions between certain countries
and the United States may reduce or eliminate foreign taxes, however, and many
foreign countries do not impose taxes on capital gains in respect of investments
by foreign investors. If more than 50% of the value of a fund's total assets at
the close of any taxable year consists of securities of foreign corporations,
the fund will be eligible to, and may, file an election with the Internal
Revenue Service that will enable its shareholders, in effect, to receive the
benefit of the foreign tax credit with respect to any foreign taxes it paid.
Pursuant to any such election, a fund would treat those taxes as dividends paid
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<PAGE>
to its shareholders and each shareholder would be required to (1) include in
gross income, and treat as paid by the shareholder, the shareholder's
proportionate share of those taxes, (2) treat the shareholder's share of those
taxes and of any dividend paid by the fund that represents income from foreign
or U.S. possessions sources as the shareholder's own income from those sources
and (3) either deduct the foreign taxes deemed paid by the shareholder in
computing the shareholder's taxable income or, alternatively, use the foregoing
information in calculating the foreign tax credit against the shareholder's
federal income tax. If a fund makes this election, it will report to its
shareholders shortly after each taxable year their respective shares of the
foreign taxes it paid and its income from sources within foreign countries and
U.S. possessions. Individuals who have no more than $300 ($600 for married
persons filing jointly) of creditable foreign taxes included on Forms 1099 and
all of whose foreign source income is "qualified passive income" may make an
election that would enable them to claim a foreign tax credit without having to
file the detailed Form 1116 that otherwise is required.
PASSIVE FOREIGN INVESTMENT COMPANIES. Each fund may invest in the stock
of "passive foreign investment companies" ("PFICs"). A PFIC is any foreign
corporation (with certain exceptions) that, in general, meets either of the
following tests: (1) at least 75% of its gross income is passive or (2) an
average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain circumstances, a fund will be subject to
federal income tax on a portion of any "excess distribution" received on the
stock of a PFIC or of any gain on disposition of that stock (collectively "PFIC
income"), plus interest thereon, even if the fund distributes the PFIC income as
a taxable dividend to its shareholders. The balance of the PFIC income will be
included in the fund's investment company taxable income and, accordingly, will
not be taxable to it to the extent it distributes that income to its
shareholders.
If a fund invests in a PFIC and elects to treat the PFIC as a
"qualified electing fund" ("QEF"), then in lieu of the foregoing tax and
interest obligation, the fund would be required to include in income each year
its pro rata share of the QEF's annual ordinary earnings and net capital gain --
which the fund probably would have to distribute to satisfy the Distribution
Requirement and avoid imposition of the Excise Tax -- even if the QEF did not
distribute those earnings and gain to the fund. In most instances it will be
very difficult, if not impossible, to make this election because of certain
requirements thereof.
Each fund may elect to "mark-to-market" its stock in any PFIC.
"Marking-to-market," in this context, means including in ordinary income each
taxable year the excess, if any, of the fair market value of the stock over a
fund's adjusted basis therein as of the end of that year. Pursuant to the
election, a fund also may deduct (as an ordinary, not capital, loss) the excess,
if any, of its adjusted basis in PFIC stock over the fair market value thereof
as of the taxable year-end, but only to the extent of any net mark-to-market
gains with respect to that stock included in income by the fund for prior
taxable years under the election (and under regulations proposed in 1992 that
provided a similar election with respect to the stock of certain PFICs). A
fund's adjusted basis in each PFIC's stock subject to the election would be
adjusted to reflect the amounts of income included and deductions taken
thereunder.
FOREIGN CURRENCIES. Gains or losses (1) from the disposition of foreign
currencies, including forward contracts, (2) on the disposition of a debt
security denominated in foreign currency that are attributable to fluctuations
in the value of the foreign currency between the dates of acquisition and
disposition of the security and (3) that are attributable to fluctuations in
exchange rates between the time a fund accrues dividends, interest or other
receivables, or expenses or other liabilities, denominated in a foreign currency
and the time the fund actually collects the receivables or pays the liabilities,
generally will be treated as ordinary income or loss. These gains or losses,
referred to under the Code as "section 988" gains or losses, will increase or
decrease the amount of a fund's investment company taxable income to be
distributed to its shareholders, as ordinary income, rather than affecting the
amount of its net capital gain.
33
<PAGE>
Financial Instruments and Foreign Currencies
--------------------------------------------
The use of hedging strategies, such as writing (selling) and purchasing
options and futures contracts and entering into forward contracts, involves
complex rules that will determine for income tax purposes the amount, character
and timing of recognition of the gains and losses a fund realizes in connection
therewith. Gains from the disposition of foreign currencies (except certain
gains that may be excluded by future regulations) -- and gains from options,
futures and forward contracts derived by a fund with respect to its business of
investing in securities or foreign currencies -- will be treated as qualifying
income under the Income Requirement.
Certain futures, listed nonequity options (such as those on a stock
index) and foreign currency contracts (with respect to which a fund has made a
certain election) in which a fund may invest will be subject to section 1256 of
the Code ("section 1256 contracts"). Section 1256 contracts held by a fund at
the end of its taxable year, other than section 1256 contracts that are part of
a "mixed straddle" with respect to which the fund has made an election not to
have the following rules apply, must be "marked-to-market" (that is, treated as
having been sold for their fair market value) for federal income tax purposes,
with the result that unrealized gains or losses will be treated as though they
were realized. Sixty percent of any net gain or loss recognized on these deemed
sales, and sixty percent of any net realized gain or loss from any actual sales
of section 1256 contracts, will be treated as long-term capital gain or loss,
and the balance will be treated as short-term capital gain or loss. These rules
may operate to increase the amount that a fund must distribute to satisfy the
Distribution Requirement (i.e., with respect to the portion treated as
short-term capital gain), which will be taxable to its shareholders as ordinary
income, and to increase the net capital gain a fund recognizes, without in
either case increasing the cash available to the fund. Section 1256 contracts
also may be marked-to-market for purposes of the Excise Tax.
When a covered call option written (sold) by a fund expires, the fund
will realize a short-term capital gain equal to the amount of the premium it
received for writing the option. When a fund terminates its obligations under
such an option by entering into a closing transaction, it will realize a
short-term capital gain (or loss), depending on whether the cost of the closing
transaction is less than (or exceeds) the premium received when it wrote the
option. When a covered call option written by a fund is exercised, it will be
treated as having sold the underlying security, producing long-term or
short-term capital gain or loss, depending on the holding period of the
underlying security and whether the sum of the option price received on the
exercise plus the premium received when it wrote the option is more or less than
the basis of the underlying security.
Code section 1092 (dealing with straddles) also may affect the taxation
of options, futures and forward contracts in which a fund may invest. That
section defines a "straddle" as offsetting positions with respect to actively
traded personal property; for these purposes, options, futures and forward
contracts are personal property. Under that section, any loss from the
disposition of a position in a straddle generally may be deducted only to the
extent the loss exceeds the unrealized gain on the offsetting position(s) of the
straddle. In addition, these rules may postpone the recognition of loss that
otherwise would be recognized under the mark-to-market rules discussed above.
The regulations under section 1092 also provide certain "wash sale" rules, which
apply to transactions where a position is sold at a loss and a new offsetting
position is acquired within a prescribed period, and "short sale" rules
applicable to straddles. If a fund makes certain elections, the amount,
character and timing of recognition of gains and losses from the affected
straddle positions would be determined under rules that vary according to the
elections made. Because only a few of the regulations implementing the straddle
rules have been promulgated, the tax consequences to a fund of straddle
transactions are not entirely clear.
If a fund has an "appreciated financial position" -- generally, an
interest (including an interest through an option, futures or forward contract
or short sale) with respect to any stock, debt instrument (other than "straight
debt") or partnership interest the fair market value of which exceeds its
adjusted basis -- and enters into a "constructive sale" of the position, the
fund will be treated as having made an actual sale thereof, with the result that
gain will be recognized at that time. A constructive sale generally consists of
34
<PAGE>
a short sale, an offsetting notional principal contract or futures or forward
contract entered into by a fund or a related person with respect to the same or
substantially identical property. In addition, if the appreciated financial
position is itself a short sale or such a contract, acquisition of the
underlying property or substantially identical property will be deemed a
constructive sale. The foregoing will not apply, however, to any transaction of
a fund during any taxable year that otherwise would be treated as a constructive
sale if the transaction is closed within 30 days after the end of that year and
the fund holds the appreciated financial position unhedged for 60 days after
that closing (i.e., at no time during that 60-day period is the fund's risk of
loss regarding that position reduced by reason of certain specified transactions
with respect to substantially identical or related property, such as having an
option to sell, being contractually obligated to sell, making a short sale, or
granting an option to buy substantially identical stock or securities).
Original Issue Discount and Pay-In-Kind Securities
--------------------------------------------------
Each fund may purchase zero coupon or other debt securities issued with
original issue discount ("OID"). As a holder of those securities, a fund must
include in its income the OID that accrues thereon during the taxable year, even
if it receives no corresponding payment on the securities during the year.
Similarly, a fund must include in its gross income securities it receives as
"interest" on pay-in-kind securities. Because each fund annually must distribute
substantially all of its investment company taxable income, including any OID
and other non-cash income, to satisfy the Distribution Requirement and avoid
imposition of the Excise Tax, it may be required in a particular year to
distribute as a dividend an amount that is greater than the total amount of cash
it actually receives. Those distributions will be made from a fund's cash assets
or from the proceeds of sales of portfolio securities, if necessary. A fund may
realize capital gains or losses from those dispositions, which would increase or
decrease its investment company taxable income and/or net capital gain.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Each fund offers two classes of shares, known as Primary Class and
Navigator Class shares. Financial Services Fund also offers a third class of
shares: Class A shares. Other classes of shares may be offered in the future.
Primary Class and Class A shares are available from Legg Mason, certain of its
affiliates and unaffiliated entities having an agreement with Legg Mason.
Navigator Class shares are available only to: Institutional Clients of Legg
Mason Trust, fsb for which they exercise discretionary investment management
responsibility and accounts of the customers with such Institutional Clients;
qualified retirement plans managed on a discretionary basis and having net
assets of at least $200 million; any qualified retirement plan having net assets
of at least $300 million; clients of Bartlett who, as of December 19, 1996 were
shareholders of Bartlett Short-Term Bond Fund or Bartlett Fixed Income Fund and
for whom Bartlett acts as an ERISA fiduciary; Class Y shareholders of Bartlett
Europe Fund or Bartlett Financial Services Fund on October 5, 1999; any
qualified retirement plan of Legg Mason, Inc. or of any of its affiliates; any
open-end management investment company advised or managed by Legg Mason Fund
Adviser, Inc. ("LMFA") or Legg Mason Fund Management, Inc. ("LMFM") or by any
person controlling, controlled by, or under common control with LMFA or LMFM and
to certain institutions who were clients of Fairfield Group, Inc. as of February
28, 1999 for investment of their own monies and monies for which they act in a
fiduciary capacity. Institutional Clients may purchase shares for Customer
Accounts maintained for individuals. Primary Class and Class A shares are
available to all other investors.
Future First Systematic Investment Plan and Transfer of Funds from Financial
Institutions
--------------------------------------------------------------------------------
If you invest in Primary Class or Class A shares, the Prospectus for
those shares explains that you may buy those shares through the Future First
Systematic Investment Plan. Under this plan, you may arrange for automatic
monthly investments in Primary Class or Class A shares of $50 or more by
authorizing Boston Financial Data Services ("BFDS"), each fund's transfer agent,
to transfer funds each month from your Legg Mason account or from your checking
account to be used to buy those shares at the per share net asset value
35
<PAGE>
determined on the day the funds are sent from your bank. You will receive a
quarterly account statement. You may terminate the Future First Systematic
Investment Plan at any time without charge or penalty. Forms to enroll in the
Future First Systematic Investment Plan are available from any Legg Mason or
affiliated office.
Investors in Primary Class and Class A shares may also buy shares
through a plan permitting transfers of funds from a financial institution.
Certain financial institutions may allow the investor, on a pre-authorized
basis, to have $50 or more automatically transferred monthly for investment in
shares of a fund to:
Legg Mason Wood Walker, Incorporated
Funds Processing
P.O. Box 1476
Baltimore, Maryland 21203-1476
If the investor's check is not honored by the institution it is drawn
on, the investor may be subject to extra charges in order to cover collection
costs. These charges may be deducted from the investor's shareholder account.
Systematic Withdrawal Plan
--------------------------
All Legg Mason funds in any Legg Mason account are eligible for the
Systematic Withdrawal Plan ("Plan"). Except for Individual Retirement Accounts
("IRA accounts"), any account with a net asset value of $5000 or more may elect
to make withdrawals of a minimum of $50 on a monthly basis. IRA accounts are not
subject to the $5000 minimum balance requirement. The amounts paid to you each
month are obtained by redeeming sufficient shares from your account to provide
the withdrawal amount that you have specified. Except IRA accounts, there are
three ways to receive payment of proceeds of redemptions made through the Plan:
(1) Credit to brokerage account - fund shares will be redeemed on the first
business day of each month and credited to the brokerage account on the third
business day; or (2) Check mailed by the funds' transfer agent - fund shares
will be redeemed on the 25th of each month or next business day and a check will
be mailed within 3 business days; or (3) ACH to checking or savings account -
redemptions of fund shares may occur on any day of the month and the checking or
savings account will be credited in approximately two business days. Credit to
brokerage account is the only option available to IRA accounts. Redemptions will
be made at the net asset value per share determined as of the close of regular
trading of the New York Stock Exchange ("Exchange") (normally 4:00 p.m., Eastern
time) on the day corresponding to the redemption option designated by the
investor. If the Exchange is not open for business on that day, the shares will
be redeemed at the per share net asset value determined as of the close of the
Exchange on the next business day. You may change the monthly amount to be paid
to you without charge by notifying Legg Mason or the affiliate with which you
have an account. You may terminate the Systematic Withdrawal Plan at any time
without charge or penalty. Each fund, its transfer agent, and Legg Mason also
reserve the right to modify or terminate the Systematic Withdrawal Plan at any
time.
Withdrawal payments are treated as a sale of shares rather than as a
dividend or other distribution. These payments are taxable to the extent that
the total amount of the payments exceeds the tax basis of the shares sold. If
the periodic withdrawals exceed reinvested dividends and distributions, the
amount of your original investment may be correspondingly reduced.
Ordinarily, you should not purchase additional shares of the fund in
which you have an account if you maintain a Systematic Withdrawal Plan, because
you may incur tax liabilities in connection with such purchases and withdrawals.
No fund will knowingly accept purchase orders from you for additional shares if
you maintain a Systematic Withdrawal Plan unless your purchase is equal to at
least one year's scheduled withdrawals. In addition, if you maintain a
Systematic Withdrawal Plan you may not make periodic investments under the
Future First Systematic Investment Plan.
36
<PAGE>
Other Information Regarding Redemption
--------------------------------------
Each fund reserves the right to modify or terminate the wire or
telephone redemption services described in the Prospectuses at any time.
The date of payment for redemption may not be postponed for more than
seven days, and the right of redemption may not be suspended, by a fund or its
distributor except (i) for any period during which the Exchange is closed (other
than for customary weekend and holiday closings), (ii) when trading in markets a
fund normally utilizes is restricted, or an emergency, as defined by rules and
regulations of the SEC, exists, making disposal of the fund's investments or
determination of its net asset value not reasonably practicable, or (iii) for
such other periods as the SEC by regulation or order may permit for protection
of a fund's shareholders. In the case of any such suspension, you may either
withdraw your request for redemption or receive payment based upon the net asset
value next determined after the suspension is lifted.
Each fund reserves the right, under certain conditions, to honor any
request for redemption by making payment in whole or in part in securities
valued in the same way as they would be valued for purposes of computing that
fund's net asset value per share. If payment is made in securities, a
shareholder should expect to incur brokerage expenses in converting those
securities into cash and will be subject to fluctuation in the market price of
those securities until they are sold. Each fund does not redeem "in kind" under
normal circumstances, but would do so where its adviser determines that it would
be in the best interests of that fund's shareholders as a whole.
Foreign securities markets may be open for trading on days when the
funds are not open for business. The net asset value of fund shares may be
significantly affected on days when investors do not have access to their
respective fund to purchase and redeem shares.
Class A shares that were purchased pursuant to the front-end sales
charge waiver on purchases of $1 million or more and are redeemed within one
year of their purchase are subject to a CDSC of 1.00% of the shares' net asset
value at the time of purchase or redemption, whichever is less.
Clients of certain institutions that maintain omnibus accounts with the
funds' transfer agent may obtain shares through those institutions. Such
institutions may receive payments from the funds' distributor for account
servicing, and may receive payments from their clients for other services
performed. Investors can purchase shares from Legg Mason without receiving or
paying for such other services.
VALUATION OF FUND SHARES
Net asset value of a fund share is determined daily for each class as
of the close of the Exchange, on every day the Exchange is open, by dividing the
value of the total assets attributable to that class, less liabilities
attributable to that class, by the number of shares of that class outstanding.
Pricing will not be done on days when the Exchange is closed. The Exchange
currently observes the following holidays: New Year's Day, Presidents' Day,
Martin Luther King, Jr. Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day, and Christmas Day. As described in the Prospectuses,
securities for which market quotations are readily available are valued at
current market value. Securities traded on an exchange or the Nasdaq Stock
Market are normally valued at last sale prices. Other OTC securities, and
securities traded on exchanges for which there is no sale on a particular day
(including debt securities), are valued at the mean of latest closing bid and
asked prices. Securities with remaining maturities of 60 days or less are valued
at amortized cost. Securities and other assets quoted in foreign currencies will
be valued in U.S. dollars based on the currency exchange rates prevailing at the
time of the valuation. All other securities are valued at fair value as
determined by or under the direction of the appropriate fund's Board of
Directors. The funds may also use fair value pricing instead of market
37
<PAGE>
quotations to value securities if, because of special circumstances, the fund
believes it would more accurately reflect the price it could realize on a
current sales of the securities. Premiums received on the sale of call options
are included in the net asset value of each class, and the current market value
of options sold by a fund will be subtracted from net assets of each class.
PERFORMANCE INFORMATION
The following tables show the value, as of the end of each fiscal year,
of a hypothetical investment of $10,000 made in each fund at commencement of
operations of each class of fund shares. The tables assume that all dividends
and other distributions are reinvested in each respective fund. They include the
effect of all charges and fees applicable to the respective class of shares the
fund has paid. (There are no fees for investing or reinvesting in the funds
imposed by the funds except for any applicable sales charges on the purchase of
Class A shares, and there are no redemption fees other than those described
above for Class A shares.) They do not include the effect of any income tax that
an investor would have to pay on distributions. Performance data is only
historical, and is not intended to indicate any fund's future performance.
VALUE TRUST:
PRIMARY CLASS SHARES
--------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1983* $ 16,160 $ 241 $ 16,401
1984 18,870 555 19,425
1985 23,583 1,100 24,683
1986 32,556 1,954 34,510
1987 35,503 2,421 37,924
1988 32,268 2,461 34,729
1989 37,650 3,459 41,109
1990 39,891 4,399 44,290
1991 37,701 5,313 43,014
1992 44,210 7,204 51,414
1993 50,184 8,819 59,003
1994 52,789 9,548 62,337
1995 57,817 10,610 68,427
1996 82,356 14,870 97,226
1997 110,379 19,502 129,881
38
<PAGE>
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1998 172,493 29,268 201,761
1999 259,794 42,708 302,502
2000 278,915 43,976 322,891
* April 16, 1982 (commencement of operations) to March 31, 1983.
NAVIGATOR CLASS SHARES
----------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1995* $10,805 $ 6 $10,811
1996 15,249 268 15,517
1997 20,323 619 20,942
1998 31,713 1,146 32,859
1999 48,038 1,688 49,726
2000 51,846 1,757 53,603
* December 1, 1994 (commencement of operations) to March 31, 1995.
With respect to Primary Class shares, if the investor had not
reinvested dividends and other distributions, the total value of the
hypothetical investment as of March 31, 2000 would have been $150,520, and the
investor would have received a total of $32,449 in distributions. With respect
to Navigator Class shares, if the investor had not reinvested dividends and
other distributions, the total value of the hypothetical investment as of March
31, 2000 would have been $41,322, and the investor would have received a total
of $5,375 in distributions. If the adviser had not waived certain fees in the
1983-2000 fiscal years, returns would have been lower.
39
<PAGE>
TOTAL RETURN TRUST:
PRIMARY CLASS SHARES
--------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1986* $10,780 - $10,780
1987 11,673 $211 11,884
1988 10,295 380 10,675
1989 11,690 603 12,293
1990 11,875 846 12,721
1991 11,499 1,216 12,715
1992 13,885 1,830 15,715
1993 16,234 2,605 18,839
1994 16,637 3,064 19,701
1995 16,593 3,482 20,075
1996 21,342 5,194 26,536
1997 26,102 6,890 32,992
1998 37,430 9,565 46,995
1999 34,742 8,903 43,175
2000 32,051 8,264 40,315
* November 21, 1985 (commencement of operations) to March 31, 1986.
NAVIGATOR CLASS SHARES
----------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1995* $10,203 $160 $10,363
1996 13,106 668 13,774
1997 15,989 1,321 17,310
1998 22,606 2,311 24,917
40
<PAGE>
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1999 20,509 2,619 23,128
2000 18,999 2,830 21,829
* December 1, 1994 (commencement of operations) to March 31, 1995.
With respect to Primary Class shares, if the investor had not
reinvested dividends and other distributions, the total value of the
hypothetical investment as of March 31, 2000 would have been $18,260, and the
investor would have received a total of $11,949 in distributions. With respect
to Navigator Class shares, if the investor had not reinvested dividends and
other distributions, the total value of the hypothetical investment as of March
31, 2000 would have been $14,390, and the investor would have received a total
of $6,533 in distributions. If the adviser had not waived certain fees in the
1986-1995 fiscal years, returns would have been lower.
SPECIAL INVESTMENT TRUST:
PRIMARY CLASS SHARES
--------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1986* $11,530 - $11,530
1987 13,051 $ 23 13,074
1988 11,107 113 11,220
1989 12,982 144 13,126
1990 14,890 253 15,143
1991 17,777 615 18,392
1992 21,249 905 22,154
1993 23,528 953 24,481
1994 28,511 1,197 29,708
1995 26,707 1,108 27,815
1996 34,291 1,442 35,733
1997 38,345 1,526 39,871
1998 54,898 2,070 56,968
41
<PAGE>
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1999 64,288 2,230 66,518
2000 83,259 2,315 85,574
* December 30, 1985 (commencement of operations) to March 31, 1986.
NAVIGATOR CLASS SHARES
----------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1995* $10,481 - $10,481
1996 13,489 $121 13,610
1997 15,224 129 15,353
1998 21,996 177 22,173
1999 25,948 193 26,141
2000 33,774 205 33,979
* December 1, 1994 (commencement of operations) to March 31, 1995.
With respect to Primary Class shares, if the investor had not
reinvested dividends and other distributions, the total value of the
hypothetical investment as of March 31, 2000 would have been $40,280, and the
investor would have received a total of $18,687 in distributions. With respect
to Navigator Class shares, if the investor had not reinvested dividends and
other distributions, the total value of the hypothetical investment as of March
31, 2000 would have been $22,454, and the investor would have received a total
of $7,458 in distributions. If the adviser had not waived certain fees in the
1986-1998 fiscal years, returns would have been lower.
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<PAGE>
AMERICAN LEADING COMPANIES:
PRIMARY CLASS SHARES
--------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1994* $9,690 $24 $9,714
1995 10,180 140 10,320
1996 12,230 283 12,513
1997 15,242 366 15,608
1998 20,658 442 21,100
1999 24,713 506 25,219
2000 23,077 465 23,542
* September 1, 1993 (commencement of operations) to March 31, 1994.
NAVIGATOR CLASS SHARES
----------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
997* $11,428 $88 $11,516
998 15,602 110 15,742
999** 15,923 109 16,032
* October 4, 1996 (commencement of operations) to March 31, 1997.
**All outstanding Navigator Class shares were redeemed December 3, 1998; this
amount reflects values up to that date. There were no Navigator Class shares
outstanding at March 31, 2000.
With respect to Primary Class shares, if the investor had not
reinvested dividends and other distributions, the total value of the
hypothetical investment as of March 31, 2000 would have been $18,690, and the
investor would have received a total of $3,655 in distributions. If the adviser
had not waived certain fees in the 1997-1999 fiscal years, returns would have
been lower.
43
<PAGE>
BALANCED TRUST:
PRIMARY CLASS SHARES
--------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1997* $10,160 $42 $10,202
1998 12,749 289 13,038
1999 12,214 473 12,687
2000 12,439 823 13,262
* October 1, 1996 (commencement of operations) to March 31, 1997.
If the investor had not reinvested dividends and other distributions,
the total value of the hypothetical investment as of March 31, 2000 would have
been $12,200, and the investor would have received a total of $980 in
distributions. If the adviser had not waived certain fees in the fiscal years
ended March 31, 1997, 1998, 1999 and 2000, returns would have been lower.
The table above is based only on Primary Class shares of Balanced
Trust. As of the date of this Statement of Additional Information, Navigator
Class shares of Balanced Trust have no performance history of their own.
SMALL-CAP VALUE TRUST:
PRIMARY CLASS SHARES
--------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1999* $ 7,810 ----- $ 7,810
2000 7,727 ----- 7,727
* June 15, 1998 (commencement of operations) to March 31, 1999.
44
<PAGE>
NAVIGATOR CLASS SHARES
----------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
1999* $ 7,944 ----- $7,944
2000 7,932 ----- 7,932
* June 19, 1998(commencement of operations) to March 31, 1999.
With respect to Primary Class shares, if the investor had not reinvested
dividends and other distributions, the total value of the hypothetical
investment as of March 31, 2000 would have been $7,450, and the investor would
have received a total of $309 in distributions. With respect to Navigator Class
shares, if the investor had not reinvested dividends and other distributions,
the total value of the hypothetical investment as of March 31, 2000 would have
been $7,651, and the investor would have received a total of $311 in
distributions. If the adviser had not waived certain fees in the 1999-2000
fiscal years, returns would have been lower.
FINANCIAL SERVICES FUND:
PRIMARY CLASS SHARES
--------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
December 31, 1998* $10,570 ----- $10,570
December 31, 1999 $9,410 ----- $9,410
March 31, 2000** $9,180 ----- $9,180
* November 16, 1998 (commencement of operations) to December 31, 1998.
** For the period January 1, 2000 to March 31, 2000. Effective January 1, 2000
the fiscal year end for Financial Services Fund changed from December 31 to
March 31.
45
<PAGE>
CLASS A SHARES
--------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
December 31, 1998* $10,580 ----- $10,580
December 31, 1999 $9,490 ----- $9,490
March 31, 2000** $9,280 ----- $9,280
* November 16, 1998 (commencement of operations) to December 31, 1999.
** For the period January 1, 2000 to March 31, 2000. Effective January 1, 2000
the fiscal year end for Financial Services Fund changed from December 31 to
March 31.
NAVIGATOR CLASS SHARES
----------------------
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Through Reinvestment of Reinvestment of
Fiscal Year Capital Gain Distributions Income Dividends Total Value
--------------------------------------------------------------------------------
December 31, 1999* $10,248 ----- $10,248
March 31, 2000** $10,022 ----- $10,022
* October 7, 1999 (inception date of Navigator Class) to December 31, 1999.
** For the period January 1, 2000 to March 31, 2000. Effective January 1, 2000
the fiscal year end for Financial Services Fund changed from December 31 to
March 31.
With respect to Primary Class shares, if the investor had not
reinvested dividends and other distributions, the total value of the
hypothetical investment as of March 31, 2000 would have been $9,180, and the
investor would have received a total of $0 in distributions. With respect to
Class A shares, if the investor had not reinvested dividends and other
distributions, the total value of the hypothetical investment as of March 31,
2000 would have been $9,280, and the investor would have received a total of $0
in distributions. With respect to Navigator Class shares, if the investor had
not reinvested dividends and other distributions, the total value of the
hypothetical investment as of March 31, 2000 would have been $10,022, and the
investor would have received a total of $0 in distributions. If the adviser had
not waived certain fees in the 1998-2000 fiscal years, returns would have been
lower.
Total Return Calculations
-------------------------
Average annual total return quotes used in a fund's advertising and
other promotional materials ("Performance Advertisements") are calculated
separately for each class according to the following formula:
46
<PAGE>
P(1+T)n = ERV
where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a
hypothetical $1,000 payment made at
the beginning of that period
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated at least to
the last day of the most recent quarter prior to submission of the Performance
Advertisements for publication. Total return, or "T" in the formula above, is
computed by finding the average annual change in the value of an initial $1,000
investment over the period. In calculating the ending redeemable value, all
dividends and other distributions by a fund are assumed to have been reinvested
at net asset value on the reinvestment dates during the period.
From time to time each fund may compare the performance of a class of
shares in advertising and sales literature to the performance of other
investment companies, groups of investment companies or various market indices.
One such market index is the Standard & Poor's 500 Composite Stock Index ("S&P
500"), a widely recognized, unmanaged index composed of the
capitalization-weighted average of the prices of 500 of the largest publicly
traded stocks in the U.S. The S&P 500 includes reinvestment of all dividends. It
takes no account of the costs of investing or the tax consequences of
distributions. The funds invest in many securities that are not included in the
S&P 500.
Each fund may also cite rankings and ratings, and compare the return of
a Class with data published by Lipper Analytical Services, Inc. ("Lipper"), CDA
Investment Technologies, Inc., Wiesenberger Investment Company Services, Value
Line, Morningstar, and other services or publications that monitor, compare
and/or rank the performance of investment companies. Each fund may also refer in
such materials to mutual fund performance rankings, ratings, comparisons with
funds having similar investment objectives, and other mutual funds reported in
independent periodicals, including, but not limited to, FINANCIAL WORLD, MONEY
Magazine, FORBES, BUSINESS WEEK, BARRON'S, FORTUNE, THE KIPLINGER LETTERS, THE
WALL STREET JOURNAL, and THE NEW YORK TIMES.
Each fund may compare the investment return of a class to the return on
certificates of deposit and other forms of bank deposits, and may quote from
organizations that track the rates offered on such deposits. Bank deposits are
insured by an agency of the federal government up to specified limits. In
contrast, fund shares are not insured, the value of fund shares may fluctuate,
and an investor's shares, when redeemed, may be worth more or less than the
investor originally paid for them. Unlike the interest paid on many certificates
of deposit, which remains at a specified rate for a specified period of time,
the return of each class of shares will vary.
Fund advertisements may reference the history of the distributor and
its affiliates, the education and experience of the portfolio manager, and the
fact that the portfolio manager engages in value investing. With value
investing, the adviser invests in those securities it believes to be undervalued
in relation to the long-term earning power or asset value of their issuers.
Securities may be undervalued because of many factors, including market decline,
poor economic conditions, tax-loss selling, or actual or anticipated unfavorable
developments affecting the issuer of the security. The adviser believes that the
securities of sound, well-managed companies that may be temporarily out of favor
due to earnings declines or other adverse developments are likely to provide a
greater total return than securities with prices that appear to reflect
anticipated favorable developments and that are therefore subject to correction
should any unfavorable developments occur.
In advertising, each fund may illustrate hypothetical investment plans
designed to help investors meet long-term financial goals, such as saving for a
child's college education or for retirement. Sources such as the Internal
Revenue Service, the Social Security Administration, the Consumer Price Index
47
<PAGE>
and Chase Global Data and Research may supply data concerning interest rates,
college tuitions, the rate of inflation, Social Security benefits, mortality
statistics and other relevant information. Each fund may use other recognized
sources as they become available.
A fund may use data prepared by Ibbotson Associates and Frontier
Analytics, Inc. to compare the returns of various capital markets and to show
the value of a hypothetical investment in a capital market. Typically, different
indices are used to calculate the performance of common stocks, corporate and
government bonds and Treasury bills.
Each fund may illustrate and compare the historical volatility of
different portfolio compositions where the performance of stocks is represented
by the performance of an appropriate market index, such as the S&P 500 and the
performance of bonds is represented by a nationally recognized bond index, such
as the Lehman Brothers Long-Term Government Bond Index.
Each fund may also include in advertising biographical information on
key investment and managerial personnel.
Each fund may advertise examples of the potential benefits of periodic
investment plans, such as dollar cost averaging, a long-term investment
technique designed to lower average cost per share. Under such a plan, an
investor invests in a mutual fund at regular intervals a fixed dollar amount
thereby purchasing more shares when prices are low and fewer shares when prices
are high. Although such a plan does not guarantee profit or guard against loss
in declining markets, the average cost per share could be lower than if a fixed
number of shares were purchased at the same intervals. Investors should consider
their ability to purchase shares through periods of low price levels.
Each fund may discuss Legg Mason's tradition of service. Since 1899,
Legg Mason and its affiliated companies have helped investors meet their
specific investment goals and have provided a full spectrum of financial
services. Legg Mason affiliates serve as investment advisers for private
accounts and mutual funds with assets of approximately $112 billion as of March
31, 2000.
In advertising, each fund may discuss the advantages of saving through
tax-deferred retirement plans or accounts, including the advantages and
disadvantages of "rolling over" a distribution from a retirement plan into an
IRA, factors to consider in determining whether you qualify for such a rollover,
and the other options available. These discussions may include graphs or other
illustrations that compare the growth of a hypothetical tax-deferred investment
to the after-tax growth of a taxable investment.
Lipper Inc., an independent rating service which measures the
performance of most U.S. mutual funds, reported that Value Trust's total return
of Primary Class shares ranked 3359 among 4148 general equity funds it measured
during the one year ended April 30, 2000. For the five years ended April 30,
2000, Value Trust's total return ranked 44 among 1612 general equity funds and
for the ten years ended April 30, 2000, Value Trust's total return ranked 36
among 583 general equity funds. Of course, there can be no assurance that
results similar to those achieved by Value Trust in the past will be realized in
future periods. Rankings may have been different if the adviser had not waived
certain fees during the periods in question.
TAX-DEFERRED QUALIFIED PLANS - PRIMARY CLASS AND CLASS A SHARES
Investors may invest in Primary Class or Class A shares of a fund
through IRAs and through SEPs, SIMPLES and other qualified retirement plans
(collectively, "qualified plans"). In general, income earned through the
investment of assets of qualified plans is not taxed to their beneficiaries
until the income is distributed to them. Primary Class or Class A share
investors who are considering establishing a qualified plan should consult their
attorneys or other tax advisers with respect to individual tax questions. Please
consult your Financial Advisor or other entity offering the funds for further
information with respect to these plans.
48
<PAGE>
Individual Retirement Account - IRAs
------------------------------------
TRADITIONAL IRA. Certain Primary Class or Class A shareholders may
obtain tax advantages by establishing an IRA. Specifically, except as noted
below, if neither you nor your spouse is an active participant in a qualified
employer or government retirement plan, or if either you or your spouse is an
active participant in such a plan and your adjusted gross income does not exceed
a certain level, then each of you may deduct cash contributions made to an IRA
in an amount for each taxable year not exceeding the lesser of 100% of your
earned income or $2,000. However, a married shareholder who is not an active
participant in such a plan and files a joint income tax return with his or her
spouse (and their combined adjusted gross income does not exceed $150,000) is
not affected by the spouse's active participant status. In addition, if your
spouse is not employed and you file a joint return, you may establish a separate
IRA for your spouse and contribute up to a total of $4,000 to the two IRAs,
provided that the contribution to either does not exceed $2,000. If your
employer's plan qualifies as a SIMPLE, permits voluntary contributions and meets
certain requirements, you may make voluntary contributions to that plan that are
treated as deductible IRA contributions.
Even if you are not in one of the categories described in the preceding
paragraph, you may find it advantageous to invest in Primary Class or Class A
shares or shares of a fund through non-deductible IRA contributions, up to
certain limits, because all dividends and other distributions on your fund
shares are then not immediately taxable to you or the IRA; they become taxable
only when distributed to you. To avoid penalties, your interest in an IRA must
be distributed, or start to be distributed, to you not later than April 1
following the calendar year in which you attain age 70 1/2. Distributions made
before age 59 1/2, in addition to being taxable, generally are subject to a
penalty equal to 10% of the distribution, except in the case of death or
disability, where the distribution is rolled over into another qualified plan or
certain other situations.
ROTH IRA. A shareholder whose adjusted gross income (or combined
adjusted gross income with his or her spouse) does not exceed certain levels may
establish and contribute up to $2,000 per tax year to a Roth IRA. In addition,
for a shareholder whose adjusted gross income does not exceed $100,000 (or is
not married filing a separate return), certain distributions from traditional
IRAs may be rolled over to a Roth IRA and any of the shareholder's traditional
IRAs may be converted to a Roth IRA; these rollover distributions and
conversions are, however, subject to federal income tax.
Contributions to a Roth IRA are not deductible; however, earnings
accumulate tax-free in a Roth IRA, and withdrawals of earnings are not subject
to federal income tax if the account has been held for at least five years (or
in the case of earnings attributable to rollover contributions from or
conversions of a traditional IRA, the rollover or conversion occurred more than
five years before the withdrawal) and the account holder has reached age 59 1/2
(or certain other conditions apply).
EDUCATION IRA. Although not technically for retirement savings, an
Education IRA provides a vehicle for saving for a child's higher education. An
Education IRA may be established for the benefit of any minor, and any person
whose adjusted gross income does not exceed certain levels may contribute to an
Education IRA, provided that no more than $500 may be contributed for any year
to Education IRAs for the same beneficiary. Contributions are not deductible and
may not be made after the beneficiary reaches age 18; however, earnings
accumulate tax-free, and withdrawals are not subject to tax if used to pay the
qualified higher education expenses of the beneficiary (or a qualified family
member).
Simplified Employee Pension Plan -- SEP
---------------------------------------
Legg Mason makes available to corporate and other employers a SEP for
investment in Primary Class or Class A shares of a fund.
49
<PAGE>
SAVINGS INCENTIVE MATCH PLAN FOR EMPLOYEES - SIMPLE
An employer with no more than 100 employees that does not maintain
another retirement plan may establish a SIMPLE either as separate IRAs or as
part of a Code section 401(k) plan. A SIMPLE, which is not subject to the
complicated nondiscrimination rules that generally apply to qualified retirement
plans, will allow certain employees to make elective contributions of up to
$6,000 per year and will require the employer to make matching contributions up
to 3% of each such employee's salary or a 2% nonelective contribution.
Withholding at the rate of 20% is required for federal income tax
purposes on certain distributions (excluding, for example, certain periodic
payments) from qualified plans (except IRAs and SEPs), unless the recipient
transfers the distribution directly to an "eligible retirement plan" (including
IRAs and other qualified plans) that accepts those distributions. Other
distributions generally are subject to regular wage withholding at the rate of
10% (depending on the type and amount of the distribution), unless the recipient
elects not to have any withholding apply. Investors in Primary Class or Class A
shares should consult their plan administrator or tax advisor for further
information.
MANAGEMENT OF THE FUNDS
Each fund's officers are responsible for the operation of the fund
under the direction of the Board of Directors. The officers and directors of the
funds and their principal occupations during the past five years are set forth
below. An asterisk (*) indicates officers and/or directors who are "interested
persons" of the funds as defined by the 1940 Act. The business address of each
officer and director is 100 Light Street, Baltimore, Maryland 21202, unless
otherwise indicated.
RAYMOND A. MASON* [9/28/36], Chairman of the Board and Director of
Value Trust, Total Return Trust and Special Investment Trust; Chairman of the
Board and President of Legg Mason, Inc. (financial services holding company);
Chairman and Director of Legg Mason Funds Management, Inc. (a registered
investment adviser), Director of Environmental Elements Corporation
(manufacturer of pollution control equipment); Officer and/or Director of
various other affiliates of Legg Mason.
JOHN F. CURLEY, JR.* [7/24/39], President and Director of Value Trust,
Total Return Trust and Special Investment Trust; Chairman of the Board and
Director of American Leading Companies, Balanced Trust, Small-Cap Value Trust,
and Financial Services Fund; President and/or Chairman of the Board and
Director/Trustee of all Legg Mason retail funds. Formerly: Vice Chairman and
Director of Legg Mason, Inc. and Legg Mason Wood Walker, Inc.; Director of Legg
Mason Fund Adviser, Inc. and Western Asset Management Company (each a registered
investment adviser); Officer and/or Director of various other affiliates of Legg
Mason, Inc.
EDWARD A. TABER, III* [8/25/43], President and/or Director of each
fund; President and/or Director/Trustee of all Legg Mason retail funds except
Legg Mason Tax Exempt; Senior Executive Vice President of Legg Mason, Inc. and
Legg Mason Wood Walker, Inc.; Chairman and Director of Legg Mason Fund Adviser,
Inc.; Director of Legg Mason Funds Management, Inc. and Western Asset Management
Company (each a registered investment adviser). Formerly: Executive Vice
President of T. Rowe Price-Fleming International, Inc. (1986-1992) and Director
of the Taxable Income Division at T. Rowe Price Associates, Inc. (1973-1992).
RICHARD G. GILMORE [6/9/27], Director of each fund; 10310 Tamo Shanter
Place, Bradenton, Florida. Independent Consultant. Director of CSS Industries,
Inc. (diversified holding company whose subsidiaries are engaged in the
manufacture and sale of decorative paper products, business forms, and specialty
metal packaging); Director of PECO Energy Company (formerly Philadelphia
Electric Company); Director/Trustee of all Legg Mason retail funds. Formerly:
Senior Vice President and Chief Financial Officer of Philadelphia Electric
Company (now PECO Energy Company); Executive Vice President and Treasurer,
50
<PAGE>
Girard Bank, and Vice President of its parent holding company, the Girard
Company; and Director of Finance, City of Philadelphia.
ARNOLD L. LEHMAN [7/18/44], Director of each fund; 200 Eastern Parkway,
Brooklyn, New York. Director, Brooklyn Museum of Art; Director/Trustee of all
Legg Mason retail funds. Formerly: Director, Baltimore Museum of Art.
JILL E. McGOVERN [8/29/44], Director of each fund; 400 Seventh Street
NW, Washington, DC. Chief Executive Officer of the Marrow Foundation.
Director/Trustee of all Legg Mason retail funds. Formerly: Executive Director of
the Baltimore International Festival (January 1991 - March 1993); and Senior
Assistant to the President of The Johns Hopkins University (1986-1991).
T. A. RODGERS [10/22/34], Director of each fund; 2901 Boston Street,
Baltimore, Maryland. Principal, T. A. Rodgers & Associates (management
consulting); Director/Trustee of all Legg Mason retail funds. Formerly: Director
and Vice President of Corporate Development, Polk Audio, Inc. (manufacturer of
audio components).
G. PETER O'BRIEN [10/13/45], Director of each fund; 118 Riverside Road,
Riverside, CT. Trustee of Colgate University; Director/Trustee of all Legg Mason
retail funds except Legg Mason Income Trust, Inc., and Legg Mason Tax Exempt
Trust, Inc. Retired: Managing Director/Equity Capital Markets Group of Merrill
Lynch & Co. (1971-1999).
NELSON A. DIAZ [5/23/47], Director of each fund; One Logan Square,
Philadelphia, PA. Partner, Blank Rome Comisky, & McCauley LLP (law firm) since
1997. Director/Trustee of all Legg Mason retail funds except Legg Mason Income
Trust, Inc. and Legg Mason Tax Exempt Trust, Inc.; Trustee of Temple University
and of Philadelphia Museum of Art. Board member of U.S. Hispanic Leadership
Institute, Democratic National Committee, and National Association for Hispanic
Elderly. Formerly: General Counsel, United States Department of Housing and
Urban Development (1993 - 1997).
The executive officers of the funds, other than those who also serve as
directors, are:
MARIE K. KARPINSKI* [1/1/49], Vice President and Treasurer of each
fund; Vice President and Treasurer of Legg Mason Fund Adviser Inc.; Vice
President and Treasurer of all Legg Mason retail funds.
PATRICIA A. MAXEY*, [7/10/67], Secretary of each fund; employee of Legg
Mason since November 1999. Formerly: Employee of Select Appointments
International (1998-1999) and Fidelity Investments (1995-1997).
WM. SHANE HUGHES* [4/24/68], Assistant Secretary and Assistant
Treasurer of each fund; employee of Legg Mason since May 1997. Formerly: Senior
Associate of C.W. Amos and Co. (a regional public accounting firm).
The Nominating Committee of the Board of Directors is responsible for
the selection and nomination of disinterested directors. The Committee is
composed of Messrs. Diaz, Gilmore, Lehman, Rodgers, O'Brien and Dr. McGovern.
Officers and directors of a fund who are "interested persons" thereof,
as defined in the 1940 Act, receive no salary or fees from the fund. Each
Director of a fund who is not an interested person of the fund ("Independent
Directors") receives an annual retainer and a per meeting fee based on the
average net assets of each fund at December 31 of the previous year.
On July 3, 2000, the directors and officers of each fund beneficially
owned, in the aggregate, less than 1% of each fund's outstanding shares.
51
<PAGE>
On June 30, 2000, the following shareholders owned of record and
beneficially the following percentages of the outstanding shares of the
Navigator Classes of each fund:
Name and Address Fund Name % of Class Held
---------------- --------- ---------------
Legg Mason Wood Walker INC Special Investment Trust 79.27%
Deferred Comp Navigator
C/O Brian Becker LM Profit SH PL
PO Box 1476 Baltimore MD 21203-1476
Boston Safe Deposit and Trust Special Investment Trust 16.81%
Company AS Trustee For
The TWA Pilots DAP/401K Plan
135 Santilli HWY #26-0320
Everett MA 02149-1906
Legg Mason Wood Walker INC Total Return Trust 94.87%
Deferred Comp Navigator
C/O Brian Becker LM Profit SH PL
PO Box 1476 Baltimore MD 21203-1476
Fidelity Investments Inst Oper Value Trust 25.19%
FIIOC As Agent for Certain Ben PL
100 Magellan Way
Mail Zone KWIC
Covington KY 41015-1999
Chase Manhattan Bank Value Trust 16.92%
FBO ADP Retirement Plan
4 New York Plaza #2
New York NY 10004-2413
Legg Mason Wood Walker INC Value Trust 16.49%
Deferred Comp Navigator
C/O Brian Becker LM Profit SH PL
PO Box 1476 Baltimore MD 21203-1476
PEBSCO Value Trust 7.76%
Maryland 457 Plan
C/O IPO Portfolio Accounting
PO Box 182029
Columbus OH 43218-2029
Old Second National Bank U.S. Small-Cap Value 100%
ATTN: Trust Operations Division
37 S River Street
Aurora IL 60506-4172
52
<PAGE>
Legg Mason Wood Walker IC Financial Services Fund 100%
Audit ACCT LM Funds
C/O Debbie Fox
PO Box 1576
Baltimore MD 21203-1476
As of June 30, 2000, the following shareholders owned of record and
beneficially the following percentages of the outstanding shares of the
Financial Services Fund Class A:
Name and Address % of Class Held
---------------- ---------------
Neuberger Berman LLC 61.20%
55 Water St FL 27
New York NY 10041-0001
KINCO & Co 5.40%
C/O Republic National Bank
One Hanson PL Lower Level
Brooklyn NY 11243-2907
53
<PAGE>
The following table provides certain information relating to the
compensation of the funds' directors for the fiscal year ended March 31, 2000.
None of the Legg Mason funds has any retirement plan for its directors.
COMPENSATION TABLE
<TABLE>
<CAPTION>
AGGREGATE AGGREGATE TOTAL COMPENSATION
AGGREGATE AGGREGATE COMPENSATION COMPENSATION FROM EACH FUND
COMPENSATION COMPENSATION FROM SPECIAL FROM AND FUND
NAME OF PERSON FROM VALUE FROM TOTAL INVESTMENT INVESTORS COMPLEX PAID TO
AND POSITION TRUST* RETURN TRUST* TRUST* TRUST* DIRECTORS**
<S> <C> <C> <C> <C> <C>
RAYMOND A. MASON
Chairman of the Board
and Director None None None None None
JOHN F. CURLEY, JR.
President and Director None None None None None
EDWARD A. TABER, III
Director None None None None None
RICHARD G. GILMORE
Director $3,600 $2,400 $3,600 $4,950 $41,100
ARNOLD L. LEHMAN
Director $3,600 $2,400 $3,600 $4,950 $41,100
JILL E. MCGOVERN
Director $3,600 $2,400 $3,600 $4,950 $41,100
T. A. RODGERS
Director $3,600 $2,400 $3,600 $4,950 $41,100
G. PETER O'BRIEN
Director*** $2,700 $1,800 $2,700 $3,600 $15,000
NELSON A. DIAZ
Director**** None None None None None
</TABLE>
* Represents fees paid to each director during the fiscal year ended March
31, 2000.
** Represents aggregate compensation paid to each director during the calendar
year ended December 31, 1999. There are twelve open-end investment
companies in the Legg Mason Complex (with a total of twenty-four funds).
*** Mr. O'Brien was appointed to the Board on November 11, 1999.
**** Mr. Diaz was appointed to the Board on February 10, 2000.
54
<PAGE>
THE FUNDS' INVESTMENT ADVISER/MANAGER
Legg Mason Funds Management, Inc. ("LMFM"), a Maryland corporation, is
located at 100 Light Street, Baltimore, Maryland 21202. LMFM is a wholly owned
subsidiary of Legg Mason, Inc., which is also the parent of Legg Mason, Legg
Mason Capital Management, Inc. ("LMCM") and Legg Mason Fund Adviser, Inc.
("LMFA"). LMFM serves as manager and investment adviser to Value Trust, Total
Return Trust, Special Investment Trust and American Leading Companies pursuant
to separate Investment Advisory and Management Agreements with each fund (each,
a "Management Agreement").
LMFA, a Maryland corporation, is located at 100 Light Street,
Baltimore, Maryland 21202. LMFA serves as manager to Balanced Trust, Small-Cap
Value Trust, and Financial Services Fund under separate Investment Advisory
Agreements with each fund (each, a "Management Agreement"). LMFA serves as
administrator to Value Trust, Total Return Trust, Special Investment Trust and
American Leading Companies Trust pursuant to separate Sub-Administration
Agreements with LMFM (each, a "Sub-Administration Agreement").
Each Management Agreement provides that, subject to overall direction
by the fund's Board of Directors, LMFM/LMFA manages or oversees the investment
and other affairs of each fund. LMFM /LMFA is responsible for managing each fund
consistent with the fund's investment objective and policies described in its
Prospectuses and this Statement of Additional Information. LMFM/LMFA also is
obligated to (a) provide each fund with office facilities and personnel and
maintain the funds' books and records; (b) supervise all aspects of each fund's
operations; (c) bear the expense of certain informational and purchase and
redemption services to each fund's shareholders; (d) arrange, but not pay for,
the periodic updating of prospectuses, proxy material, tax returns and reports
to shareholders and state and federal regulatory agencies; and (e) report
regularly to each fund's officers and directors. In addition, LMFM has agreed to
reduce advisory fees for Value Trust and Special Investment Trust in an amount
equal to those funds' auditing fees and compensation of their independent
directors. LMFM/LMFA and its affiliates pay all compensation of directors and
officers of each fund who are officers, directors or employees of LMFM/LMFA.
Each fund pays all of its expenses which are not expressly assumed by LMFM/LMFA.
These expenses include, among others, interest expense, taxes, brokerage fees
and commissions, expenses of preparing and printing prospectuses, proxy
statements and reports to shareholders and of distributing them to existing
shareholders, custodian charges, transfer agency fees, distribution fees to Legg
Mason, each fund's distributor, compensation of the independent directors, legal
and audit expenses, insurance expense, shareholder meetings, proxy
solicitations, expenses of registering and qualifying fund shares for sale under
federal and state law, governmental fees and expenses incurred in connection
with membership in investment company organizations. Each fund also is liable
for such nonrecurring expenses as may arise, including litigation to which the
fund may be a party. Each fund may also have an obligation to indemnify its
directors and officers with respect to litigation.
LMFM receives for its services to Value Trust, Total Return Trust,
Special Investment Trust and American Leading Companies a management fee,
calculated daily and payable monthly.
FEE RATE
--------
Value Trust 1.00% up to $100 million of average
daily net assets; 0.75% between
$100 million and $1 billion of
average daily net assets; and 0.65%
of average daily net assets
exceeding $1 billion
Special Investment Trust 1.00% up to $100 million of average
daily net assets; 0.75% between
$100 million and $1 billion of
average daily net assets; and 0.65%
of average daily net assets
exceeding $1 billion
55
<PAGE>
Total Return Trust 0.75% up to $1 billion of average
daily net assets; and 0.65% of
average daily net assets exceeding
$1 billion
American Leading Companies 0.75% up to $1 billion of average
daily net assets; and 0.65% of
average daily net assets exceeding
$1 billion
LMFM has agreed to waive its fees for Total Return Trust and American
Leading Companies, for expenses related to Primary Class shares (exclusive of
taxes, interest, brokerage and extraordinary expenses) in excess of the
following amounts for the noted periods:
EXPENSE CAP EXPIRATION DATE
----------- ---------------
Total Return Trust 1.95% Indefinite
American Leading Companies 1.95% Indefinite
LMFM has agreed to waive its fees for Total Return Trust and American
Leading Companies Trust, for expenses related to Navigator Class shares
(exclusive of taxes, interest, brokerage and extraordinary expenses) in excess
of the following amounts:
EXPENSE CAP EXPIRATION DATE
----------- ---------------
Total Return Trust 0.95% Indefinite
American Leading Companies 0.95% Indefinite
LMFA receives for its services to Balanced Trust, Small-Cap Value Trust
and Financial Services Fund a management fee, calculated daily and payable
monthly.
FEE RATE
--------
Balanced Trust 0.75% of average daily net assets
Small-Cap Value Trust 0.85% up to $100 million of average
daily net assets; 0.75% between
$100 million and $1 billion of
average daily net assets; and 0.65%
of average daily net assets
exceeding $1 billion
Financial Services Fund 1.00% up to $100 million of average
daily net assets; 0.75% between
$100 million and $1 billion of
average daily net assets; and 0.65%
of average daily net assets
exceeding $1 billion
LMFA has agreed to waive its fees for Balanced Trust, Small-Cap Value
Trust and Financial Services Fund for expenses related to Primary Class shares
and Class A shares of Financial Services Fund (exclusive of taxes, interest,
56
<PAGE>
brokerage and extraordinary expenses) in excess of the following amounts for the
noted periods:
EXPENSE CAP EXPIRATION DATE
----------- ---------------
Balanced Trust 1.85% August 1, 2001
Small-Cap Value Trust 2.00% August 1, 2001
Financial Services Fund
Primary Class 2.25% August 1, 2001
Class A 1.50% August 1, 2001
LMFA has agreed to waive its fees for Balanced Trust, Small-Cap Value
Trust and Financial Services Fund for expenses related to Navigator Class shares
(exclusive of taxes, interest, brokerage and extraordinary expenses) in excess
of the following amounts:
EXPENSE CAP EXPIRATION DATE
----------- ---------------
Balanced Trust 1.10% August 1, 2001
Small-Cap Value Trust 1.00% August 1, 2001
Financial Services Fund 1.25% August 1, 2001
Prior to August 1, 2000, LMFA served as manager and investment adviser
to Value Trust, Total Return Trust, Special Investment Trust and American
Leading Companies under compensation arrangements identical to those with LMFM.
For the fiscal years ended March 31, the funds paid advisory fees to
LMFA of (prior to fees waived):
2000 1999 1998
Value Trust $80,416,828 $45,014,441 $24,282,523
Total Return Trust $ 3,969,946 $ 4,952,596 $ 4,031,818
Special Investment Trust $16,299,473 $11,608,871 $ 9,875,632
American Leading Companies $ 2,385,889 $ 1,655,396 $ 1,190,729
Balanced Trust $ 355,804 $ 419,683 $ 215,415
Small-Cap Value Trust $ 606,718 $ 329,973* N/A
*For the period June 15, 1998 (commencement of operations) through March 31,
1999.
For the fiscal years ended March 31, the following advisory fees were
waived by LMFA:
2000 1999 1998
American Leading Companies -- -- $69,496
Balanced Trust $ 14,212 $ 25,964 $83,278
Small-Cap Value Trust $242,349 $147,480* --
*For the period June 15, 1998 (commencement of operations) through March 31,
1999.
Pursuant to Sub-Administration Agreements between LMFM and LMFA, LMFA
agrees, among other things, to provide Value Trust, Total Return Trust, Special
Investment Trust, and American Leading Companies with office facilities and
personnel, maintain the funds' books and records and supply the directors and
57
<PAGE>
officers of the funds with statistical reports and information regarding the
funds. For LMFA's services to the funds, LMFM, not the funds, pays LMFA 0.05% of
each fund's average daily net assets.
From November 16, 1998 (commencement of operations) through October 5,
1999, Bartlett served as manager to Financial Services Fund under compensation
arrangements substantially similar to those with LMFA. For the periods January
1, 1999 to October 5, 1999 and November 16, 1998 to December 31, 1998, the fund
paid Bartlett advisory fees in the amount of $139,411 and $17,081. For the
periods October 6, 1999 to December 31, 1999 and January 1, 2000 to March 31,
2000, the fund paid LMFA management fees in the amount of $75,300 and $50,387,
respectively.
Gray, Seifert, 380 Madison Avenue, New York, New York, serves as
investment sub-adviser to Financial Services Fund under a Sub-Advisory Agreement
between Gray, Seifert and LMFA ("Sub-Advisory Agreement"). From November 16,
1998 (commencement of operations) through October 5, 1999, Gray, Seifert served
as sub-adviser to the fund under arrangements with Bartlett substantially
similar to those with LMFA.
Gray, Seifert is responsible for providing investment advice to
Financial Services Fund in accordance with its investment objective and
policies, and for placing orders to purchase and sell portfolio securities
pursuant to directions from the fund's officers. For Gray, Seifert's services to
Financial Services Fund, LMFA (not the fund) pays Gray, Seifert a fee equal to
60% of the fee it receives from the fund under the Management Agreement. For the
periods January 1, 1999 to October 5, 1999 and November 16, 1998 (commencement
of operations) to December 31, 1998, Bartlett paid $83,647 and $10,249 to Gray,
Seifert. For the periods October 6, 1999 to December 31, 1999 and January 1,
2000 to March 31, 2000, LMFA paid $45,180 and $30,232 to Gray, Seifert for its
services to the fund.
Bartlett, 36 East Fourth Street, Cincinnati, Ohio 45202, an affiliate
of Legg Mason, serves as investment adviser to Balanced Trust pursuant to an
Investment Advisory Agreement between Bartlett and LMFA ("Sub-Advisory
Agreement"). Under the Advisory Agreement, Bartlett is responsible, subject to
the general supervision of the Manager and the fund's Board of Directors, for
the actual management of the fund's assets, including responsibility for making
decisions and placing orders to buy, sell or hold a particular security. For
Bartlett's services to the fund, LMFA (not the fund) pays Bartlett a fee,
computed daily and payable monthly, at an annual rate equal to 66 2/3% of the
fee received by LMFM from the fund, net of any waivers by LMFA. For the fiscal
years ended March 31, 2000, 1999, and 1998, Bartlett received $227,716, $262,479
and $88,092, respectively, in advisory fees on behalf of Balanced Trust.
Brandywine Asset Management, Inc. ("Brandywine"), 201 North Walnut
Street, Wilmington, Delaware, an affiliate of Legg Mason, serves as investment
adviser to Small-Cap Value Trust pursuant to an Investment Advisory Agreement
between Brandywine and LMFA ("Sub-Advisory Agreement"). Under the Advisory
Agreement, Brandywine is responsible, subject to the general supervision of LMFA
and Investors Trust's Board of Directors, for the actual management of the
fund's assets, including responsibility for making decisions and placing orders
to buy, sell or hold a particular security. For Brandywine's services to the
fund, LMFA (not the fund) pays Brandywine a fee, computed daily and payable
monthly, at an annual rate equal to 0.50% of the fund's average daily net assets
or 58.8% of the fee received by LMFA from the fund, net of any waivers by LMFA.
For the fiscal year ended March 31, 2000, and for the period June 15, 1998 to
March 31, 1999, Brandywine received $214,249 and $107,306 in advisory fees on
behalf of Small-Cap Value Trust.
LMCM previously served as investment adviser to American Leading
Companies pursuant to an Investment Advisory Agreement between LMCM and LMFA.
During the fiscal years ended March 31, 1999 and 1998 and LMCM received $0.00
and $610,704, respectively, for such services.
Under each Management Agreement or Sub-Advisory Agreement, each fund
has the non-exclusive right to use the name "Legg Mason" until that Agreement is
terminated, or until the right is withdrawn in writing by LMFM or LMFA, as
appropriate.
58
<PAGE>
Under each Management Agreement, Sub-Administration Agreement and
Sub-Advisory Agreement, LMFM/LMFA/Bartlett/Brandywine/Gray, Seifert will not be
liable for any error of judgment or mistake of law or for any loss by a fund in
connection with the performance of the Agreement, except a loss resulting from a
breach of fiduciary duty with respect to the receipt of compensation for
services or a loss resulting from willful misfeasance, bad faith or gross
negligence on its part in the performance of its duties or from reckless
disregard of its obligations or duties under the respective Agreement.
Each Management Agreement and Sub-Advisory Agreement terminates
automatically upon assignment and is terminable at any time without penalty by
vote of the respective fund's Board of Directors, by vote of a majority of the
fund's outstanding voting securities, or by LMFA/LMFM/Bartlett/Brandywine/Gray,
Seifert, on not less than 60 days' notice to the other party to the Agreement,
and may be terminated immediately upon the mutual written consent of all parties
to the Agreement. Each Sub-Advisory Agreement terminates immediately upon
termination of the associated Management Agreement.
The funds, LMFM, LMFA, Legg Mason, Brandywine, Bartlett, and Gray,
Seifert each has adopted a code of ethics under Rule 17j-1 of the 1940 Act,
which permits personnel covered by the code to invest in securities that may be
purchased or held by a fund, but prohibits fraudulent, deceptive or manipulative
conduct in connection with that personal investing.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The portfolio turnover rate is computed by dividing the lesser of
purchases or sales of securities for the period by the average value of
portfolio securities for that period. Short-term securities are excluded from
the calculation. For the fiscal years ended March 31, 2000 and 1999, the
portfolio turnover rates for Value Trust were 19.7% and 19.3%, respectively; the
portfolio turnover rates for Total Return Trust were 85.4% and 44.2%,
respectively; the portfolio turnover rates for Special Investment Trust were
29.3% and 47.8%, respectively; the portfolio turnover rates for American Leading
Companies were 43.5% and 47.6%, respectively; and the portfolio turnover rates
for Balanced Trust were 58.0% and 50.0%, respectively. For the fiscal year ended
March 31, 2000 and for the period June 15, 1998 (commencement of operations) to
March 31, 1999, the portfolio turnover rate for Small Cap Value Trust was 66.2%
and 29.5% (annualized). For the fiscal year ended December 31, 1999 and the
period November 16, 1998 (commencement of operations) to December 31, 1998, the
portfolio turnover rate for Financial Services Fund was 27.1% and 0%
(annualized). For the period January 1, 2000 to March 31, 2000, the portfolio
turnover rate for Financial Services Fund was 60.9% (annualized).
Under the Advisory Agreement with each fund, each fund's adviser is
responsible for the execution of the fund's portfolio transactions. Corporate
and government debt securities are generally traded on the OTC market on a "net"
basis without a stated commission, through dealers acting for their own account
and not as brokers. Prices paid to a dealer in debt securities will generally
include a "spread," which is the difference between the price at which the
dealer is willing to purchase and sell the specific security at the time, and
includes the dealer's normal profit. Some portfolio transactions may be executed
through brokers acting as agent. In selecting brokers or dealers, each adviser
must seek the most favorable price (including the applicable dealer spread or
brokerage commission) and execution for such transactions, subject to the
possible payment as described below of higher brokerage commissions or spreads
to broker-dealers who provide research and analysis. A fund may not always pay
the lowest commission or spread available. Rather, in placing orders on behalf
of a fund, each adviser also takes into account such factors as size of the
order, difficulty of execution, efficiency of the executing broker's facilities
(including the services described below), and any risk assumed by the executing
broker.
Consistent with the policy of most favorable price and execution, each
adviser may give consideration to research, statistical and other services
furnished by brokers or dealers to that adviser for its use, may place orders
with brokers who provide supplemental investment and market research and
59
<PAGE>
securities and economic analysis, and may pay to these brokers a higher
brokerage commission than may be charged by other brokers. Such services
include, without limitation, advice as to the value of securities; the
advisability of investing in, purchasing, or selling securities; advice as to
the availability of securities or of purchasers or sellers of securities; and
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy and the performance of accounts.
Such research and analysis may be useful to each fund's adviser in connection
with services to clients other than the fund whose brokerage generated the
service. On the other hand, research and analysis received by the adviser from
broker-dealers executing orders for clients other than the funds may be used for
the funds' benefit. The adviser's fee is not reduced by reason of its receiving
such brokerage and research services.
From time to time each fund may use Legg Mason as broker for agency
transactions in listed and over-the-counter securities at commission rates and
under circumstances consistent with the policy of best execution. Commissions
paid to Legg Mason will not exceed "usual and customary brokerage commissions."
Rule 17e-1 under the 1940 Act defines "usual and customary" commissions to
include amounts which are "reasonable and fair compared to the commission, fee
or other remuneration received by other brokers in connection with comparable
transactions involving similar securities being purchased or sold on a
securities exchange during a comparable period of time." In the over-the-counter
market, each fund generally deals with responsible primary market-makers unless
a more favorable execution can otherwise be obtained.
For the fiscal years ended March 31, 2000, 1999, and 1998, Legg Mason
received brokerage commissions of $5,000, $59,620, and $3,120 from Value Trust,
$0, $0, and $1,134 from Total Return Trust, and $22,362, $0, and $0, from
Special Investment Trust. Value Trust paid total brokerage commissions of
$8,688,617, $5,503,410, and $1,360,133, Total Return Trust paid total brokerage
commissions of $1,734,491, $1,024,770, and $477,779, and Special Investment
Trust paid total brokerage commissions of $3,569,516, $2,824,033, and
$1,333,903, during the fiscal years ended March 31, 2000, 1999, and 1998. The
amounts paid by the funds to Legg Mason in brokerage commissions for their most
recent fiscal year represent (1) for Value Trust, 0.06% of the total brokerage
commissions paid and 0.0009% of the total dollar amount of transactions
involving the payment of brokerage commissions; (2) for Total Return Trust, 0%
of the total brokerage commissions paid and 0% of the total dollar amount of
transactions involving the payment of brokerage commissions; and (3) for Special
Investment Trust, 0.63% of the total brokerage commissions paid and 0.58% of the
total dollar amount of transactions involving the payment of brokerage
commissions.
For the fiscal years ended March 31, 2000, 1999, and 1998, American
Leading Companies paid total brokerage commissions of $470,721, $329,996, and
$203,625, respectively. Legg Mason received no brokerage commissions from
American Leading Companies for the same periods.
For the fiscal years ended March 31, 2000, 1999, and 1998, Balanced
Trust paid total brokerage commissions of $35,450, $64,034 and $34,738,
respectively. Legg Mason received no brokerage commissions from Balanced Trust
for the same periods.
For the fiscal year ended March 31, 2000 and for the period June 15,
1998 (commencement of operations) to March 31, 1999, Small-Cap Value Trust paid
total brokerage commissions of $313,051 and $295,140. Legg Mason received no
brokerage commissions from Small-Cap Value Trust for that same period.
For the period January 1, 2000 to March 31, 2000, the fiscal year ended
December 31, 1999, and the fiscal period November 16, 1998 (commencement of
operations) to December 31, 1998, Financial Services Fund paid total brokerage
commissions of $27,993, $44,923, and $20,148. Legg Mason received no brokerage
commission from Financial Services Fund for that period.
60
<PAGE>
Except as permitted by SEC rules or orders, each fund may not buy
securities from, or sell securities to, Legg Mason or its affiliated persons as
principal. Each fund's Board of Directors has adopted procedures in conformity
with Rule 10f-3 under the 1940 Act whereby the fund may purchase securities that
are offered in certain underwritings in which Legg Mason or any of its
affiliated persons is a participant. These procedures, among other things, limit
each fund's investment in the amount of securities of any class of securities
offered in an underwriting in which Legg Mason or any of its affiliated persons
is a participant so that a fund together with all other registered investment
companies having the same adviser may not purchase more than 25% of the
principal amount of the offering of such class. In addition, a fund may not
purchase securities during the existence of an underwriting if Legg Mason is the
sole underwriter for those securities.
Section 11(a) of the Securities Exchange Act of 1934 prohibits Legg
Mason from receiving compensation for executing transactions on an exchange for
its affiliates, such as the funds, unless the affiliate expressly consents by
written contract. Each fund's Advisory Agreement expressly provides such
consent.
61
<PAGE>
Of the broker-dealers regularly used by each respective fund during the
fiscal year ended March 31, 2000, Financial Services Fund, American Leading
Companies, Value Trust and Total Return Trust at that date owned shares of the
following broker-dealers or parent companies of broker-dealers:
FINANCIAL SERVICES FUND
Name Market Value
---------------------------------------------------------------
A.G. Edwards 400,000.00
Lehman Brothers 291,000.00
Merrill Lynch & Co 630,000.00
Morgan Stanley 407,812.50
Neuberger Berman 366,437.50
Wachovia Securities,
Inc 405,375.00
AMERICAN LEADING COMPANIES TRUST
Name Market Value
---------------------------------------------------------------
Bank of America 5,191,313.00
VALUE TRUST
Name Market Value
---------------------------------------------------------------
Bank of America 209,750,000.00
Bear Stearns 150,904,688.00
TOTAL RETURN TRUST
Name Market Value
---------------------------------------------------------------
Bank of America 3,932,813.00
Bear Stearns 1,838,231.00
Special Investment Trust, Balanced Trust, and Small-Cap Value Trust
held no shares of their regular broker-dealers as of March 31, 2000.
Investment decisions for each fund are made independently from those of
other funds and accounts advised by LMFA, LMFM, Bartlett, Brandywine or Gray,
Seifert. However, the same security may be held in the portfolios of more than
one fund or account. When two or more accounts simultaneously engage in the
purchase or sale of the same security, the prices and amounts will be equitably
allocated to each account. In some cases, this procedure may adversely affect
the price or quantity of the security available to a particular account. In
other cases, however, an account's ability to participate in large-volume
transactions may produce better executions and prices.
62
<PAGE>
THE FUNDS' DISTRIBUTOR
Legg Mason acts as distributor of the funds' shares pursuant to a
separate Underwriting Agreement with each fund. Each Underwriting Agreement
obligates Legg Mason to promote the sale of fund shares and to pay certain
expenses in connection with its distribution efforts, including expenses for the
printing and distribution of prospectuses and periodic reports used in
connection with the offering to prospective investors (after the prospectuses
and reports have been prepared, set in type and mailed to existing shareholders
at each fund's expense), and for supplementary sales literature and advertising
costs.
Under each Underwriting Agreement, each fund has the non-exclusive
right to use the name "Legg Mason" until that agreement is terminated, or until
the right is withdrawn in writing by Legg Mason.
Each fund has adopted a Distribution Plan for Primary Class shares
("Primary Class Plans"), and Financial Services Fund has also adopted a
Distribution Plan for Class A shares ("Class A Plan"), each of which, among
other things, permits a fund to pay Legg Mason fees for its services related to
sales and distribution of Primary Class shares or Class A shares and the
provision of ongoing services to holders of those shares. Payments are made only
from assets attributable to a respective fund's Primary Class shares or Class A
shares. Under the Primary Class Plans, the aggregate fees may not exceed an
annual rate of each fund's average daily net assets attributable to Primary
Class shares as follows: 1.00% for Total Return Trust, Special Investment Trust,
American Leading Companies, Small-Cap Value Trust and Financial Services Fund,
0.75% for Balanced Trust and 0.95% for Value Trust. Under the Class A Plan, the
aggregate fees may not exceed an annual rate of 0.25% of Financial Services
Fund's average daily net assets attributable to Class A shares. Distribution
activities for which such payments may be made include, but are not limited to,
compensation to persons who engage in or support distribution and redemption of
shares, printing of prospectuses and reports for persons other than existing
shareholders, advertising, preparation and distribution of sales literature,
overhead, travel and telephone expenses, all with respect to the respective
class of shares only.
With respect to Primary Class shares, LMFA and LMFM have agreed to
waive their fees for Total Return Trust, American Leading Companies, Balanced
Trust and Small-Cap Value Trust as described under "The Funds' Investment
Adviser/Manager."
The Primary Class Plans and the Class A Plan were each adopted, as
required by Rule 12b-1 under the 1940 Act, by a vote of the Board of Directors
of each respective fund including a majority of the directors who are not
"interested persons" of each fund as that term is defined in the 1940 Act and
who have no direct or indirect financial interest in the operation of any Plan
or any Underwriting Agreement ("12b-1 Directors"). In approving the
establishment or continuation of each Plan, in accordance with the requirements
of Rule 12b-1, the directors determined that there was a reasonable likelihood
that each Plan would benefit the respective fund, class and its shareholders.
The directors considered, among other things, the extent to which the potential
benefits of the Plan to the fund's Primary Class or Class A shareholders, as
applicable, could offset the costs of the Plan; the likelihood that the Plan
would succeed in producing such potential benefits; the merits of certain
possible alternatives to the Plan; and the extent to which the retention of
assets and additional sales of the fund's Primary Class shares and Class A
shares, as applicable, would be likely to maintain or increase the amount of
compensation paid by that fund to the adviser.
In considering the costs of each Plan, the directors gave particular
attention to the fact that any payments made by a fund to Legg Mason under a
Plan would increase the fund's level of expenses in the amount of such payments.
Further, the directors recognized that the adviser would earn greater management
fees if a fund's assets were increased, because such fees are calculated as a
percentage of a fund's assets and thus would increase if net assets increase.
The directors further recognized that there can be no assurance that any of the
potential benefits described below would be achieved if each Plan was
implemented.
63
<PAGE>
Among the potential benefits of the Plans, the directors noted that the
payment of commissions and service fees to Legg Mason and its investment
executives could motivate them to improve their sales efforts with respect to
each fund's Primary Class shares and Class A shares, as applicable, and to
maintain and enhance the level of services they provide to a fund's respective
class of shareholders. These efforts, in turn, could lead to increased sales and
reduced redemptions, eventually enabling a fund to achieve economies of scale
and lower per share operating expenses. Any reduction in such expenses would
serve to offset, at least in part, the additional expenses incurred by a fund in
connection with its Plan. Furthermore, the investment management of a fund could
be enhanced, as net inflows of cash from new sales might enable its portfolio
manager to take advantage of attractive investment opportunities, and reduced
redemptions could eliminate the potential need to liquidate attractive
securities positions in order to raise the funds necessary to meet the
redemption requests.
Each Plan will continue in effect only so long as it is approved at
least annually by the vote of a majority of the Board of Directors, including a
majority of the 12b-1 Directors, cast in person at a meeting called for the
purpose of voting on that Plan. A Plan may be terminated by a vote of a majority
of the 12b-1 Directors or by a vote of a majority of the outstanding voting
securities of the applicable class of that fund. Any change in a Plan that would
materially increase the distribution costs to a fund requires approval by the
shareholders of the applicable class of the fund; otherwise a Plan may be
amended by the directors, including a majority of the 12b-1 Directors, as
previously described.
Rule 12b-1 requires that any person authorized to direct the
disposition of monies paid or payable by a fund, pursuant to a Plan or any
related agreement shall provide to that fund's Board, and the directors shall
review, at least quarterly, a written report of the amounts so expended and the
purposes for which the expenditures were made. Rule 12b-1 also provides that a
fund may rely on that Rule only if, while a Plan is in effect, the nomination
and selection of that fund's independent directors is committed to the
discretion of such independent directors.
As compensation for its services and expenses, Legg Mason receives from
each fund an annual distribution fee equivalent to a percentage of the fund's
average daily net assets as follows: 0.70% for Value Trust; 0.75% for Special
Investment Trust; 0.75% for Total Return Trust; 0.75% for American Leading
Companies; 0.50% for Balanced Trust; 0.75% for Small Cap Value; and 0.75% for
Financial Services, and an annual service fee equivalent to 0.25% of its average
daily net assets attributable to Primary Class shares in accordance with each
Primary Class Plan. For Legg Mason's services in connection with Class A shares,
Legg Mason receives from Financial Services Fund an annual service fee
equivalent to 0.25% of its average daily net assets attributable to Class A
shares in accordance with the Class A Plan. All distribution and service fees
are calculated daily and paid monthly.
For the years ended March 31, the funds paid Legg Mason distribution
and service fees of:
2000 1999 1998
Value Trust $106,509,822 $60,265,880 $32,477,903
Total Return Trust $ 5,143,151 $ 6,436,510 $ 5,232,873
Special Investment Trust $ 22,163,544 $15,329,259 $12,733,789
American Leading Companies $ 3,181,185 $ 2,206,663 $ 1,587,015
Balanced Trust $ 355,812 $ 419,683 $ 215,415
Small-Cap Value Trust $ 713,274 $ 387,871* N/A
*For the period between June 15, 1998 (commencement of operations) and March 31,
1999.
From November 16, 1998 (commencement of operations) to October 5, 1999,
LM Financial Partners, Inc. ("LMFP") served as distributor of Financial Services
Fund's Class A and Primary Class shares under arrangements with LMFP
substantially similar to those with Legg Mason. For the periods January 1, 1999
to October 5, 1999 and November 16, 1998 to December 31, 1998, Financial
64
<PAGE>
Services Fund paid LMFP $9,779 and $1,785 in distribution and/or service fees
under the Class A Plan, from assets attributable to Class A shares; and $181,012
and $12,955 in service fees under the Primary Class Plan, from assets
attributable to Primary Class shares, respectively. For the periods October 6,
1999 to December 31, 1999 and January 1, 2000 to March 31, 2000, Financial
Services Fund paid Legg Mason $6,193 and $5,350 in service fees under the Class
A Plan, from assets attributable to Class A shares; and $74,074 and $66,809 in
distribution and/or service fees under the Primary Class Plan, from assets
attributable to Primary Class shares.
For the fiscal year ended March 31, 2000, Legg Mason incurred the
following expenses in connection with distribution and shareholder services for
each of the following funds:
<TABLE>
<CAPTION>
Total Special American
Return Investment Leading Balanced Small-Cap
Value Trust Trust Trust Companies Trust Value Trust
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Compensation to sales
personnel $60,471,631 $2,566,884 $12,370,592 $1,633,913 $179,532 $370,532
Advertising 3,340,513 509,689 915,344 368,033 347,293 509,689
Printing and mailing of
prospectuses to
prospective shareholders
1,253,925 188,665 358,793 116,131 109,988 175,469
Other 35,305 1,915 5,854 1,233 256 649
------------------------------------------------------------------------------------
Total expenses $65,101,374 $3,267,153 $13,650,583 $2,119,310 $637,069 $1,056,339
====================================================================================
</TABLE>
For the period January 1, 1999 to October 5, 1999, LMFP incurred the
following expenses with respect to Primary Class shares and Class A shares of
Financial Services Fund:
Primary Class Shares Class A Shares
---------------------------------------------
Compensation to sales
personnel $157,681 $31,631
Advertising 54,235 20,535
Printing and mailing
of prospectuses
to prospective shareholders 8,413 3,185
Other 20,271 7,675
---------------------------------------------
Total expenses $240,600 $63,026
==============================================
For the period October 6, 1999 to December 31, 1999, Legg Mason
incurred the following expenses with respect to Primary Class shares and Class A
shares of Financial Services Fund:
65
<PAGE>
Primary Class Shares Class A Shares
---------------------------------------------
Compensation to sales
personnel $49,347 $9,900
Advertising 16,973 6,426
Printing and mailing
of prospectuses
to prospective shareholders 2,633 997
Other 6,343 2,402
--------------------------------------------
Total expenses $75,296 $19,725
============================================
For the period January 1, 2000 to March 31, 2000, Legg Mason incurred
the following expenses with respect to Primary Class shares and Class A shares
of Financial Services Fund:
Primary Class Shares Class A Shares
---------------------------------------------
Compensation to sales
personnel $42,031 $3,366
Advertising 9,467 758
Printing and mailing
of prospectuses
to prospective shareholders 2,987 239
Other 42 3
-------------------------------------------
Total expenses $54,527 $4,366
===========================================
The foregoing are estimated and do not include all expenses fairly
allocable to LMFP's, Legg Mason's or their affiliates' efforts to distribute
Primary Class shares or Class A shares.
CAPITAL STOCK INFORMATION
Value Trust has authorized capital of 500 million shares of common
stock, par value $0.001 per share. Total Return Trust has authorized capital of
100 million shares of common stock, par value $0.001 per share. Special
Investment Trust has authorized capital of 150 million shares of common stock,
par value $0.001 per share. The Articles of Incorporation of Investors Trust
authorize issuance of 500 million shares of par value $.001 per share of
American Leading Companies, 250 million shares of par value $.001 per share of
Balanced Trust, 100 million shares of par value $.001 per share of Small-Cap
Value Trust, and three hundred seventy five million shares of par value $.001
per share of Financial Services Fund. Each corporation may issue additional
series of shares. Each fund currently offers two classes of shares -- Primary
Class shares and Navigator Class shares. Financial Services Fund offers a third
class of shares: Class A shares. Each class represents interests in the same
pool of assets. A separate vote is taken by a class of shares of a fund if a
matter affects just that class of shares. Each class of shares may bear certain
differing class-specific expenses and sales charges, which may affect
performance.
The Board of each fund does not anticipate that there will be any
conflicts among the interests of the holders of the different classes of a
fund's shares. On an ongoing basis, the Board will consider whether any such
conflict exists and, if so, take appropriate actions. Shareholders of each fund
are entitled to one vote per share and fractional votes for fractional shares
held. Voting rights are not cumulative. All shares of the funds are fully paid
and nonassessible and have no preemptive or conversion rights.
66
<PAGE>
For each fund, shareholder meetings will not be held except: where the
Investment Company Act of 1940 requires a shareholder vote on certain matters
(including the election of directors, approval of an advisory contract, and
certain amendments to a plan of distribution pursuant to Rule 12b-1), at the
request of 10% or more of the shares entitled to vote as set forth in the
by-laws of the fund; or as the Board of Directors from time to time deems
appropriate.
THE FUNDS' CUSTODIAN AND TRANSFER AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company ("State Street"), P.O. Box 1713,
Boston, Massachusetts 02105, serves as custodian of each fund's assets. Boston
Financial Data Services ("BFDS"), P.O. Box 953, Boston, Massachusetts 02103, as
agent for State Street, serves as transfer and dividend-disbursing agent, and
administrator of various shareholder services. Legg Mason assists BFDS with
certain of its duties as transfer agent and receives compensation from BFDS for
its services. Each fund reserves the right, upon 60 days' written notice, to
make other charges to investors to cover administrative costs.
THE FUNDS' LEGAL COUNSEL
Kirkpatrick & Lockhart LLP, 1800 Massachusetts Ave., N.W.,
Washington, D.C. 20036-1800, serves as counsel to each fund.
THE FUNDS' INDEPENDENT ACCOUNTANTS/AUDITORS
PricewaterhouseCoopers LLP, 250 W. Pratt Street, Baltimore, MD 21201,
serves as independent accountants for Value Trust, Total Return Trust, and
Special Investment Trust. Ernst & Young LLP, 2001 Market Street, Philadelphia,
PA 19103, serves as independent auditors for American Leading Companies Trust,
Balanced Trust, Small-Cap Value Trust and Financial Services Fund.
FINANCIAL STATEMENTS
The Statement of Net Assets as of March 31, 2000; the Statements of
Operations for the year ended March 31, 2000; the Statements of Changes in Net
Assets for the years ended March 31, 2000 and 1999; the Financial Highlights for
the periods presented; the Notes to Financial Statements and the Report of
PricewaterhouseCoopers LLP, the funds' independent accountants, each with
respect to Value Trust, Total Return Trust and Special Investment Trust, are
included in the combined annual reports for the year ended March 31, 2000, and
are hereby incorporated by reference in this Statement of Additional
Information.
The Statements of Net Assets as of March 31, 2000; the Statements of
Operations for the year ended March 31, 2000; the Statements of Changes in Net
Assets for the years ended March 31, 2000 and 1999; the Financial Highlights for
the periods presented; the Notes to Financial Statements and the Reports of
Ernst & Young LLP, the funds' independent auditors, each with respect to
American Leading Companies Trust, Balanced Trust and U.S. Small-Cap Value Trust,
are included in the combined annual reports (Primary Class and Navigator Class)
for the year ended March 31, 2000, and are hereby incorporated by reference in
this Statement of Additional Information.
The Statement of Net Assets as of March 31, 2000; the Statement of
Operations for the three months ended March 31, 2000 and the year ended December
31, 1999; the Statement of Changes in Net Assets and Financial Highlights for
the three months ended March 31, 2000, the year ended December 31, 1999; the
Notes to Financial Statements and the Reports of Ernst & Young LLP, the funds'
independent auditors, each with respect to Financial Services Fund, are included
in the combined annual reports (Primary Class and Class A; Navigator Class) for
the year ended March 31, 2000, and are hereby incorporated by reference in this
Statement of Additional Information.
67
<PAGE>
Appendix A
RATINGS OF SECURITIES
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") CORPORATE BOND
RATINGS:
--------------------------------------------------------------------------------
AAA-Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edge". Interest payments are protected by a large or exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
AA-Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A-Bonds which are rated A possess many favorable investment attributes
and are to be considered upper-medium grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment sometime in the future.
BAA-Bonds which are rated Baa are considered medium-grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
BA-Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B-Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
CAA-Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
CA-Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C-Bonds which are rated C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
A-1
<PAGE>
DESCRIPTION OF STANDARD & POOR'S ("S&P") CORPORATE BOND RATINGS:
---------------------------------------------------------------
AAA-An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong.
AA -An obligation rated AA differs from the highest rated obligations
only in small degree. The obligor's capacity to meet its financial commitment on
the obligation is very strong.
A-An obligation rated A is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB-An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation. Obligations rated BB, B, CCC, CC, and C are regarded as
having significant speculative characteristics. BB indicates the least degree of
speculation and C the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
BB-An obligation rated BB is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B-An obligation rated B is more vulnerable to nonpayment than
obligations rated BB, but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC-An obligation rated CCC is currently vulnerable to nonpayment, and
is dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC-An obligation rated CC is currently highly vulnerable to nonpayment.
C-A subordinated debt or preferred stock obligation rated C is
currently highly vulnerable to nonpayment. The C rating may be used to cover a
situation where a bankruptcy petition has been filed or similar action has been
taken, but payments on this obligation are being continued. A C also will be
assigned to a preferred stock issue in arrears on dividends or sinking fund
payments but that is currently paying.
D-An obligation rated D is in payment default. The D rating category is
used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating also will be used upon the
filing of a bankruptcy petition or the taking of a similar action if payments on
an obligation are jeopardized.
PLUS (+) OR MINUS (-)-The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
r-This symbol is attached to the ratings of instruments with
significant noncredit risks. It highlights risks to principal or volatility of
expected returns which are not addressed in the credit rating. Examples include:
A-2
<PAGE>
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk-such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
N.R.-This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate a
particular obligation as a matter of policy.
A-3
