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PAINEWEBBER
NATIONAL TAX-FREE INCOME FUND
CLASS Y SHARES
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
/ / FEDERAL TAX-FREE INCOME
/ / PROFESSIONAL MANAGEMENT
/ / PORTFOLIO DIVERSIFICATION
/ / DIVIDEND AND CAPITAL GAIN REINVESTMENT
/ / LOW MINIMUM INVESTMENT
PaineWebber National Tax-Free Income Fund ("Fund") is a series of PaineWebber
Mutual Fund Trust ("Trust"). This Prospectus concisely sets forth information
about the Fund a prospective investor should know before investing. Please
retain this Prospectus for future reference. A Statement of Additional
Information dated November 10, 1995, as supplemented January 22, 1996, (which is
incorporated by reference herein) has been filed with the Securities and
Exchange Commission. The Statement of Additional Information can be obtained
without charge, and further inquiries can be made, by contacting the Fund, your
PaineWebber investment executive or PaineWebber's correspondent firms or by
calling toll-free 1-800-647-1568.
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THE CLASS Y SHARES DESCRIBED IN THIS PROSPECTUS ARE CURRENTLY OFFERED FOR
SALE PRIMARILY TO PARTICIPANTS IN THE INSIGHT INVESTMENT ADVISORY
PROGRAM ('INSIGHT'), WHEN PURCHASED THROUGH THAT PROGRAM. SEE
'PURCHASES.'
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS ANY SUCH COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRE-
SENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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THE DATE OF THIS PROSPECTUS IS NOVEMBER 10, 1995, AS SUPPLEMENTED JANUARY 22,
1996.
PAINEWEBBER MUTUAL FUNDS
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH THE OFFERING
MADE BY THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR
ITS DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING BY THE FUND OR
ITS DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE
MADE.
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FUND EXPENSES
The following tables are intended to assist investors in understanding the
expenses associated with investing in Class Y shares of the Fund.
SHAREHOLDER TRANSACTION EXPENSES
Sales charge on purchases of shares.................................. None
Sales charge on reinvested dividends................................. None
Redemption fee or deferred sales charge.............................. None
Maximum annual investment advisory fee payable by shareholders
through INSIGHT (as a percentage of average daily value of
shares held)(1).................................................... 1.50%
ANNUAL FUND OPERATING EXPENSES(2)
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
Management fees...................................................... 0.50%
12b-1 fees........................................................... 0.00
Other expenses (estimated)........................................... 0.13
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Total operating expenses (estimated)................................. 0.63%
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(1) Participation in INSIGHT is subject to payment of an advisory fee at the
maximum annual rate of 1.50% of assets held through INSIGHT (generally
charged quarterly in advance), which may be charged to the INSIGHT
participants' PaineWebber account.
(2) See 'Management' for additional information. 'Other expenses' are estimated
based on the expenses incurred by the Fund's Class A shares for the fiscal
year ended February 28, 1995. Does not include the INSIGHT fee.
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EXAMPLE OF EFFECT OF FUND EXPENSES
An investor would directly or indirectly pay the following expenses
(including 1.50% annual INSIGHT fee) on a $1,000 investment in each Fund,
assuming a 5% annual return:
ONE YEAR THREE YEARS
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$22 $67
This Example assumes that all dividends and other distributions are
reinvested and that the percentage amounts listed under Annual Fund Operating
Expenses remain the same in the years shown. The above tables and the assumption
in the Example of a 5% annual return are required by regulations of the
Securities and Exchange Commission ('SEC') applicable to all mutual funds; the
assumed 5% annual return is not a prediction of, and does not represent, the
projected or actual performance of the Class Y shares of the Fund.
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES, AND THE FUND'S ACTUAL EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN.
The actual expenses attributable to the Class Y shares of the Fund will depend
upon, among other things, the level of average net assets and the extent to
which the Fund incurs variable expenses, such as transfer agency costs.
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INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide high current income exempt
from federal income tax, consistent with the preservation of capital and
liquidity within the Fund's quality standards. The Fund is a diversified series
of an open-end management investment company. Mitchell Hutchins Asset Management
Inc. ('Mitchell Hutchins') is the Fund's investment adviser and administrator.
The Fund invests primarily in investment grade debt obligations of varying
maturities issued by states, municipalities and public authorities and other
issuers that pay interest that is exempt from federal income tax ('municipal
securities' or 'municipal obligations'). The Fund seeks to invest 100% of its
net assets in municipal obligations with varying maturities. Except under
unusual market conditions, the Fund invests at least 80% of its net assets in
municipal obligations that pay interest that is not an item of tax preference
for purposes of the federal alternative minimum tax ('AMT') ('AMT exempt
interest'). See 'Other Investment Policies.'
The Fund may invest in municipal obligations of issuers in any state that
meet its investment standards and pay interest that is exempt from federal
income tax. Municipal obligations include, but are not limited to, municipal
bonds, floating rate and variable rate municipal obligations, inverse floaters,
participation interests in municipal bonds, tax-exempt commercial paper, tender
option bonds and short-term municipal notes. Municipal bonds include industrial
development bonds ('IDBs'), municipal lease obligations and certificates of
participation therein, put bonds and private activity bonds ('PABs'). The Fund
also may invest in stand-by commitments, as described in the Statement of
Additional Information. The Fund may not invest more than 10% of its total
assets in inverse floaters. Because most PABs do not pay AMT exempt interest,
the Fund will not invest more than 20% of its net assets in such PABs, except
under unusual market conditions. The principal municipal obligations in which
the Fund invests are described in Appendix A to this Prospectus.
There can be no assurance that the Fund will achieve its investment
objective. The Fund's net asset value fluctuates based upon changes in the value
of its portfolio securities. The Fund's investment objective and certain
investment limitations described in the Statement of Additional Information are
fundamental policies that may not be changed without shareholder approval. In
addition, the Fund's policy of investing at least 80% of its net assets in
municipal obligations that pay AMT exempt interest may not be changed without
shareholder approval. All other investment policies may be changed without
shareholder approval by the Trust's board of trustees.
OTHER INVESTMENT POLICIES AND RISK FACTORS
CREDIT QUALITY. The Fund invests only in municipal securities that present
acceptable credit risks in the judgment of Mitchell Hutchins and that at the
time of purchase are rated at least Baa or MIG-2 by Moody's Investors Service,
Inc. ('Moody's'), BBB or SP-2 by Standard & Poor's, a division of The McGraw
Hill Companies, Inc. ('S&P'), have been assigned an equivalent rating by another
nationally recognized statistical rating organization ('NRSRO') or, if unrated,
are determined by Mitchell Hutchins to be of comparable quality.
Moody's and S&P may assign equivalent ratings to those described above for
specific categories of securities. See the Statement of Additional Information
for further information about Moody's and S&P's ratings.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The Fund may purchase
securities on a 'when-issued' basis, or may purchase or sell securities for
delayed delivery. In when-issued or delayed delivery transactions, delivery of
the securities occurs beyond normal settlement periods, but the Fund would not
pay for such securities or start earning interest on them until they are
delivered. However, when the Fund purchases securities on a when-issued or
delayed delivery basis, it immediately assumes the risks of ownership, including
the risk
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of price fluctuation. Failure by a counter party to deliver a security purchased
on a when-issued or delayed delivery basis may result in the Fund's incurring a
loss or missing an opportunity to make an alternative investment. Depending on
market conditions, the Fund's when-issued and delayed delivery purchase
commitments could cause its net asset value per share to be more volatile,
because such securities may increase the amount by which the Fund's total
assets, including the value of when-issued and delayed delivery securities held
by the Fund, exceed its net assets.
YIELD AND RISK FACTORS. The yield of a municipal security depends on a
variety of factors, including general municipal and fixed-income security market
conditions, the financial condition of the issuer, the size of the particular
offering, the maturity, credit quality and rating of the issue and expectations
regarding changes in tax rates. Generally, the longer the maturity of a
municipal security, the higher the rate of interest paid and the greater the
volatility. Further, if general market interest rates are increasing, the prices
of municipal obligations ordinarily will decrease and, if rates decrease, the
opposite generally will be true. During periods of market uncertainty, the
market values of fixed income securities can become volatile. The Fund may
invest in municipal securities with a broad range of maturities, based on
Mitchell Hutchins' judgment of current and future market conditions as well as
other factors, such as the Fund's liquidity needs. Accordingly, the average
weighted maturity of the Fund's portfolio may vary.
Ratings of municipal securities represent the NRSROs' opinions regarding
their quality, are not a guarantee of quality and may be reduced after a Fund
has acquired the security. Mitchell Hutchins will consider such an event in
deciding whether the Fund should continue to hold the security but is not
required to dispose of it. However, in the event that, due to a downgrade of one
or more debt securities, an amount in excess of 5% of the net assets of the Fund
is held in securities rated below investment grade and comparable unrated
securities, Mitchell Hutchins will engage in an orderly disposition of these
securities to the extent necessary to ensure that the Fund's holdings of these
securities do not exceed 5% of its net assets. Credit ratings attempt to
evaluate the safety of principal and interest payments and do not reflect an
assessment of the volatility of the security's market value or the liquidity of
an investment in the security. Also, NRSROs may fail to make timely changes in
credit ratings in response to subsequent events, so that an issuer's current
financial condition may be better or worse than the rating indicates. Securities
rated BBB by S&P or Baa by Moody's are investment grade, but Moody's considers
securities rated Baa to have speculative characteristics. Changes in economic
conditions or other circumstances are more likely to lead to a weakened capacity
for such securities to make principal and interest payments than is the case for
higher grade municipal securities. In addition, future federal, state and local
laws may adversely affect the tax-exempt status of interest on the Fund's
portfolio securities or of the exempt-interest dividends paid by the Fund,
extend the time for payment of principal or interest or otherwise constrain
enforcement of such obligations. Opinions relating to the validity of municipal
securities and the tax-exempt status of interest thereon are rendered by the
issuer's bond counsel at the time of issuance; Mitchell Hutchins will rely on
such opinions without independent investigation.
The Fund may invest more than 25% of its total assets in municipal
securities that are related in such a way that an economic, business or
political development or change affecting one such security also might affect
the other securities, such as securities the interest on which is paid from
revenues of similar types of projects. The Fund may be subject to greater risk
than other funds that do not follow this practice.
OTHER INVESTMENT POLICIES. During unusual market conditions, including
when in the opinion of Mitchell Hutchins there are insufficient suitable
municipal obligations available, the Fund, for defensive purposes, temporarily
may invest more than 20% of its net assets in other municipal obligations.
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For this purpose, 'suitable municipal obligations' means municipal obligations
that pay AMT exempt interest.
The Fund expects that under normal circumstances it will maintain needed
liquidity through the purchase of short-term municipal securities, including
tender option bonds. However, when Mitchell Hutchins believes unusual
circumstances warrant a defensive position, including when in the opinion of
Mitchell Hutchins no suitable municipal obligations are available, the Fund
temporarily and without percentage limit may hold cash and invest in taxable
money market instruments, including repurchase agreements. Interest earned from
such taxable investments will be taxable to investors as ordinary income when
distributed. If the Fund holds cash, the cash would not earn income and would
reduce the Fund's yield.
The Fund is authorized to engage in certain option income strategies and to
use options and futures in hedging strategies, all of which may generate taxable
income. The Fund has not engaged in these strategies in the past and has no
intention of so doing during the coming year. A discussion of these strategies
is included in the Statement of Additional Information. The Fund may borrow
money for emergency or temporary purposes, but not in excess of 10% of its total
assets. The Fund will not invest more than 10% of its net assets in illiquid
securities. The term 'illiquid securities' for this purpose means securities
that cannot be disposed of within seven days in the ordinary course of business
at approximately the amount at which the Fund has valued the securities and
includes, among other things, repurchase agreements maturing in more than seven
days and municipal lease obligations (including certificates of participation)
other than those Mitchell Hutchins has determined are liquid pursuant to
guidelines established by the Trust's board of trustees.
PURCHASES
Class Y shares are sold to eligible investors at the net asset value next
determined (see 'Valuation of Shares') after the purchase order is received at
PaineWebber's New York City offices. No initial or contingent deferred sales
charge is imposed, nor are Class Y shares subject to Rule 12b-1 distribution or
service fees. Mitchell Hutchins is the distributor of the Fund's shares and has
appointed PaineWebber Incorporated ('PaineWebber') as the exclusive dealer for
the sale of those shares. The Fund and Mitchell Hutchins reserve the right to
reject any purchase order and to suspend the offering of the Class Y shares for
a period of time.
PURCHASES BY INSIGHT PARTICIPANTS. An investor who purchases $50,000 or
more of shares of the mutual funds that are available to INSIGHT participants
(which include the PaineWebber mutual funds in the Flexible Pricing Systemsm and
certain specified other mutual funds) may take part in INSIGHT, a total
portfolio asset allocation program sponsored by PaineWebber, and thus become
eligible to purchase Class Y shares. INSIGHT offers comprehensive investment
services, including a personalized asset allocation investment strategy using an
appropriate combination of funds, monitoring of investment performance and
comprehensive quarterly reports that cover market trends, portfolio summaries
and personalized account information. Participation in INSIGHT is subject to
payment of an advisory fee to PaineWebber at the maximum annual rate of 1.5% of
assets held through the program (generally charged quarterly in advance), which
covers all INSIGHT investment advisory services and program administration fees.
Employees of PaineWebber and its affiliates are entitled to a 50% reduction in
the fee otherwise payable for participation in INSIGHT. INSIGHT clients may
elect to have their INSIGHT fees charged to their PaineWebber accounts (by the
automatic redemption of money market fund shares) or, if a qualified plan,
invoiced. Please contact your PaineWebber investment executive or PaineWebber
correspondent firm or call 1-800-697-1568 for more information
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concerning mutual funds that are available to INSIGHT participants or for other
INSIGHT program information.
ACQUISITION OF CLASS Y SHARES BY OTHERS. Certain present holders of Class Y
shares who are not current INSIGHT participants may acquire Class A shares of
the Fund without a sales charge. This category includes former employees of
Kidder, Peabody & Co., Incorporated, their associated accounts and present and
former directors and trustees of the former Kidder, Peabody mutual funds. The
Fund is authorized to offer Class Y shares to employee benefit and retirement
plans of Paine Webber Group Inc., and its affiliates and certain other
investment advisory programs that are sponsored by PaineWebber and that may
invest in PaineWebber mutual funds. At present, however, INSIGHT participants
are the only purchasers in these two categories.
REDEMPTIONS
Class Y shares may be redeemed at their net asset value and redemption
proceeds will be paid after receipt of a redemption request as described below.
REDEMPTION THROUGH PAINEWEBBER OR CORRESPONDENT FIRMS. INSIGHT
participants may submit redemption requests to their investment executives or
correspondent firms in person or by telephone, mail or wire. As the Fund's
agent, PaineWebber may honor a redemption request by repurchasing Class Y shares
from a redeeming shareholder at the shares' net asset value next determined
after receipt of the request by PaineWebber's New York City offices. Within
three Business Days of receipt of the request, repurchase proceeds will be paid
by check or credited to the shareholder's brokerage account at the election of
the shareholder. PaineWebber investment executives and correspondent firms are
responsible for promptly forwarding redemption requests to PaineWebber's New
York City offices. A 'Business Day' is any day, Monday through Friday, on which
the New York Stock Exchange ('NYSE') is open for business.
PaineWebber reserves the right not to honor any redemption request, in
which case PaineWebber promptly will forward the request to the Transfer Agent
for treatment as described below.
REDEMPTION THROUGH THE TRANSFER AGENT. Shareholders also may redeem Class Y
shares through the Fund's transfer agent, PFPC Inc. ('Transfer Agent').
Shareholders should mail redemption requests directly to the Transfer Agent:
PFPC Inc., Attn: PaineWebber Mutual Funds, P.O. Box 8950, Wilmington, Delaware
19899. A redemption request will be executed at the net asset value next
computed after it is received in 'good order' and redemption proceeds will be
paid within seven days of receipt of the request. 'Good order' means that the
request must be accompanied by the following: (1) a letter of instruction or a
stock assignment specifying the number of shares or amount of investment to be
redeemed (or that all shares credited to a Fund account be redeemed), signed by
all registered owners of the shares in the exact names in which they are
registered, (2) a guarantee of the signature of each registered owner by an
eligible institution acceptable to the Transfer Agent and in accordance with SEC
rules, such as a commercial bank, trust company or member of a recognized stock
exchange and (3) other supporting legal documents for estates, trusts,
guardianships, custodianships, partnerships and corporations. Shareholders are
responsible for ensuring that a request for redemption is received in 'good
order.'
ADDITIONAL INFORMATION ON REDEMPTIONS. A shareholder may have redemption
proceeds of $1 million or more wired to the shareholder's PaineWebber brokerage
account or a commercial bank account designated by the shareholder. Questions
about this option, or redemption requirements generally, should be referred to
the shareholder's PaineWebber investment executive or correspondent firm. If a
shareholder requests redemption of shares which were purchased recently, the
Fund may delay payment until it is assured that good payment has been received.
In the case of purchases by check, this can take up to 15 days.
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Because the Fund incurs certain fixed costs in maintaining shareholder
accounts, the Fund reserves the right to redeem all Fund shares in any
shareholder account having a net asset value below the lesser of $500 or the
current minimum for initial purchases. If the Fund elects to do so, it will
notify the shareholder and provide the shareholder the opportunity to increase
the amount invested to the minimum required level or more within 60 days of the
notice. The Fund will not redeem accounts that fall below the minimum required
level solely as a result of a reduction in net asset value per share.
DIVIDENDS AND TAXES
DIVIDENDS. Dividends from the Fund's net investment income are declared
daily and paid monthly, on about the fifteenth day of each month. Net investment
income includes accrued interest and discount, less amortization of premium and
accrued expenses, with respect to municipal securities. The Fund distributes
substantially all of its net capital gain (the excess of net long-term capital
gain over net short-term capital loss), if any, together with any other taxable
income (including any net short-term capital gain) at least annually. The Fund
may make more frequent distributions of any net capital gain and other taxable
income if necessary to avoid a 4% excise tax on undistributed income and capital
gain.
Dividends and other distributions are paid in additional Class Y shares at
net asset value unless the shareholder has requested cash payments. Shareholders
who wish to receive dividends and/or capital gain distributions in cash, either
mailed to the shareholder by check or credited to the shareholder's PaineWebber
account, should contact their PaineWebber investment executives or correspondent
firms.
FEDERAL INCOME TAX. The Fund intends to continue to qualify for treatment
as a regulated investment company ('RIC') under the Internal Revenue Code so
that it will be relieved of federal income tax on the part of its investment
company taxable income (consisting generally of taxable net investment income
and net short-term capital gain) and net capital gain that is distributed to its
shareholders.
Distributions by the Fund that it designates as 'exempt-interest dividends'
generally may be excluded from gross income by a shareholder. In order to pay
exempt-interest dividends to its shareholders, the Fund must (and intends to
continue to) satisfy the requirement that, at the close of each quarter of its
taxable year, at least 50% of the value of its total assets consists of
municipal securities.
Interest on indebtedness incurred or continued by a shareholder to purchase
or carry Fund shares is not deductible. If the Fund invests in certain PABs,
shareholders must include a portion of their exempt-interest dividends from the
Fund in calculating their liability for the AMT. Corporate shareholders must
include all of their exempt-interest dividends in calculating their liability
for that tax.
If the Fund realizes capital gains as a result of market transactions, any
distribution of those gains is taxable to its shareholders.
The Fund notifies its shareholders following the end of each calendar year
of the amounts of exempt-interest dividends (and any portion thereof that is not
AMT exempt interest), taxable dividends and capital gain distributions paid (or
deemed paid) that year.
A redemption of shares of the Fund may result in taxable gain or loss to
the redeeming shareholder, depending upon whether the redemption proceeds are
more or less than the shareholder's adjusted basis for the redeemed shares.
ADDITIONAL INFORMATION. The foregoing is only a summary of some of the
important federal income tax considerations generally affecting the Fund and its
shareholders; see the Statement of Additional Information for a further
discussion. There may be other federal, state or local tax considerations
applicable to a particular investor. Therefore prospective investors are urged
to consult their tax advisers.
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VALUATION OF SHARES
The net asset value of the Fund's shares fluctuates and is determined as of
the close of regular trading on the NYSE (currently 4:00 p.m., Eastern time)
each Business Day. The Fund's net asset value per share is determined by
dividing the value of the securities held by the Fund plus any cash or other
assets minus all liabilities by the total number of Fund shares outstanding.
The Fund values its assets based on their current market value when market
quotations are readily available. If such value cannot be established, assets
are valued at fair value as determined in good faith by or under the direction
of the Trust's board of trustees. The amortized cost method of valuation
generally is used to value debt obligations with 60 days or less remaining to
maturity, unless the board of trustees determines that this does not represent
fair value.
MANAGEMENT
The Trust's board of trustees, as part of its overall management
responsibility, oversees various organizations responsible for the day-to-day
management of the Fund. Mitchell Hutchins, the Fund's investment adviser and
administrator, makes and implements all investment decisions and supervises all
aspects of the Fund's operations. Mitchell Hutchins receives a monthly fee from
the Fund for these services at the annual rate of 0.50% of the Fund's average
daily net assets. Brokerage transactions for the Fund may be conducted through
PaineWebber in accordance with procedures adopted by the Trust's board of
trustees.
The Fund also pays PaineWebber an annual fee of $4.00 per active
shareholder account held at PaineWebber for certain services not provided by the
Transfer Agent. The Fund incurs other expenses, such as custody and transfer
agency fees, brokerage commissions, professional fees, expenses of board and
shareholder meetings, fees and expenses relating to registration of its shares,
taxes and governmental fees, fees and expenses of the trustees, costs of
obtaining insurance, expenses of printing and distributing shareholder
materials, and extraordinary expenses, including costs or losses in any
litigation.
Mitchell Hutchins is located at 1285 Avenue of the Americas, New York, New
York 10019. It is a wholly owned subsidiary of PaineWebber, which is in turn
wholly owned by Paine Webber Group Inc., a publicly owned financial services
holding company. As of October 31, 1995, Mitchell Hutchins was adviser or
subadviser of 38 investment companies with 75 separate portfolios and aggregate
assets of over $29.0 billion.
Elbridge (Ebby) T. Gerry III, a senior vice president of Mitchell Hutchins,
is a portfolio manager for the Fund. Richard S. Murphy, a senior vice president
of Mitchell Hutchins, is also a portfolio manager and has day-to-day
responsibility for the Fund. Mr. Gerry has held his Fund responsibilities since
January 22, 1996. Mr. Murphy has held his Fund responsibilities since July 1,
1994.
Mr. Gerry manages or oversees over $4 billion in municipal assets at
Mitchell Hutchins, including municipal bonds and money funds and private
accounts. Mr. Gerry has been with Mitchell Hutchins since January 1996. Prior to
that date Mr. Gerry was associated with J.P. Morgan Private Banking since 1981
where he was responsible for managing municipal assets, including several
municipal bond funds. Mr. Murphy has been with Mitchell Hutchins since April
1994. From 1990 to March 1994, he was a vice president at American International
Group, where he managed the municipal bond portfolio.
Other members of Mitchell Hutchins' tax-exempt investments group provide
input on market outlook, interest rate forecasts, and other considerations
pertaining to tax-exempt investments.
Mitchell Hutchins investment personnel may engage in securities
transactions for their own accounts pursuant to a code of ethics that
establishes
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procedures for personal investing and restricts certain transactions.
PERFORMANCE INFORMATION
The Fund performs a standarized computation of annualized total return and
may show this return in advertisements or promotional materials. Standardized
return shows the change in value of an investment in the Fund as a steady
compound annual rate of return. Actual year-by-year returns fluctuate and may be
higher or lower than standardized return. Standardized return for one-, five-
and ten-year periods will be shown, unless the Class has been in existence for a
shorter period. Total return calculations assume reinvestment of dividends and
other distributions.
The Fund may use other total return presentations in conjunction with
standardized return. These may cover the same or different periods as those used
for standardized return and may include cumulative returns, average annual
rates, actual year-by-year rates or any combination thereof.
The Fund also may advertise its yield or tax-equivalent yield. Yield
reflects investment income net of expenses over a 30-day (or one-month) period
on a Class Y share, expressed as an annualized percentage of the net asset value
per share at the end of the period. Tax-equivalent yield shows the yield that
would produce the same income after a stated rate of taxes as the Fund's
tax-exempt yield (yield excluding taxable income). Yield computations differ
from other accounting methods and therefore may differ from dividends actually
paid or reported net income.
Total return and yield information reflects past performance and does not
necessarily indicate future results. Investment return and principal values will
fluctuate, and proceeds upon redemption may be more or less than a shareholder's
cost.
GENERAL INFORMATION
ORGANIZATION. PaineWebber Mutual Fund Trust is a Massachusetts business
trust which is registered with the SEC as open-end management investment
company. PaineWebber Mutual Fund Trust was organized under a Declaration of
Trust dated November 21, 1986. The trustees of the Trust have authority to issue
an unlimited number of shares of beneficial interest of separate series, par
value $.001 per share. At present, shares of one other series have been
authorized.
The shares of beneficial interest of the Fund are divided into four
Classes, designated Class A shares, Class B shares, Class C shares and Class Y
shares. Each Class represents interests in the same assets of the Fund. Class A,
B and C differ as follows: (1) each Class has exclusive voting rights on matters
pertaining to its plan of distribution, (2) Class A shares generally are subject
to an initial sales charge, (3) Class B shares bear ongoing distribution fees,
may be subject to a contingent deferred sales charge upon redemption and will
automatically convert to Class A shares approximately six years after issuance,
(4) Class C shares are not subject to an initial sales charge, but are subject
to a contingent deferred sales charge if redeemed within one year of purchase,
bear ongoing distribution fees and do not convert into another Class and (5)
each Class may bear differing amounts of certain Class-specific expenses. Class
Y shares, which may be offered only to limited classes of investors, are subject
to neither an initial or contingent deferred sales charge nor ongoing service or
distribution fees.
The different sales charges and other expenses applicable to the different
Classes of Fund shares may affect the performance of those Classes. More
information concerning the other Classes of shares of the Fund may be obtained
from a PaineWebber investment executive or correspondent firm or by calling
1-800-647-1968.
The Trust does not hold annual shareholder meetings. There normally will be
no meetings of shareholders to elect trustees unless fewer than a majority of
the trustees holding office have been
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elected by shareholders. Shareholders of record holding at least two-thirds of
the outstanding shares of the Trust may remove a trustee by votes cast in person
or by proxy at a meeting called for that purpose. The trustees of the Trust are
required to call a meeting of shareholders for the purpose of voting upon the
question of removal of any trustee when so requested in writing by the
shareholders of record holding at least 10% of the Trust's outstanding shares.
Each share of the Fund has equal voting rights, except as noted above. Each
share of the Fund is entitled to participate equally in dividends and other
distributions and the proceeds of any liquidation, except that, due to the
differing expenses borne by the four Classes of shares, such dividends are
likely to be lower for the other Classes than for the Class Y shares. The shares
of each series of the Trust will be voted separately except when an aggregate
vote of all series is required by the Investment Company Act of 1940 ('1940
Act').
To avoid additional operating costs and for investor convenience, the Fund
does not issue share certificates. Ownership of shares of the Fund is recorded
on a share register by the Transfer Agent and shareholders have the same rights
of ownership with respect to such shares as if certificates had been issued.
CUSTODIAN AND TRANSFER AGENT. State Street Bank and Trust Company, One
Heritage Drive, North Quincy, Massachusetts 02171 is custodian of each Fund's
assets. PFPC Inc., a subsidiary of PNC Bank, National Association, whose
principal business address is 400 Bellevue Parkway, Wilmington, Delaware 19809,
is the Fund's transfer and dividend disbursing agent.
CONFIRMATIONS AND STATEMENTS. Shareholders receive confirmations of
purchases and redemptions of shares of the Fund. PaineWebber clients receive
statements at least quarterly that report their Fund activity and consolidated
year-end statements that show all Fund transactions for that year. Shareholders
who are not PaineWebber clients receive quarterly statements from the Transfer
Agent. Shareholders also receive audited annual and unaudited semi-annual
financial statements of the Fund.
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APPENDIX A
The Fund may invest in a variety of municipal securities, as described
below:
MUNICIPAL BONDS. Municipal bonds are debt obligations issued to obtain
funds for various public purposes that pay interest that is exempt from federal
income tax in the opinion of issuer's counsel. The two principal classifications
of municipal bonds are 'general obligation' and 'revenue' bonds. General
obligation bonds are secured by the issuer's pledge of its full faith, credit
and taxing power for the payment of principal and interest. Revenue bonds are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise tax or other
specific revenue source such as from the user of the facility being financed.
The term 'municipal bonds' also includes 'moral obligation' issues, which are
normally issued by special purpose authorities. In the case of such issues, an
express or implied 'moral obligation' of a related government unit is pledged to
the payment of the debt service, but is usually subject to annual budget
appropriations. The term 'municipal bonds' also includes municipal lease
obligations, such as leases, installment purchase contracts and conditional
sales contracts, and certificates of participation therein. Municipal lease
obligations are issued by state and local governments and authorities to
purchase land or various types of equipment or facilities and may be subject to
annual budget appropriations. The Fund generally invests in municipal lease
obligations through certificates of participation. The Fund does not presently
intend to purchase municipal lease obligations that are not rated by Moody's or
S&P.
INDUSTRIAL DEVELOPMENT BONDS AND PRIVATE ACTIVITY BONDS. IDBs and PABs are
issued by or on behalf of public authorities to finance various privately
operated facilities, such as airport or pollution control facilities. These
obligations are included within the term 'municipal bonds' if the interest paid
thereon is exempt from federal income tax in the opinion of the bond issuer's
counsel. IDBs and PABs are in most cases revenue bonds and thus are not payable
from the unrestricted revenues of the issuer. The credit quality of IDBs and
PABs is usually directly related to the credit standing of the user of the
facilities being financed. IDBs issued after August 15, 1986 generally are
considered PABs, and to the extent the Fund invests in such PABs, shareholders
generally will be required to include a portion of their exempt-interest
dividends from that Fund in calculating their liability for the AMT. See
'Dividends and Taxes.' The Fund is authorized to invest more than 25% of its net
assets in IDBs and PABs.
FLOATING RATE AND VARIABLE RATE OBLIGATIONS. Floating rate and variable
rate obligations bear interest at rates that are not fixed, but that vary with
changes in specified market rates or indices. Accordingly, as interest rates
decrease or increase, the potential for capital appreciation or capital
depreciation is less than for fixed rate obligations. Floating rate or variable
rate obligations typically permit the holder to demand payment of principal from
the issuer or remarketing agent at par value prior to maturity and may permit
the issuer to prepay principal, plus accrued interest, at its discretion after a
specified notice period. Frequently, floating rate or variable rate obligations
and/or the demand features thereon are secured by letters of credit or other
credit support arrangements provided by banks, the credit standing of which
affects the credit quality of the obligations.
PARTICIPATION INTERESTS. Participation interests are interests in
municipal bonds, including IDBs and PABs, and floating and variable rate
obligations that are owned by banks. These interests carry a demand feature
permitting the holder to tender them back to the bank, which demand feature
generally is backed by an irrevocable letter of credit or guarantee of the bank.
The credit standing of such bank affects the credit quality of the participation
interests.
TENDER OPTION BONDS. Tender option bonds are long-term municipal
securities sold by a
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bank subject to a 'tender option' that gives the purchaser the right to tender
them to the bank at par plus accrued interest at designated times (the 'tender
option'). The tender option may be exercisable at intervals ranging from
bi-weekly to semi-annually, and the interest rate on the bonds is typically
reset at the end of the applicable interval in an attempt to cause the bonds to
have a market value that approximates their par value. The tender option
generally would not be exercisable in the event of a default on, or significant
downgrading of, the underlying municipal securities. Therefore, the Fund's
ability to exercise the tender option will be affected by the credit standing of
both the bank involved and the issuer of the underlying securities.
PUT BONDS. A put bond is a municipal bond which gives the holder the
unconditional right to sell the bond back to the issuer or a remarketing agent
at a specified price and exercise date, which is typically well in advance of
the bond's maturity date. The obligation to purchase the bond on the exercise
date may be supported by a letter of credit or other credit support arrangement
from a bank, insurance company or other financial institution, the credit
standing of which affects the credit quality of the obligation.
TAX-EXEMPT COMMERCIAL PAPER AND SHORT-TERM MUNICIPAL NOTES. Tax-exempt
commercial paper and short-term municipal notes include tax anticipation notes,
bond anticipation notes, revenue anticipation notes and other forms of
short-term loans. Such notes are issued with a short-term maturity in
anticipation of the receipt of tax funds, the proceeds of bond placements and
other revenues.
INVERSE FLOATERS. The Fund may invest in municipal obligations on which
the rate of interest varies inversely with interest rates on other municipal
obligations or an index. Such obligations include components of securities on
which interest is paid in two separate parts-an auction component, which pays
interest at a market rate that is set periodically through an auction process or
other method, and a residual component, or 'inverse floater,' which pays
interest at a rate equal to the difference between the rate that the issuer
would have paid on a fixed-rate obligation at the time of issuance and the rate
paid on the auction component. The market value of an inverse floater will be
more volatile than that of a fixed-rate obligation and, like most debt
obligations, will vary inversely with changes in interest rates.
Because the interest rate paid to holders of inverse floaters is generally
determined by subtracting the interest rate paid to the holders of auction
components from a fixed amount, the interest rate paid to holders of inverse
floaters will decrease as market rates increase and increase as market rates
decrease. Moreover, the extent of the increases and decreases in the market
value of inverse floaters may be larger than comparable changes in the market
value of an equal principal amount of a fixed rate municipal obligation having
similar credit quality redemption provisions and maturity. In a declining
interest rate environment, inverse floaters can provide the Fund with a means of
increasing or maintaining the level of tax-exempt interest paid to shareholders.
However, because of the market volatility associated with inverse floaters, the
Fund will not invest more than 10% of its total assets in inverse floaters.
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[COVER]
PAINEWEBBER
National Tax-Free
Income Fund
Class Y Shares
------------------------------
TABLE OF CONTENTS
PAGE
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Fund Expenses.................................. 2
Investment Objective and Policies.............. 4
Purchases...................................... 6
Redemptions.................................... 7
Dividends and Taxes............................ 8
Valuation of Shares............................ 9
Management..................................... 9
Performance Information........................ 10
General Information............................ 10
Appendix A..................................... 12
PROSPECTUS
November 10, 1995, as
supplemented January 22, 1996.
(Copyright) 1995 PaineWebber Incorporated
Recycled
Paper
<PAGE>
PAINEWEBBER NATIONAL TAX-FREE INCOME FUND
CLASS Y SHARES
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
PaineWebber National Tax-Free Income Fund ('Fund') is a series of
PaineWebber Mutual Fund Trust ('Trust'), a professionally managed mutual fund.
The Fund seeks high current income exempt from federal income tax, consistent
with the preservation of capital and liquidity within the Fund's quality
standards. The Fund's investment adviser, administrator and distributor is
Mitchell Hutchins Asset Management Inc. ('Mitchell Hutchins'), a wholly owned
subsidiary of PaineWebber Incorporated ('PaineWebber'). As distributor for the
Fund, Mitchell Hutchins has appointed PaineWebber to serve as the exclusive
dealer for the sale of Fund shares. This Statement of Additional Information is
not a prospectus and should be read only in conjunction with the Fund's current
Prospectus, dated November 10, 1995, as revised January 22, 1996. A copy of the
Prospectus may be obtained by calling any PaineWebber investment executive or
correspondent firm or by calling toll-free 1-800-647-1568. This Statement of
Additional Information is dated November 10, 1995, as revised January 22, 1996.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the Fund's investment policies and limitations.
RATINGS AS INVESTMENT CRITERIA. Moody's Investors Service, Inc.
('Moody's') and Standard & Poor's, a division of The McGraw Hill Companies, Inc.
('S&P') are private services that provide ratings of the credit quality of debt
obligations, including issues of municipal securities. A description of the
range of ratings assigned to municipal securities by Moody's and S&P is included
in Appendix B to this Statement of Additional Information. The Fund may use
these ratings in determining whether to purchase, sell or hold a security. It
should be emphasized, however, that ratings are general and are not absolute
standards of quality. Consequently, municipal securities with the same maturity,
interest rate and rating may have different market prices. Credit ratings
attempt to evaluate the safety of principal and interest payments and do not
evaluate the risks of fluctuations in market value. Also, rating agencies may
fail to make timely changes in credit ratings in response to subsequent events,
so that an issuer's current financial condition may be better or worse than the
rating indicates. Subsequent to its purchase by the Fund, an issue of municipal
securities may cease to be rated or its rating may be reduced below the minimum
rating required for purchase by the Fund.
Opinions relating to the validity of municipal securities and to the
exemption of interest thereon from federal income tax (and also, when available,
from the federal alternative minimum tax) are rendered by bond counsel to the
respective issuing authorities at the time of issuance. Neither the Fund nor
Mitchell Hutchins will review the proceedings relating to the issuance of
municipal securities or the basis for such opinions. An issuer's obligations
under its municipal securities are subject to the provisions of bankruptcy,
insolvency and other laws affecting the rights and remedies of creditors (such
as the federal bankruptcy laws) and federal, state and local laws that may be
enacted that adversely affect the tax-exempt status of interest on the municipal
securities held by the Fund or of the exempt-interest dividends received by the
Fund's shareholders, extend the time for payment of principal or interest, or
both, or impose 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
<PAGE>
issuers to meet their obligations for the payment of principal of and interest
on their municipal securities may be materially and adversely affected.
TYPES OF MUNICIPAL SECURITIES. The types of municipal securities
identified in the Prospectus may include obligations of issuers whose revenues
are primarily derived from mortgage loans on housing projects for moderate to
low income families. The Fund also may purchase mortgage subsidy bonds that are
normally issued by special purpose public authorities. In some cases the
repayment of such bonds depends upon annual legislative appropriations; in other
cases repayment is a legal obligation of the issuer and, if the issuer is unable
to meet its obligations, repayment becomes a moral commitment of a related
government unit (subject, however, to such appropriations).
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. As stated in the Prospectus,
the Fund may purchase securities on a 'when-issued' or delayed delivery basis. A
security purchased on a when-issued or delayed delivery basis is recorded as an
asset on the commitment date and is subject to changes in market value,
generally based upon changes in the level of interest rates. Thus, fluctuation
in the value of the security from the time of the commitment date will affect
the Fund's net asset value. When the Fund commits to purchase securities on a
when-issued or delayed delivery basis, its custodian segregates assets to cover
the amount of the commitment. See 'Investment Policies and Restrictions--
Segregated Accounts.' The Fund purchases when-issued securities only with the
intention of taking delivery, but may sell the right to acquire the security
prior to delivery if Mitchell Hutchins deems it advantageous to do so, which may
result in capital gain or loss to the Fund.
STAND-BY COMMITMENTS. The Fund may acquire stand-by commitments pursuant
to which a bank or other municipal bond dealer agrees to purchase securities
that are held in the Fund's portfolio or that are being purchased by the Fund,
at a price equal to (1) the acquisition cost (excluding any accrued interest
paid on acquisition), less any amortized market premium or plus any accrued
market or original issue discount, plus (2) all interest accrued on the
securities since the last interest payment date or the date the securities were
purchased by the Fund, whichever is later. Although the Fund does not currently
intend to acquire stand-by commitments with respect to municipal securities held
in their portfolios, the Fund may acquire such commitments under unusual market
conditions to facilitate portfolio liquidity.
The Fund would enter into stand-by commitments only with those banks or
other dealers that, in the opinion of Mitchell Hutchins, present minimal credit
risk. The Fund's right to exercise stand-by commitments would be unconditional
and unqualified. A stand-by commitment would not be transferable by the Fund,
although the Fund could sell the underlying securities to a third party at any
time. The Fund may pay for stand-by commitments either separately in cash or by
paying a higher price for the securities that are acquired subject to such a
commitment (thus reducing the yield to maturity otherwise available for the same
securities). The acquisition of a stand-by commitment would not ordinarily
affect the valuation or maturity of the underlying municipal securities.
Stand-by commitments acquired by the Fund would be valued at zero in determining
net asset value. Whether the Fund paid directly or indirectly for a stand-by
commitment, its cost would be treated as unrealized depreciation and would be
amortized over the period the commitment is held by the Fund.
PUT BONDS. The Fund may invest in put bonds that have a fixed rate of
interest and a final maturity beyond the date on which the put may be exercised.
If the put is a 'one time only' put, the Fund ordinarily will either sell the
bond or put the bond, depending upon the more favorable price. If the bond has a
series of puts after the first put, the bond will be held as long as, in the
judgment of Mitchell Hutchins, it is in the best interest of the Fund to do so.
There is no assurance that the issuer of a put bond acquired by the Fund will be
2
<PAGE>
able to repurchase the bond upon the exercise date, if the Fund chooses to
exercise its right to put the bond back to the issuer.
MUNICIPAL LEASE OBLIGATIONS. Although municipal lease obligations do not
constitute general obligations of the municipality for which the municipality's
taxing power is pledged, they ordinarily are backed by the municipality's
covenant to budget for, appropriate and make the payments due under the lease
obligation. The leases underlying certain municipal lease obligations, however,
provide that lease payments are subject to partial or full abatement if, because
of material damage or destruction of the leased property, there is substantial
interference with the lessee's use or occupancy of such property. This
'abatement risk' may be reduced by the existence of insurance covering the
leased property, the maintenance by the lessee of reserve funds or the provision
of credit enhancements such as letters of credit.
Certain municipal lease obligations contain 'non-appropriation' clauses
which provide that the municipality has no obligation to make lease or
installment purchase payments in future years unless money is appropriated for
such purpose on a yearly basis. Some municipal lease obligations of this type
are insured as to timely payment of principal and interest, even in the event of
a failure by the municipality to appropriate sufficient funds to make payments
under the lease. However, in the case of an uninsured municipal lease
obligation, the Fund's ability to recover under the lease in the event of a
non-appropriation or default will be limited solely to the repossession of
leased property without recourse to the general credit of the lessee, and
disposition of the property in the event of foreclosure might prove difficult.
The Fund does not intend to invest more than 5% of its total assets in such
uninsured 'non-appropriation' municipal lease obligations. There is no
limitation on the Fund's ability to invest in other municipal lease obligations.
PARTICIPATION INTERESTS. The Fund also may invest in participation
interests in municipal bonds, including industrial development bonds ('IDBs'),
private activity bonds ('PABs') and floating and variable rate securities. A
participation interest gives the Fund an undivided interest in a municipal bond
owned by a bank. The Fund has the right to sell the instrument back to the bank.
Such right generally is backed by the bank's irrevocable letter of credit or
guarantee and permits the Fund to draw on the letter of credit on demand, after
specified notice, for all or any part of the principal amount of the Fund's
participation interest plus accrued interest. Generally, the Fund intends to
exercise the demand under the letters of credit or other guarantees only (1)
upon a default under the terms of the underlying bond, (2) to maintain the
Fund's portfolio in accordance with its investment objective and policies or (3)
as needed to provide liquidity to the Fund in order to meet redemption requests.
The ability of a bank to fulfill its obligations under a letter of credit or
guarantee might be affected by possible financial difficulties of its borrowers,
adverse interest rate or economic conditions, regulatory limitations or other
factors. Mitchell Hutchins will monitor the pricing, quality and liquidity of
the participation interests held by the Fund, and the credit standing of banks
issuing letters of credit or guarantees supporting such participation interests
on the basis of published financial information reports of rating services and
bank analytical services.
REPURCHASE AGREEMENTS. The Fund does not intend to enter into repurchase
agreements except as a temporary measure and under unusual circumstances,
because repurchase agreements are transactions that generate taxable income. The
Fund is, however, authorized to enter into repurchase agreements with U.S. banks
and dealers with respect to any obligation issued or guaranteed by the U.S.
government, its agencies or instrumentalities and also with respect to
commercial paper, bank certificates of deposit and bankers' acceptances.
Repurchase agreements are transactions in which the Fund purchases securities
from a bank or recognized securities dealer and simultaneously commits to resell
the securities to the bank or dealer at an agreed-upon date and price reflecting
a market rate of interest unrelated to the coupon rate or maturity of the
purchased securities. The Fund maintains custody of the underlying securities
prior to their repurchase; thus,
3
<PAGE>
the obligation of the bank or dealer to pay the repurchase price on the date
agreed to is, in effect, secured by such securities. If the value of these
securities is less than the repurchase price, plus any agreed upon additional
amount, the other party to the agreement must provide additional collateral so
that at all times the collateral is at least equal to the repurchase price, plus
any agreed-upon additional amount. The difference between the total amount to be
received upon repurchase of the securities and the price which was paid by the
Fund upon acquisition is accrued as interest and included in the Fund's net
investment income.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to the Fund if the other party to
a repurchase agreement becomes insolvent. The Fund intends to enter into
repurchase agreements only with banks and dealers in transactions believed by
Mitchell Hutchins to present minimal credit risks in accordance with guidelines
established by the Trust's board of trustees. Mitchell Hutchins will review and
monitor the creditworthiness of those institutions under the board's general
supervision.
FLOATING RATE AND VARIABLE RATE MUNICIPAL SECURITIES. As noted in the
Prospectus, the Fund may invest in floating rate and variable rate municipal
securities with or without demand features. A demand feature gives the Fund the
right to sell the securities to a specified party, usually a remarketing agent,
on a specified date. A demand feature is often backed by a letter of credit or
guarantee from a bank. As discussed under 'Participation Interests,' to the
extent that payment of an obligation is backed by a bank's letter of credit or
guarantee, such payment may be subject to the bank's ability to satisfy that
commitment. The interest rate on floating rate or variable rate securities
ordinarily is readjusted on the basis of the prime rate of the bank that
originated the financing or some other index or published rate, such as the
90-day U.S. Treasury Bill rate. Generally, these interest rate adjustments cause
the market value of floating rate and variable rate municipal securities to
fluctuate less than the market value of fixed rate obligations. Accordingly, as
interest rates decrease or increase, the potential for capital appreciation or
capital depreciation is less than for fixed rate obligations.
ILLIQUID SECURITIES. The Fund may invest up to 10% of its net assets in
illiquid securities. The term 'illiquid securities' for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the amount at which the Fund has valued the
securities and includes, among other things, repurchase agreements maturing in
more than seven days and municipal lease obligations (including certificates of
participation) other than those Mitchell Hutchins has determined are liquid
pursuant to guidelines established by the Trust's board of trustees.
The Trust's board of trustees has delegated the function of making
day-to-day determinations of liquidity to Mitchell Hutchins, pursuant to
guidelines approved by the board. Mitchell Hutchins takes into account a number
of factors in reaching liquidity decisions, including (1) the frequency of
trades for the security, (2) the number of dealers that make quotes for the
security, (3) the number of dealers that have undertaken to make a market in the
security, (4) the number of other potential purchasers and (5) the nature of the
security and how trading is effected (e.g., the time needed to sell the
security, how offers are solicited and the mechanics of transfer). Mitchell
Hutchins monitors the liquidity of securities in each Fund's portfolio and
reports periodically on liquidity decisions to the Trust's board of trustees.
In making determinations as to the liquidity of municipal lease
obligations, Mitchell Hutchins will distinguish between direct investments in
municipal lease obligations (or participations therein) and investments in
securities that may be supported by municipal lease obligations or certificates
of participation therein. Since these municipal lease obligation-backed
securities are based on a well-established means of securitization, Mitchell
Hutchins does not believe that investing in such securities presents the same
liquidity
4
<PAGE>
issues as direct investments in municipal lease obligations. The assets used as
cover for any over-the-counter ('OTC') options written by the Fund would 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
an OTC option written subject to this procedure will be considered illiquid only
to the extent that the maximum repurchase price under the formula exceeds the
intrinsic value of the option.
SEGREGATED ACCOUNTS. When the Fund enters into certain transactions that
involve obligations to make future payments to third parties, including the
purchase of securities on a when-issued or delayed delivery basis, the Fund will
maintain with an approved custodian in a segregated account cash, U.S.
government securities or other liquid high-grade debt securities, marked to
market daily, in an amount at least equal to the Fund's obligation or commitment
under such transactions. As described below under 'Hedging and Related Income
Strategies,' segregated accounts may also be required in connection with certain
transactions involving options or futures contracts.
INVESTMENT LIMITATIONS OF THE FUND
The Fund may not (1) issue senior securities or borrow money, except from
banks for emergency or temporary purposes, and then in an aggregate amount not
in excess of 10% of the value of the Fund's total assets at the time of such
borrowing; provided that the Fund will not purchase securities while borrowings
in excess of 5% of the value of the Fund's total assets are outstanding; (2)
underwrite securities of other issuers, except to the extent that, in connection
with the disposition of portfolio securities, the Fund may be deemed an
underwriter under federal securities laws; (3) purchase or sell real estate,
provided that the Fund may invest in municipal bonds secured by real estate or
interests therein; (4) purchase securities on margin, make short sales of
securities or maintain a short position, except that the Fund may make margin
deposits, make short sales and maintain short positions in connection with its
use of options, futures contracts and options on futures contracts; (5) purchase
or sell commodities or commodity contracts, except that the Fund may purchase or
sell futures contracts on municipal securities and on indexes of municipal
securities and options thereon; (6) invest in oil, gas or mineral exploration or
development programs; (7) purchase voting securities of any issuer or acquire
securities of other investment companies, except in connection with a merger,
consolidation or acquisition; (8) make loans, except through repurchase
agreements, provided that for purposes of this restriction the acquisition of
municipal bonds or other municipal debt obligations shall not be deemed to be
the making of a loan; (9) purchase any security if, as a result, 25% or more of
the value of the Fund's total assets would be invested in the securities of
issuers having their principal business activities in the same industry, except
that this limitation does not apply to municipal bonds; or (10) purchase the
securities of any issuer if as a result more than 5% of its total assets would
be invested in the securities of that issuer, provided that any securities
issued or guaranteed by the U.S. government, its agencies and instrumentalities
are not subject to this limitation and further provided that up to 25% of the
value of the Fund's assets may be invested without regard to this 5% limitation.
For purposes of limitations (9) and (10) above, the District of Columbia,
Puerto Rico, each state or territory, each political subdivision, agency,
instrumentality and authority thereof, and each multi-state agency of which a
state is a member is a separate 'issuer'. When the assets and revenues of an
agency, authority, instrumentality or other political subdivision are separate
from the government creating the subdivision and the security is backed only by
the assets and revenues of the subdivision, such subdivision would be deemed to
be the sole issuer. Similarly, in the case of an IDB or PAB, if that bond is
backed only by the assets and revenues of the nongovernmental user, then such
nongovernmental user would be deemed to be the sole
5
<PAGE>
issuer. However, if in either case the creating government or some other agency
guarantees a security, then to the extent that the value of all securities
issued or guaranteed by such government or entity exceeds 10% of the Fund's
total assets, such a guarantee would be considered a separate security and would
be treated as an issue of such government or other agency.
It is possible that the Fund from time to time will invest more than 25% of
its assets in a particular segment of the municipal securities market, such as
hospital revenue bonds, housing agency bonds, IDBs, PABs or airport bonds or in
securities the interest upon which is paid from revenues of a similar type of
project. In such circumstances, economic, business, political or other changes
affecting one bond might also affect other bonds in the same segment, thereby
potentially increasing market risk.
The foregoing investment limitations cannot be changed without the
affirmative vote of the lesser of (1) more than 50% of the outstanding shares of
the Fund or (2) 67% or more of the shares present at a shareholders' meeting if
more than 50% of the outstanding shares are represented at the meeting in person
or by proxy. If a percentage restriction is adhered to at the time of an
investment or transaction, later changes in percentage resulting from a change
in values of portfolio securities or the amount of total assets will not be
considered a violation of any of the foregoing limitations.
The following investment restrictions may be changed by the Trust's board
of trustees without shareholder approval: The Fund will not (1) purchase any
security if as a result of such purchase more than 5% of its assets would be
invested in securities with respect to which payment of interest and principal
are the responsibility of a company, including its predecessors, with less than
three years operating history; (2) invest more than 10% of its net assets in
illiquid securities, a term which means securities that cannot be disposed of
within seven days in the ordinary course of business at approximately the amount
at which the Fund has valued the securities and includes, among other things,
repurchase agreements maturing in more than seven days; (3) make investments in
warrants if such investments, valued at the lower of cost or market, exceed 5%
of the value of its net assets, which amount may include warrants that are not
listed on the New York Stock Exchange, Inc. ('NYSE') or the American Stock
Exchange, Inc. ('AMEX'), provided that such unlisted warrants, valued at the
lower of cost or market, do not exceed 2% of the Fund's net assets and further
provided that restriction does not apply to warrants attached to, or sold as a
unit with, other securities; (4) purchase or retain the securities of any issuer
if the officers and trustees of the Fund and the officers and directors of
Mitchell Hutchins (each owning beneficially more than 0.5% of the outstanding
securities of an issuer) own in the aggregate more than 5% of the securities of
an issuer; or (5) invest more than 35% of its total assets in debt securities
rated Ba or lower by Moody's or BB or lower by S&P (or determined by Mitchell
Hutchins to be of comparable quality). This non-fundamental policy (5) can be
changed only upon 30 days' advance notice to shareholders. The Fund will
continue to interpret fundamental investment limitation (3) to prohibit
investment in real estate limited partnerships.
6
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HEDGING AND RELATED INCOME STRATEGIES
As discussed in the Prospectus, Mitchell Hutchins may use a variety of
financial instruments ('Hedging Instruments'), including certain options,
futures contracts (sometimes referred to as 'futures') and options on futures
contracts, to attempt to hedge the Fund's portfolios and may use options to
attempt to enhance the Fund's income. The particular Hedging Instruments are
described in Appendix A to this Statement of Additional Information. Because the
Fund intends to use options and futures for hedging purposes, the Fund may enter
into options and futures transactions that approximate (but do not exceed) the
full value of its portfolio. However, the Fund currently does not intend to
engage in hedging or related income strategies. Any income realized from the use
of options and futures would be taxable to shareholders; therefore, the Fund
would engage in hedging or related income strategies only under unusual market
conditions. The use of options and futures solely to enhance income may be
considered a form of speculation.
Hedging strategies can be broadly categorized as 'short hedges' and 'long
hedges.' A short hedge is a purchase or sale of a Hedging Instrument intended to
partially or fully offset potential declines in the value of one or more
investments held in the Fund's portfolio. Thus, in a short hedge the Fund takes
a position in a Hedging Instrument whose price is expected to move in the
opposite direction of the price of the investment being hedged. For example, the
Fund might purchase a put option on a security to hedge against a potential
decline in the value of that security. If the price of the security declined
below the exercise price of the put, the Fund could exercise the put and thus
limit its loss below the exercise price to the premium paid plus transaction
costs. In the alternative, because the value of the put option can be expected
to increase as the value of the underlying security declines, the Fund might be
able to close out the put option and realize a gain to offset the decline in the
value of the security.
Conversely, a long hedge is a purchase or sale of a Hedging Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that the Fund intends to acquire. Thus, in a
long hedge the Fund takes a position in a Hedging Instrument whose price is
expected to move in the same direction as the price of the prospective
investment being hedged. For example, the Fund might purchase a call option on a
security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the exercise
price of the call, the Fund could exercise the call and thus limit its
acquisition cost to the exercise price plus the premium paid and transaction
costs. Alternatively, the Fund might be able to offset the price increase by
closing out an appreciated call option and realizing a gain.
Hedging Instruments on securities generally are used to hedge against price
movements in one or more particular securities positions that the Fund owns or
intends to acquire. Hedging Instruments on debt securities may be used to hedge
either individual securities or broad fixed income market sectors.
The use of Hedging Instruments is subject to applicable regulations of the
Securities and Exchange Commission ('SEC'), the several options and futures
exchanges upon which they are traded, the Commodity Futures Trading Commission
('CFTC') and various state regulatory authorities. In addition, the Fund's
ability to use Hedging Instruments will be limited by tax considerations. See
'Taxes.'
In addition to the products, strategies and risks described below, Mitchell
Hutchins expects to discover additional opportunities in connection with
options, futures contracts and other hedging techniques. These new opportunities
may become available as Mitchell Hutchins develops new techniques, as regulatory
authorities broaden the range of permitted transactions and as new options,
futures contracts or other techniques are developed. Mitchell Hutchins may
utilize these opportunities to the extent that they are
7
<PAGE>
consistent with the Fund's investment objectives and permitted by the Fund's
investment limitations and applicable regulatory authorities. The Fund's
Prospectus or 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 Prospectus.
SPECIAL RISKS OF HEDGING STRATEGIES. The use of Hedging Instruments
involves special considerations and risks, as described below. Risks pertaining
to particular Hedging Instruments are described in the sections that follow.
(1) Successful use of most Hedging Instruments depends upon Mitchell
Hutchins' ability to predict movements of the overall securities and interest
rate markets, which requires different skills than predicting changes in the
prices of individual securities. While Mitchell Hutchins is experienced in the
use of Hedging Instruments, there can be no assurance that any particular
hedging strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Hedging Instrument and price movements of the investments
being hedged. For example, if the value of a Hedging 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 Hedging Instruments are
traded. The effectiveness of hedges using Hedging Instruments on indices will
depend on the degree of correlation between price movements in the index and
price movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly or
partially offsetting the negative effect of unfavorable price movements in the
investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if the Fund entered into a
short hedge because Mitchell Hutchins 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 Hedging Instrument. Moreover, if the price of the
Hedging Instrument declined by more than 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 hedged at all.
(4) As described below, the Fund might be required to maintain assets as
'cover,' maintain segregated accounts or make margin payments when it takes
positions in Hedging Instruments involving obligations to third parties (i.e.,
Hedging Instruments other than purchased options). If the Fund were unable to
close out its positions in such Hedging 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 the 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. The Fund's ability to close out a position
in a Hedging 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 a contra party to enter into a transaction closing out the
position. Therefore, there is no assurance that any hedging position can be
closed out at a time and price that is favorable to the Fund.
COVER FOR HEDGING STRATEGIES. Transactions using Hedging Instruments,
other than purchased options, expose the Fund to an obligation to another party.
The Fund will not enter into any such transactions unless it owns either (1) an
offsetting ('covered') position in securities or other options or futures
contracts or
8
<PAGE>
(2) cash and short-term liquid debt securities, with a value sufficient at all
times to cover its potential obligations to the extent not covered as provided
in (1) above. The Fund will comply with SEC guidelines regarding cover for
hedging transactions and will, if the guidelines so require, set aside cash,
U.S. government securities or other liquid, high-grade debt securities in a
segregated account with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Hedging Instrument is open, unless they are
replaced with similar assets. As a result, the commitment of a large portion of
the Fund's assets to cover or segregated accounts could impede portfolio
management or the Fund's ability to meet redemption requests or other current
obligations.
OPTIONS. The Fund may purchase put and call options, and write (sell)
covered put and call options, on debt securities. The purchase of call options
serves as a long hedge, and the purchase of put options serves as a short hedge.
Writing covered put or call options can enable the Fund to enhance income by
reason of the premiums paid by the purchasers of such options. However, if the
market price of the security underlying a covered put option declines to less
than the exercise price of the option, minus the premium received, the Fund
would expect to suffer a loss. Writing covered call options serves 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 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 at less than its market value. If the covered
call option is an OTC option, the securities or other assets used as cover would
be considered illiquid to the extent described under 'Investment Policies and
Restrictions--Illiquid Securities.'
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 normally have expiration dates
of up to nine months. Generally, OTC options on debt securities 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. Options that
expire unexercised have no value.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the 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, the 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 the Fund to realize profits or
limit losses on an option position prior to its exercise or expiration.
The Fund may purchase or write both exchange-traded and OTC options.
However, exchange-traded or liquid OTC options on municipal debt securities are
not currently available. Exchange markets for options on debt securities exist
but are relatively new, and these instruments are primarily traded on the OTC
market. Exchange-traded options in the United States are issued by a clearing
organization affiliated with the exchange on which the option is listed which,
in effect, guarantees completion of every exchange-traded option transaction. In
contrast, OTC options are contracts between the Fund and its contra party
(usually a securities dealer or a bank) with no clearing organization guarantee.
Thus, when the Fund purchases or writes an OTC option, it relies on the contra
party to make or take delivery of the underlying investment upon exercise of the
option. Failure by the contra party to do so would result in the loss of any
premium paid by the Fund as well as
9
<PAGE>
the loss of any expected benefit of the transaction. The Fund will enter into
OTC option transactions only with contra parties that have a net worth of at
least $20 million.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary 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 contra party, or by a
transaction in the secondary market if any such market exists. Although the Fund
will enter into OTC options only with contra parties that are expected to be
capable of entering into closing transactions with the Fund, there is no
assurance that the 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
contra party, the Fund might be unable to close out an OTC option position at
any time prior to its expiration.
If the 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 the 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.
In the event that options on indices of municipal and non-municipal debt
securities become available, the Fund may purchase and write put and call
options on such indices in much the same manner as the more traditional options
discussed above, except that index options may serve as a hedge against overall
fluctuations in the debt securities markets (or market sectors) rather than
anticipated increases or decreases in the value of a particular security.
GUIDELINES FOR OPTIONS. The Fund's use of options is governed by the
following guidelines, which can be changed by the Trust's board of trustees
without shareholder vote:
1. The Fund may purchase a put or call option, including any straddles
or spreads, only if the value of its premium, when aggregated with the
premiums on all other options held by the Fund, does not exceed 5% of the
Fund's total assets.
2. The aggregate value of securities underlying put options written by
the Fund determined as of the date the put options are written, will not
exceed 50% of the Fund's net assets.
3. The aggregate premiums paid on all options (including options on
securities and indices of debt securities and options on futures contracts)
purchased by the Fund that are held at any time will not exceed 20% of the
Fund's net assets.
FUTURES. The Fund may purchase and sell municipal bond index futures
contracts, municipal debt futures contracts and purchase put and call options,
and write covered put and call options, on such futures contracts. The purchase
of futures or call options thereon can serve as a long hedge, and the sale of
futures or the purchase of put options thereon can serve as a short hedge.
Writing covered call options on futures contracts can serve as a limited short
hedge, and writing covered put options on futures contracts can serve as a
limited long hedge, using a strategy similar to that used for writing covered
call options on securities or indices.
Futures strategies also can be used to manage the average duration of the
Fund's portfolio. If Mitchell Hutchins wishes to shorten the average duration of
a Fund, the Fund may sell a futures contract or a call option thereon, or
purchase a put option on that futures contract. If Mitchell Hutchins wishes to
lengthen the
10
<PAGE>
average duration of the Fund, the Fund may buy a 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 the Fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, 'initial margin' consisting of cash, U.S. government
securities or other liquid, high-grade debt securities, in an amount generally
equal to 10% or less of the contract value. Margin must also be deposited when
writing a call 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, the
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 the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the 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 the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous.
Holders and writers of futures positions 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 held or written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
The Fund intends to enter into futures transactions only on exchanges or boards
of trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or related option 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 the Fund were unable to liquidate a futures or related options 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.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options markets
are subject to daily variation margin calls and might be compelled to liquidate
futures or related options positions whose prices are moving unfavorably to
avoid being subject to further calls. These liquidations could increase price
11
<PAGE>
volatility of the instruments and distort the normal price relationship between
the futures or options and the investments being hedged. Also, because initial
margin deposit requirements in the futures market are less onerous than margin
requirements in the securities markets, there might be increased participation
by speculators in the futures markets. This participation also might cause
temporary price distortions. In addition, activities of large traders in both
the futures and securities markets involving arbitrage, 'program trading' and
other investment strategies might result in temporary price distortions.
GUIDELINES FOR FUTURES AND RELATED OPTIONS. The Fund's use of futures and
related options is governed by the following guidelines, which can be changed by
the Trust's board of trustees without shareholder vote:
1. To the extent the Fund enters into futures contracts and options on
futures positions that are not for bona fide hedging purposes (as defined
by the CFTC), the aggregate initial margin and premiums on those positions
(excluding the amount by which options are 'in-the-money') may not exceed
5% of the Fund's net assets.
2. The aggregate premiums paid on all options (including options on
securities and indices of debt securities and options on futures contracts)
purchased by the Fund that are held at any time will not exceed 20% of the
Fund's net assets.
3. The aggregate margin deposits on all futures contracts and options
thereon held at any time by the Fund will not exceed 5% of the Fund's total
assets.
12
<PAGE>
TRUSTEES AND OFFICERS
The trustees and executive officers of the Trust, their ages, business
addresses and principal occupations during the past five years are:
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS* WITH THE TRUST OTHER DIRECTORSHIPS
- ------------------------------ --------------- ------------------------------
E. Garrett Bewkes, Jr.**; 69 Trustee and Mr. Bewkes is a director of,
Chairman of the and consultant to, Paine
Board of Webber Group Inc. ('PW
Trustees Group') (holding company of
PaineWebber and Mitchell
Hutchins). Prior to 1988, he
was chairman of the board,
president and chief
executive office of American
Bakeries Company. Mr. Bewkes
is also a director of
Interstate Bakeries
Corporation and NaPro
BioTherapeutics, Inc. and a
director or trustee of 24
other investment companies
for which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Meyer Feldberg; 53 Trustee Mr. Feldberg is Dean and
Columbia University Professor of Management of
101 Uris Hall the Graduate School of
New York, New York 10027 Business, Columbia
University. Prior to 1989,
he was president of the
Illinois Institute of
Technology. Dean Feldberg is
also a director of AMSCO
International Inc.,
Federated Department Stores
Inc., and New World
Communications Group
Incorporated and a director
or trustee of 16 other
investment companies for
which Mitchell Hutchins or
PaineWebber serves as
investment adviser.
George W. Gowen; 66 Trustee Mr. Gowen is a partner in the
666 Third Avenue law firm of Dunnington,
New York, New York 10017 Bartholow & Miller. Prior to
May 1994, he was a partner
in the law firm of Fryer,
Ross & Gowen. Mr. Gowen is
also a director of Columbia
Real Estate Investments,
Inc. and a director or
trustee of 14 other
investment companies for
which Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Frederic V. Malek; 59 Trustee Mr. Malek is chairman of
901 15th Street, N.W. Thayer Capital Partners
Suite 300 (investment bank) and a
Washington, D.C. 20005 co-chairman and director of
CB Commercial Group Inc.
(real estate). From January
1992 to November 1992, he
was campaign manager of
Bush-Quayle '92. From 1990
to 1992, he was vice
chairman and,
13
<PAGE>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS* WITH THE TRUST OTHER DIRECTORSHIPS
- ------------------------------ --------------- ------------------------------
from 1989 to 1990, he was
president of Northwest
Airlines Inc., NWA Inc.
(holding company of
Northwest Airlines Inc.) and
Wings Holdings Inc. (holding
company of NWA Inc.). Prior
to 1989, he was employed by
the Marriott Corporation
(hotels, restaurants,
airline catering and
contract feeding), where he
most recently was an
executive vice president and
president of Marriott Hotels
and Resorts. Mr. Malek is
also a director of American
Management Systems, Inc.,
Automatic Data Processing,
Inc., Avis, Inc., FPL Group,
Inc., ICF International,
Manor Care, Inc. National
Education Corporation and
Northwest Airlines Inc. and
a director or trustee of 14
other investment companies
for which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Judith Davidson Moyers; 60 Trustee Mrs. Moyers is president of
Public Affairs Television Public Affairs Television,
356 W. 58th Street Inc., an educational
New York, New York 10019 consultant and a home
economist. Mrs. Moyers is
also a director of Ogden
Corporation and a director
or trustee of 14 other
investment companies for
which Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Margo N. Alexander; 48 President Mrs. Alexander is president,
chief executive officer and
a director of Mitchell
Hutchins. Prior to January
1995, Mrs. Alexander was an
executive vice president of
PaineWebber. Mrs. Alexander
is also a director or
trustee of eight investment
companies and president of
31 other investment
companies for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Cynthia N. Bow; 37 Vice President Ms. Bow is a vice president of
Mitchell Hutchins. Ms. Bow
has been with Mitchell
Hutchins since 1982. Ms. Bow
is also a vice president of
one other investment company
for which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Teresa M. Boyle; 37 Vice President Ms. Boyle is a first vice
president and manager--
advisory administration of
Mitchell Hutchins.
14
<PAGE>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS* WITH THE TRUST OTHER DIRECTORSHIPS
- ------------------------------ --------------- ------------------------------
Prior to November 1993, she
was Compliance Manager of
Hyperion Capital Management,
Inc., an investment advisory
firm. Prior to April 1993,
Ms. Boyle was a vice
president and manager--legal
administration of Mitchell
Hutchins. Ms. Boyle is also
a vice president of 31 other
investment companies for
which Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Gigi L. Capes; 31 Vice President Ms. Capes is a vice president
and and the tax manager of the
Assistant mutual fund finance division
Treasurer of Mitchell Hutchins. Prior
to 1992, she was a tax
senior consultant with KPMG
Peat Marwick. Ms. Capes is
also a vice president and
assistant treasurer of 30
other investment companies
for which Mitchell Hutchins
and PaineWebber serves as
investment adviser.
Joan L. Cohen; 31 Vice President Ms. Cohen is a vice president
and and attorney of Mitchell
Assistant Hutchins. Prior to December
Secretary 1993, she was an associate
at the law firm of Seward &
Kissel. Ms. Cohen is also a
vice president and assistant
secretary of 24 other
investment companies for
which Mitchell Hutchins or
PaineWebber serves as
investment adviser.
C. William Maher; 34 Vice President Mr. Maher is a first vice
and president and a senior
Assistant manager of the mutual fund
Treasurer finance division of Mitchell
Hutchins. Mr. Maher is also
a vice president and
assistant treasurer of 31
other investment companies
for which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Dennis McCauley; 48 Vice President Mr. McCauley is a managing
director and Chief
Investment Officer--Fixed
Income of Mitchell Hutchins.
Prior to December 1994, he
was Director of Fixed Income
Investments of IBM
Corporation. Mr. McCauley is
also a vice president of 17
other investment companies
for which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
15
<PAGE>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS* WITH THE TRUST OTHER DIRECTORSHIPS
- ------------------------------ --------------- ------------------------------
Ann E. Moran; 38 Vice President Ms. Moran is a vice president
and of Mitchell Hutchins. Ms.
Assistant Moran is also a vice
Treasurer president of 31 other
investment companies for
which Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Richard S. Murphy; 40 Vice President Mr. Murphy is a senior vice
president of Mitchell
Hutchins. Prior to March
1994 Mr. Murphy was a vice
president at American
International Group.
Dianne E. O'Donnell; 43 Vice President Ms. O'Donnell is a senior vice
and president and deputy general
Secretary counsel of Mitchell
Hutchins. Ms. O'Donnell is
also a vice president and
secretary of 31 other
investment companies for
which Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Victoria E. Schonfeld; 45 Vice President Ms. Schonfeld is a managing
director and general counsel
of Mitchell Hutchins. From
April 1990 to May 1994, she
was a partner in the law
firm of Arnold & Porter. Ms.
Schonfeld is also a vice
president of 31 other
investment companies for
which Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Paul H. Schubert; 33 Vice President Mr. Schubert is a first vice
and president and a senior
Assistant manager of the mutual fund
Treasurer finance division of Mitchell
Hutchins. From August 1992
to August 1994, he was a
vice president at BlackRock
Financial Management, Inc.
Prior to August 1992, he was
an audit manager with Ernst
& Young LLP. Mr. Schubert is
also a vice president and
assistant treasurer of 31
other investment companies
for which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Julian F. Sluyters; 35 Vice President Mr. Sluyters is a senior vice
and president and the director
Treasurer of the mutual fund finance
division of Mitchell
Hutchins. Prior to 1991, he
was an audit senior manager
with Ernst & Young LLP. Mr.
Sluyters is also a vice
president and treasurer of
31 other investment
companies for
16
<PAGE>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS* WITH THE TRUST OTHER DIRECTORSHIPS
- ------------------------------ --------------- ------------------------------
which Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Gregory K. Todd; 39 Vice President Mr. Todd is a first vice
and president and associate
Assistant general counsel of Mitchell
Secretary Hutchins. Prior to 1993, he
was a partner in the firm of
Shereff, Friedman, Hoffman &
Goodman. Mr. Todd is also a
vice president and assistant
secretary of 31 other
investment companies for
which Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Keith A. Weller; 34 Vice President Mr. Weller is a first vice
and president and associate
Assistant general counsel of Mitchell
Secretary Hutchins. From September
1987 to May 1995, he was an
attorney in private
practice. Mr. Weller is also
a vice president and
assistant secretary of 23
other investment companies
for which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
- ------------------
* Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019.
** Mr. Bewkes is an 'interested person' of the Trusts as defined in the 1940 Act
by virtue of his position with PW Group.
17
<PAGE>
The Trust pays trustees who are not 'interested persons' of the Trust
('disinterested trustees') $2,000 annually. The Trust also pays its
disinterested trustees $250 per meeting of the board or any committee thereof.
Trustees are reimbursed for any expenses incurred in attending meetings.
Trustees and officers of the Trusts own in the aggregate less than 1% of the
shares of the Fund. Because Mitchell Hutchins and PaineWebber perform
substantially all of the services necessary for the operation of the Trust and
the Fund, the Trust requires no employees. No officer, director or employee of
Mitchell Hutchins or PaineWebber presently receives any compensation from the
Trust for acting as a trustee or officer. The table below includes certain
information relating to the compensation of the Trust's current trustees who
held office during the fiscal year ended February 28, 1995.
COMPENSATION TABLE
<TABLE>
<CAPTION>
PENSION OR TOTAL
RETIREMENT COMPENSATION
AGGREGATE BENEFITS ESTIMATED FROM THE
COMPENSATION ACCRUED AS ANNUAL TRUST AND
FROM PART OF A BENEFITS THE
THE TRUST'S UPON FUND
NAME OF PERSON, POSITION TRUST* EXPENSES RETIREMENT COMPLEX**
- ------------------------------ ------------ ---------- ---------- ------------
<S> <C> <C> <C> <C>
E. Garrett Bewkes, Jr.,
Trustee and Chairman of the
Board of Trustees........... -- -- -- --
Meyer Feldberg,
Trustee..................... $2,750 -- -- $106,375
George W. Gowen,
Trustee..................... 2,500 -- -- 99,750
Frederic V. Malek,
Trustee..................... 2,750 -- -- 99,750
Judith Davidson Moyers,
Trustee..................... 2,500 -- -- 98,500
</TABLE>
- ------------------
* Represents fees paid to each trustee during the fiscal year ended February
28, 1995.
** Represents total compensation paid to each trustee during the calendar year
ended December 31, 1995.
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator of the Fund pursuant to a contract dated April 21,
1988 with the Trust, as supplemented by a Fee Agreement dated June 30, 1992
('Advisory Contract'). Under the Advisory Contract, the Fund pays Mitchell
Hutchins a fee, computed daily and paid monthly, at the annual rate of 0.50% of
the Fund's average daily net assets.
Pursuant to the Advisory Contract and a substantially identical prior
contract, for the fiscal years ended February 28, 1995, February 28, 1994, the
fiscal period ended February 28, 1993 and the fiscal year ended November 30,
1992, the Fund paid (or accrued) to Mitchell Hutchins the amounts of $2,891,059,
$3,374,932, $695,966 and $2,136,708, respectively.
18
<PAGE>
Under a Service Agreement with the Trust that is reviewed by the Trust's
board of trustees annually, PaineWebber provides certain services to the Fund
not otherwise provided by the Fund's transfer agent. Pursuant to the Service
Agreement, during the fiscal years ended February 28, 1995, February 28, 1994,
the fiscal period ended February 28, 1993 and the fiscal year ended November 30,
1992, the Fund paid (or accrued) the amounts of $64,620, $67,293, $14,710 and
$47,399, respectively.
Under the terms of the Advisory Contract, the Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. General expenses of the Trust not readily identifiable as belonging to
a particular Fund are allocated between the appropriate Funds by or under the
direction of the board of trustees in such manner as the board deems fair and
equitable. Expenses borne by each Fund include the following: (1) the cost
(including brokerage commissions, if any) of securities purchased or sold by the
Fund and any losses incurred in connection therewith; (2) fees payable to and
expenses incurred on behalf of the Fund by Mitchell Hutchins; (3) organizational
expenses; (4) filing fees and expenses relating to the registration and
qualification of the Fund's shares under federal and state securities laws and
maintenance of such registrations and qualifications; (5) fees and salaries
payable to trustees who are not interested persons of the Fund or Mitchell
Hutchins; (6) all expenses incurred in connection with the trustees' services,
including travel expenses; (7) taxes (including any income or franchise taxes)
and governmental fees; (8) costs of any liability, uncollectible items of
deposit and other insurance or fidelity bonds; (9) any costs, expenses or losses
arising out of a liability of or claim for damages or other relief asserted
against the Fund for violation of any law; (10) legal, accounting and auditing
expenses, including legal fees of special counsel for the independent trustees;
(11) charges of custodians, transfer agents and other agents; (12) costs of
preparing share certificates; (13) expenses of setting in type and printing
prospectuses and supplements thereto, statements of additional information and
supplements thereto, reports and proxy materials for existing shareholders and
costs of mailing such materials to existing shareholders; (14) any extraordinary
expenses (including fees and disbursements of counsel) incurred by the Fund;
(15) fees, voluntary assessments and other expenses incurred in connection with
membership in investment company organizations; (16) costs of mailing and
tabulating proxies and costs of meetings of shareholders, the board and any
committees thereof; (17) the cost of investment company literature and other
publications provided to trustees and officers; and (18) costs of mailing,
stationery and communications equipment.
As required by state regulation, Mitchell Hutchins will reimburse the Fund
if and to the extent that the aggregate operating expenses of the Fund in any
fiscal year exceed applicable limits. Currently the most restrictive such limit
applicable to a Fund is 2.5% of the first $30 million of the Fund's average
daily net assets, 2.0% of the next $70 million of its average daily net assets
and 1.5% of its average daily net assets in excess of $100 million. Certain
expenses, such as brokerage commissions, taxes, interest, distribution fees and
extraordinary items, are excluded from this limitation. For the fiscal years
ended February 28, 1995, February 28, 1994, for the fiscal period ended February
28, 1993 and for the fiscal year ended November 30, 1992, PaineWebber and
Mitchell Hutchins were not required to reimburse either the Fund pursuant to
state limitations.
Under the Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund in
connection with the performance of the Advisory Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part of
Mitchell Hutchins in the performance of its duties or from reckless disregard of
its duties and obligations thereunder. The Advisory Contract terminates
automatically upon its assignment and is terminable at any time without penalty
by the board of trustees or by vote of the holders of a majority of the Fund's
outstanding voting securities, on 60 days' written notice to Mitchell Hutchins
or by Mitchell Hutchins on 60 days' written notice to the Fund.
19
<PAGE>
The following table shows the approximate net assets as of December 31,
1995, sorted by category of investment objective, of the investment companies as
to which Mitchell Hutchins serves as adviser or sub-adviser. An investment
company may fall into more than one of the categories below.
NET ASSETS
INVESTMENT CATEGORY ($ MIL)
------------------- ----------
Domestic (excluding Money Market)........................... $ 5,674.6
Global...................................................... 2,847.3
Equity/Balanced............................................. 2,810.4
Fixed Income (excluding Money Market)....................... 5,711.5
Taxable Fixed Income................................... 3,957.9
Tax-Free Fixed Income.................................. 1,753.6
Money Market Funds.......................................... 20,622.2
Mitchell Hutchins personnel may invest in securities for their own accounts
pursuant to a code of ethics that describes the fiduciary duty owed to
shareholders of the PaineWebber mutual funds and other Mitchell Hutchins'
advisory accounts by all Mitchell Hutchins' directors, officers and employees,
establishes procedures for personal investing and restricts certain
transactions. For example, employee accounts generally must be maintained at
PaineWebber, personal trades in most securities require pre-clearance and
short-term trading and participation in initial public offerings generally are
prohibited. In addition, the code of ethics puts restrictions on the timing of
personal investing in relation to trades by PaineWebber mutual funds and other
Mitchell Hutchins advisory clients.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of the
Class Y shares of the Fund under a distribution contract with the Trust dated
November 10, 1995 ('Distribution Contract'). The Distribution Contract requires
Mitchell Hutchins to use its best efforts, consistent with its other businesses,
to sell shares of the Fund. Class Y shares of the Fund are offered continuously.
Under an exclusive dealer agreement between Mitchell Hutchins and PaineWebber
dated November 10, 1995 ('Exclusive Dealer Agreement'), PaineWebber and its
correspondent firms sell the Fund's Class Y shares.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Trust's board of trustees, Mitchell
Hutchins is responsible for the execution of the Fund's portfolio transactions
and the allocation of brokerage transactions. In executing portfolio
transactions, Mitchell Hutchins seeks to obtain the best net results for the
Fund, taking into account such factors as the price (including the applicable
dealer spread or brokerage commission), size of order, difficulty of execution
and operational facilities of the firm involved. The Fund effects its portfolio
transactions with municipal bond dealers. Municipal securities are 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 dealers in principal
transactions generally include a 'spread,' which is the difference between the
prices at which the dealer is willing to purchase and sell a specific security
at that time. Since inception, the Fund has not paid any brokerage commissions.
For purchases or sales with broker-dealer firms which act as principal,
Mitchell Hutchins seeks best execution. Although Mitchell Hutchins may receive
certain research or execution services in connection with those transactions,
Mitchell Hutchins will not purchase securities at a higher price or sell
securities at a lower price than would otherwise be paid if no weight was
attributed to the services provided by the executing
20
<PAGE>
dealer. Moreover, Mitchell Hutchins will not enter into any explicit soft dollar
arrangements relating to principal transactions and will not receive in
principal transactions the types of services which could be purchased for hard
dollars. Mitchell Hutchins may engage in agency transactions in OTC debt
securities in return for research and execution services. These transactions are
entered into only in compliance with procedures ensuring that the transaction
(including commissions) is at least as favorable as it would have been if
effected directly with a market-maker that did not provide research or execution
services. These procedures include Mitchell Hutchins receiving multiple quotes
from dealers before executing the transactions on an agency basis.
Information and research services furnished by dealers or brokers with or
through which the Fund effects securities transactions may be used by Mitchell
Hutchins in advising other funds or accounts and, conversely, research services
furnished to Mitchell Hutchins by dealers or brokers in connection with other
funds or accounts Mitchell Hutchins advises may be used by Mitchell Hutchins in
advising the Fund. Information and research received from such brokers or
dealers will be in addition to, and not in lieu of, the services required to be
performed by Mitchell Hutchins under the Advisory Contract.
Investment decisions for the Fund and for other investment accounts managed
by Mitchell Hutchins are made independently of each other in light of differing
considerations for the various accounts. However, the same investment decision
may occasionally be made for the Fund and one or more such accounts. In such
cases, simultaneous transactions are inevitable. Purchases or sales are then
averaged as to price and allocated between the Fund and such other account(s) as
to amount according to a formula deemed equitable to the Fund and such
account(s). While in some cases this practice could have a detrimental effect
upon the price or value of the security as far as the Fund is concerned, or upon
its ability to complete its entire order, in other cases it is believed that
coordination and the ability to participate in volume transactions will be
beneficial to the Fund.
The Fund will not purchase securities that are offered in underwritings in
which Mitchell Hutchins or any of its affiliates is a member of the underwriting
or selling group, except pursuant to procedures adopted by the Trust's board of
trustees pursuant to Rule 10f-3 under the 1940 Act. Among other things, these
procedures require that the commission or spread paid in connection with such a
purchase be reasonable and fair, that the purchase be at not more than the
public offering price prior to the end of the first business day after the date
of the public offering and that Mitchell Hutchins or any affiliate thereof not
participate in or benefit from the sale to the Fund.
PORTFOLIO TURNOVER. The Fund's annual portfolio turnover rate may vary
greatly from year to year, but it will not be a limiting factor when management
deems portfolio changes appropriate. The portfolio turnover rate is calculated
by dividing the lesser of the Fund's annual sales or purchases of portfolio
securities (exclusive of purchases or sales of securities whose maturities at
the time of acquisition were one year or less) by the monthly average value of
the securities in the portfolio during the year. For the fiscal years ended
February 28, 1995 and February 28, 1994, respectively, the portfolio turnover
rates for the Fund were 59.85% and 15.87%.
VALUATION OF SHARES
The Fund determines the net asset value per share separately for each Class
of shares as of the close of regular trading (currently 4:00 p.m., Eastern time)
on the NYSE on each Business Day, which is defined as each Monday through Friday
when the NYSE is open. Currently, the NYSE is closed on the observance of the
following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
21
<PAGE>
Where market quotations are readily available, portfolio securities are
valued based upon market quotations, provided such quotations adequately
reflect, in the judgment of Mitchell Hutchins, the fair value of the security.
Where such market quotations are not readily available, securities are valued
based upon appraisals received from a pricing service using a computerized
matrix system or based upon appraisals derived from information concerning the
security or similar securities received from recognized dealers in those
securities. The amortized cost method of valuation generally is used with
respect to debt obligations with 60 days or less remaining to maturity unless
the Trust's board of trustees determines that this does not represent fair
value. All other assets will be valued at fair value as determined in good faith
by or under the direction of the Trust's board of trustees.
PERFORMANCE INFORMATION
The Fund's performance data quoted in advertising and other promotional
materials ('Performance Advertisements') represent past performance and are not
intended to indicate future performance. The investment return and principal
value of an investment will fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their original cost.
TOTAL RETURN CALCULATIONS. Average annual total return quotes
('Standardized Return') used in a Fund's Performance Advertisements are
calculated according to the following formula:
P(1 + T)n = ERV
where: P = a hypothetical initial payment of $1,000 to purchase shares
of a specified Class
T = average annual total return of shares of that Class
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 to the last
day of the most recent quarter prior to submission of the advertisement 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. All dividends and other distributions are assumed to have been
reinvested at net asset value. The Fund also may refer in Performance
Advertisements to total return performance data that are not calculated
according to the formula set forth above ('Non-Standardized Return'). The Fund
calculates Non-Standardized Return for specified periods of time by assuming an
investment of $1,000 in Fund shares and assuming the reinvestment of all
dividends and other distributions. The rate of return is determined by
subtracting the initial value of the investment from the ending value and by
dividing the remainder by the initial value. Because Class Y shares are subject
to neither initial nor contingent deferred sales charges, Non-Standardized
Return for the same period of time will be the same as Standardized Return.
YIELD. Yields used in the Fund's Performance Advertisements are calculated
by dividing the Fund's interest income attributable to a Class of shares for a
30-day period ('Period'), net of expenses attributable to such Class, by the
average number of shares of such Class entitled to receive dividends during the
Period and
22
<PAGE>
expressing the result as an annualized percentage (assuming semi-annual
compounding) of the net asset value per share at the end of the Period. Yield
quotations are calculated according to the following formula:
6
YIELD = 2 [( a - b + 1) -1]
-----
cd
where: a = interest earned during the Period attributable to a Class of
shares
b = expenses accrued for the Period attributable to a Class of
shares (net of reimbursements)
c = the average daily number of shares of the Class outstanding
during the Period that were entitled to receive dividends
d = the net asset value per share on the last day of the Period.
Except as noted below, in determining net investment income earned during
the Period (variable 'a' in the above formula), the Fund calculates interest
earned on each debt obligation held by it during the Period by (1) computing the
obligation's yield to maturity, based on the market value of the obligation
(including actual accrued interest) on the last business day of the Period or,
if the obligation was purchased during the Period, the purchase price plus
accrued interest and (2) dividing the yield to maturity by 360 and multiplying
the resulting quotient by the market value of the obligation (including actual
accrued interest) to determine the interest income on the obligation for each
day of the period that the obligation is in the portfolio. Once interest earned
is calculated in this fashion for each debt obligation held by the Fund,
interest earned during the Period is then determined by totalling the interest
earned on all debt obligations. For purposes of these calculations, the maturity
of an obligation with one or more call provisions is assumed to be the next date
on which the obligation reasonably can be expected to be called or, if none, the
maturity date.
Tax-exempt yield is calculated according to the same formula except that
variable 'a' equals interest exempt from federal income tax earned during the
Period. This tax-exempt yield is then translated into tax-equivalent yield
according to the following formula:
E
TAX EQUIVALENT YIELD = (---) + t
1-p
E = tax-exempt yield of a Class of shares
p = stated income tax rate
t = taxable yield of a Class of shares
OTHER INFORMATION. In Performance Advertisements, the Fund may compare its
Standardized Return and/or its Non-Standardized Return with data published by
Lipper Analytical Services, Inc. ('Lipper'), CDA Investment Technologies, Inc.
('CDA'), Wiesenberger Investment Companies Service ('Wiesenberger'), Investment
Company Data Inc. ('ICD') or Morningstar Mutual Funds ('Morningstar'), or with
the performance of recognized stock, bond and other indexes, including (but not
limited to) the Municipal Bond Buyers Indices, Lehman Bond Index, the Standard &
Poor's 500 Composite Stock Price Index, the Dow Jones Industrial Average,
Merrill Lynch Municipal Bond Indices, the Morgan Stanley Capital International
World Index, the Lehman Brothers Treasury Bond Index, Lehman Brothers
Government/Corporate Bond Index, the Salomon Brothers World Government Bond
Index and changes in the Consumer Price Index as published by the U.S.
Department of Commerce. Each Fund also may refer in such materials to mutual
fund performance rankings and other data, such as comparative asset, expense and
fee levels, published by Lipper, CDA,
23
<PAGE>
Wiesenberger, ICD or Morningstar. Performance Advertisements also may refer to
discussions of a Fund and comparative mutual fund data and ratings reported in
independent periodicals, including (but not limited to) THE WALL STREET JOURNAL,
MONEY Magazine, FORBES, BUSINESS WEEK, FINANCIAL WORLD, BARRON'S, FORTUNE, THE
NEW YORK TIMES, THE CHICAGO TRIBUNE, THE WASHINGTON POST and THE KIPLINGER
LETTERS. Comparisons in performance advertisements may be in graphic form.
The Fund may include discussions or illustrations of the effects of
compounding in Performance Advertisements. 'Compounding' refers to the fact
that, if dividends or other distributions on an investment in a Fund are
reinvested by being paid in additional Fund shares, any future income or capital
appreciation of the Fund would increase the value, not only of the original Fund
investment, but also of the additional Fund shares received through
reinvestment. As a result, the value of the Fund investment would increase more
quickly than if dividends or other distributions had been paid in cash.
The Fund may also compare its performance with the performance of bank
certificates of deposit (CDs) as measured by the CDA Investment Technologies,
Inc. Certificate of Deposit Index and the Bank Rate Monitor National Index and
the averages of yields of CDs of major banks published by Banxquote(Registered)
Money Markets. In comparing the Fund's performance to CD performance, investors
should keep in mind that bank CDs are insured in whole or in part by an agency
of the U.S. government and offer fixed principal and fixed or variable rates of
interest, and that bank CD yields may vary depending on the financial
institution offering the CD and prevailing interest rates. Fund shares are not
insured or guaranteed by the U.S. government and returns and net asset value
will fluctuate. The securities held by the Fund generally have longer maturities
than most CDs and may reflect interest rate fluctuations for longer term
securities. An investment in the Fund involves greater risks than an investment
in either a money market fund or a CD.
TAXES
FEDERAL TAXES. In order to continue to qualify for treatment as a
regulated investment company ('RIC') under the Internal Revenue Code, the Fund
must distribute to its shareholders for each taxable year at least 90% of the
sum of its net interest income excludable from gross income under section 103(a)
of the Internal Revenue Code plus its investment company taxable income
(consisting generally of taxable net investment income plus net short-term
capital gain) and must meet several additional requirements. These requirements
include the following: (1) the Fund must derive at least 90% of its gross income
each taxable year from dividends, interest, payments with respect to securities
loans and gains from the sale or other disposition of securities, or other
income (including gains from options or futures) derived with respect to its
business of investing in securities ('Income Requirement'); (2) the Fund must
derive less than 30% of its gross income each taxable year from the sale or
other disposition of securities, options or futures held for less than three
months ('Short-Short Limitation'); (3) 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 that are 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 (4) 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 securities (other than
U.S. government securities or the securities of other RICs) of any one issuer.
24
<PAGE>
Entities or persons who are 'substantial users' (or persons related to
'substantial users') of facilities financed by IDBs or PABs should consult their
tax advisers before purchasing Fund shares because, for users of certain of
these facilities, the interest on those bonds is not exempt from federal income
tax. For these purposes, 'substantial user' is defined to include a 'non-exempt
person' who regularly uses in a trade or business a part of a facility financed
from the proceeds of IDBs or PABs.
Up to 85% of social security and railroad retirement benefits may be
included in taxable income for recipients whose adjusted gross income (including
income from tax-exempt sources such as the Fund) plus 50% of their benefits
exceeds certain base amounts. Exempt-interest dividends from a Fund still are
tax-exempt to the extent described in the Prospectus; they are only included in
the calculation of whether a recipient's income exceeds the established amounts.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be disallowed to the extent of any exempt-interest dividends
received on those shares and any loss not disallowed will be treated as
long-term, instead of short-term, capital loss to the extent of any capital gain
distributions received thereon. Investors also should be aware that if shares
are purchased shortly before the record date for a capital gain distribution,
the shareholder will pay full price for the shares and receive some portion of
the price back as a taxable distribution.
Although the Fund currently does not expect to invest in instruments that
generate taxable interest income, if the Fund does so, under the circumstances
described in the Prospectus and in the discussion of municipal market discount
bonds below, the portion of any Fund dividend attributable to the interest
earned thereon will be taxable to the Fund's shareholders as ordinary income to
the extent of the Fund's earnings and profits, and only the remaining portion
will qualify as an 'exempt-interest dividend' (as described in the Prospectus).
The respective portions will be determined by the 'actual earned' method, under
which the portion of any dividend that qualifies as exempt-interest may vary,
depending on the relative proportions of tax-exempt and taxable interest earned
during the dividend period. Moreover, if the Fund realizes capital gain as a
result of market transactions, any distributions of the gain will be taxable to
its shareholders. The Fund is required to withhold 31% of all taxable dividends,
capital gain distributions and redemption proceeds payable to any individuals
and certain other noncorporate shareholders who do not provide the Fund with a
correct taxpayer identification number. The Fund also is required to withhold
31% of all taxable dividends and capital gain distributions payable to those
shareholders who otherwise are subject to backup withholding.
Dividends and other distributions declared by the Fund in October, November
or December of any year and payable to shareholders of record on a date in any
of those months will be deemed to have been paid by the Fund and received by the
shareholders on December 31 of that year if the distributions are paid by the
Fund during the following January. The Fund invests exclusively in debt
securities and receives no dividend income; accordingly, no portion of the
dividends or other distributions paid by the Fund is eligible for the
dividends-received deduction allowed to corporations.
The Fund will be subject to a nondeductible 4% excise tax to the extent it
fails to distribute by the end of any calendar year substantially all of its
ordinary (taxable) income for the calendar year and capital gain net income for
the one-year period ending on October 31 of that year, plus certain other
amounts.
The use of hedging and option income strategies, such as writing (selling)
and purchasing options and futures, involves complex rules that will determine
for income tax purposes the character and timing of recognition of the gains and
losses the Fund realizes in connection therewith. Income from transactions in
options and futures derived by a Fund with respect to its business of investing
in securities will qualify as permissible income under the Income Requirement.
However, income from the disposition of options and futures will be subject to
the Short-Short Limitation if they are held for less than three months.
25
<PAGE>
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a 'designated hedge' will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
Short-Short Limitation. Thus, only the net gain (if any) from the designated
hedge will be included in gross income for purposes of that limitation. The Fund
will consider whether it should seek to qualify for this treatment for its
hedging transactions. To the extent the Fund does not qualify for this
treatment, it may be forced to defer the closing out of certain options and
futures beyond the time when it otherwise would be advantageous to do so, in
order for the Fund to continue to qualify as a RIC.
The Fund may invest in municipal bonds that are purchased, generally not on
their original issue, with market discount (that is, at a price less than the
principal amount of the bond or, in the case of a bond that was issued with
original issue discount, a price less than the amount of the issue price plus
accrued original issue discount) ('municipal market discount bonds'). If a
bond's market discount is less than the product of (1) 0.25% of the redemption
price at maturity times (2) the number of complete years to maturity after the
taxpayer acquired the bond, then no market discount is considered to exist. Gain
on the disposition of a municipal market discount bond purchased by the Fund
after April 30, 1993 (other than a bond with a fixed maturity date within one
year from its issuance) generally is treated as ordinary (taxable) income,
rather than capital gain, to the extent of the bond's accrued market discount at
the time of disposition. Market discount on such a bond generally is accrued
ratably, on a daily basis, over the period from the acquisition date to the date
of maturity. In lieu of treating the disposition gain as above, the Fund may
elect to include market discount in its gross income currently, for each taxable
year to which it is attributable.
TAX-FREE INCOME VS. TAXABLE INCOME. Table I below illustrates approximate
equivalent taxable and tax-free yields at the 1995 federal individual income tax
rates. For example, a couple with taxable income of $90,000 in 1995, or single
individuals with taxable income of $55,000 in 1995, whose investments earn a 6%
tax-free yield, would have to earn approximately an 8.70% taxable yield to
receive the same benefit.
1995 FEDERAL TAXABLE VS. TAX-FREE YIELDS*
<TABLE>
<CAPTION>
A TAX-FREE YIELD OF
TAXABLE INCOME (000'S) ---------------------------------------------
- ------------------------------- 4.00% 5.00% 6.00% 7.00% 8.00%
SINGLE JOINT FEDERAL TAX ----- ----- ----- ----- -----
RETURN RETURN BRACKET IS EQUAL TO A TAXABLE YIELD OF APPROXIMATELY:
- ------------ -------------- ----------- ---------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
$ 0-- 22.1 $ 0-- 36.9 15.00% 4.71% 5.88% 7.06% 8.24% 9.41%
22.1-- 53.5 36.9-- 89.2 28.00 5.56 6.94 8.33 9.72 11.11
53.5--115.0 89.2--140.0 31.00 5.80 7.25 8.70 10.14 11.59
115.0--250.0 140.0--250.0 36.00 6.25 7.81 9.38 10.94 12.50
Over 250.0 Over 250.0 39.60 6.62 8.28 9.93 11.59 13.25
</TABLE>
- ------------------
*Single rate assumes no dependents; joint rate assumes two dependents. The
yields listed are for illustration only and are not necessarily representative
of the Fund's yield. The Fund invests primarily in obligations the interest on
which is exempt from federal income tax; however, some of the Fund's
investments may generate taxable income. Effective tax rates shown are those in
effect on the date of this Statement of Additional Information; such rates
might change after that date. The effective rates reflect the highest tax
bracket within each range of income listed. The figures set forth above do not
reflect the federal alternative minimum tax, limitations on federal or state
itemized deductions and personal exemptions or any state or local taxes payable
on Fund distributions.
26
<PAGE>
OTHER INFORMATION
The name of the Trust is PaineWebber Mutual Fund Trust. Prior to April 6,
1992, the name of PaineWebber Mutual Fund Trust was PaineWebber California
Tax-Free Income Fund. Prior to July 1, 1991, the name of this Trust was
PaineWebber California Tax-Exempt Income Fund. Prior to June 30, 1992, National
Tax-Free Income Fund was a series of a different Massachusetts business trust,
PaineWebber Managed Municipal Trust.
The Trust is an entity of the type commonly known as a 'Massachusetts
business trust.' Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the Trust or the
Fund. However, the Declaration of Trust disclaims shareholder liability for the
obligations of the Trust or the Fund and requires that notice of such disclaimer
be given in each note, bond, contract, instrument, certificate or undertaking
made or issued by the Trust's trustees or by any officers or officer by or on
behalf of the Fund, the trustees or any of them in connection with the Fund. The
Declaration of Trust provides for indemnification from the Fund's property for
all losses and expenses of any Fund shareholder held personally liable for the
obligations of the Fund. Thus, the risk of a shareholder's incurring financial
loss on account of shareholder liability is limited to circumstances in which
the Fund itself would be unable to meet its obligations, a possibility that
Mitchell Hutchins believes is remote and not material. Upon payment of any
liability incurred by a shareholder solely by reason of being or having been a
shareholder, the shareholder paying such liability will be entitled to
reimbursement from the general assets of the Fund. The trustees intend to
conduct the operations of the Fund in such a way as to avoid, as far as
possible, ultimate liability of the shareholders for liabilities of the Fund.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C., 20036-1800, counsel to the Fund, has passed upon
the legality of the shares offered by the Fund's Prospectus. Kirkpatrick &
Lockhart LLP also acts as counsel to Mitchell Hutchins and PaineWebber in
connection with other matters.
AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New York 10019,
serves as independent auditors for the Fund.
FINANCIAL STATEMENTS
The Fund's Annual Report to Shareholders for the fiscal year ended February
28, 1995 is a separate document supplied with this Statement of Additional
Information and the financial statements, accompanying notes and report of
independent auditors appearing therein are incorporated herein by this
reference.
27
<PAGE>
APPENDIX A
THE FUND MAY USE THE FOLLOWING HEDGING AND OPTION INCOME INSTRUMENTS:
OPTIONS ON DEBT SECURITIES--A call option is a short-term contract pursuant
to which the purchaser of the option, in return for a premium, has the right to
buy the security underlying the option at a specified price at any time during
the term of the option. The writer of the call option, who receives the premium,
has the obligation, upon exercise of the option during the option term, to
deliver the underlying security against payment of the exercise price. A put
option is a similar contract which gives its purchaser, in return for a premium,
the right to sell the underlying security at a specified price during the option
term. The writer of the put option, who receives the premium, has the
obligation, upon exercise during the option term, to buy the underlying security
at the exercise price. Options on debt securities are traded primarily in the
OTC market rather than on any of the several options exchanges. At present, only
options on U.S. Treasury securities are listed for trading on any recognized
exchange.
OPTIONS ON INDEXES OF DEBT SECURITIES--An index assigns relative values to
the securities included in the index and fluctuates with changes in the market
values of such securities. Index options operate in the same way as more
traditional options except that exercises of index options are effected with
cash payments and do not involve delivery of securities. Thus, upon exercise of
an index option, the purchaser will realize and the writer will pay, an amount
based on the difference between the exercise price and the closing price of the
index. Currently, options on indexes of debt securities do not exist.
MUNICIPAL BOND INDEX FUTURES CONTRACTS--A municipal bond index futures
contract is a bilateral agreement pursuant to which one party agrees to accept
and the other party agrees to make delivery of an amount of cash equal to a
specified dollar amount times the difference between the index value at the
close of trading of the contract and the price at which the futures contract is
originally struck. No physical delivery of the bonds comprising the index is
made; generally contracts are closed out prior to the expiration date of the
contract.
MUNICIPAL DEBT FUTURES CONTRACTS--A municipal debt futures contract is a
bilateral agreement pursuant to which one party agrees to accept and the other
party agrees to make delivery of the specific type of municipal debt security
called for in the contract at a specified future time and at a specified price.
Currently there is no public market for municipal debt futures contracts.
OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities except that an option on a futures contract gives the
purchaser the right, in return for the premium, to assume a position in a
futures contract (a long position if the option is a call and a short position
if the option is a put), rather than to purchase or sell a security, at a
specified price at any time during the option term. Upon exercise of the option,
the delivery of the futures position to the holder of the option will be
accompanied by delivery of the accumulated balance, which represents the amount
by which the market price of the futures contract exceeds, in the case of a
call, or is less than, in the case of a put, the exercise price of the option on
the future. The writer of an option, upon exercise, will assume a short position
in the case of a call, and a long position in the case of a put.
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APPENDIX B
Municipal bonds are rated by Moody's and S&P. Moody's and S&P also publish
separate ratings for municipal notes and tax-exempt commercial paper.
Descriptions of these ratings are set forth below.
DESCRIPTION OF MOODY'S MUNICIPAL BOND RATINGS:
Aaa. Bonds which are rated Aaa are judged to be of the best quality and
carry the smallest degree of investment risk. Interest payments are protected by
a large or by an exceptionally stable margin and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of such
issues.
Aa. Bonds which are rated Aa are judged to be of high quality by all
standards. They are rated lower than the Aaa bonds because margins of protection
may not be as large as in Aaa securities, fluctuation of protective elements may
be of greater amplitude, or there may be other elements present which made the
long-term risks appear somewhat larger than in Aaa securities.
A. Bonds which are rated A are judged to be upper medium grade
obligations. Security for principal and interest are considered adequate, but
elements may be present which suggest susceptibility to impairment sometime in
the future.
Baa. Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
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.
DESCRIPTION OF S&P'S MUNICIPAL BOND RATINGS:
AAA. Debt rated AAA has the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A. Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB. Debt rated BBB is regarded as having adequate capacity to pay
principal and interest. Whereas it normally exhibits protection parameters,
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adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay interest and repay principal for debt in this
category than in higher rated categories.
BB, B, CCC, CC AND C. Debt rated BB, B, CCC, CC and C is regarded as
having predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. BB indicates the least degree of speculation and C
the highest. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
CI. This rating is reserved for income bonds on which no interest is being
paid.
D. Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments 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 if debt service payments are continued.
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
ratings categories.
DESCRIPTION OF MOODY'S RATINGS OF STATE AND MUNICIPAL NOTES AND OTHER SHORT-TERM
LOANS:
Moody's ratings for state and municipal notes and other short-term loans
are designated 'Moody's Investment Grade' ('MIG' or, for variable or floating
rate obligations, 'VMIG'). Such ratings recognize the differences between
short-term credit risk and long-term risk. Factors affecting the liquidity of
the borrower and short-term cyclical elements are critical in short-term
ratings. Symbols used will be as follows:
MIG-1/VMIG-1. This designation denotes best quality. There is present
strong protection by established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing.
MIG-2/VMIG-2. This designation denotes high quality. Margins of
protection are ample although not so large as in the preceding group.
MIG-3/VMIG-3. This designation denotes favorable quality. All
security elements are accounted for but there is lacking the undeniable
strength of the preceding grades. Liquidity and cash flow protection may be
narrow and market access for refinancing is likely to be less well
established.
MIG-4/VMIG-4. This designation denotes adequate quality. Protection
commonly regarded as required of an investment security is present and
although not distinctly or predominantly speculative, there is specific
risk.
DESCRIPTION OF S&P'S RATINGS OF STATE AND MUNICIPAL NOTES AND OTHER SHORT-TERM
LOANS:
S&P's tax-exempt note ratings are generally given to such notes that mature
in three years or less. The three rating categories are as follows:
SP-1. Strong capacity to pay principal and interest. Issues
determined to possess very strong characteristics are given a plus (+)
designation.
SP-2. Satisfactory capacity to pay principal and interest with some
vulnerability to adverse financial and economic changes over the term of
the notes.
SP-3. Speculative capacity to pay principal and interest.
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DESCRIPTION OF COMMERCIAL PAPER RATINGS
Commercial paper rated Prime-1 by Moody's are judged by Moody's to be of
the best quality. Their short-term debt obligations carry the smallest degree of
investment risk. Margins of support for current indebtedness are large or stable
with cash flow and asset protection well assured. Current liquidity provides
ample coverage of near-term liabilities and unused alternative financing
arrangements are generally available. While protective elements may change over
the intermediate or longer term, such changes are most unlikely to impair the
fundamentally strong position of short-term obligations.
Commercial paper rated A by S&P have the following characteristics.
Liquidity ratios are better than industry average. Long-term debt rating is A or
better. The issuer has access to at least two additional channels of borrowing.
Basic earnings and cash flow are in an upward trend. Typically, the issuer is a
strong company in a well-established industry and has superior management.
Issuers rated A are further refined by use of numbers 1, 2, and 3 to denote
relative strength within this highest classification. Those issues rated A-1
that are determined by S&P to possess extremely strong safety characteristics
are denoted with a plus (1) sign designation.
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[COVER]
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THE PROSPECTUS OR IN THIS STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS DISTRIBUTOR. THE PROSPECTUS
AND THIS STATEMENT OF ADDITIONAL INFORMATION DO NOT CONSTITUTE AN OFFERING BY
THE FUND OR BY THE DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY
NOT LAWFULLY BE MADE.
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TABLE OF CONTENTS
PAGE
----
Investment Policies and Restrictions........... 1
Hedging and Related Income Strategies.......... 7
Trustees and Officers.......................... 13
Investment Advisory and Distribution
Arrangements................................. 18
Portfolio Transactions......................... 20
Valuation of Shares............................ 21
Performance Information........................ 22
Taxes.......................................... 24
Other Information.............................. 27
Financial Statements........................... 27
Appendix A..................................... 28
Appendix B..................................... 29
PAINEWEBBER
NATIONAL
TAX-FREE
INCOME FUND
CLASS Y SHARES
------------------------
STATEMENT OF ADDITIONAL
INFORMATION
------------------------
PAINEWEBBER
------------------------
NOVEMBER 10, 1995, AS REVISED JANUARY 22, 1996.
(Copyright)1996 PaineWebber Incorporated
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