GMO TRUST
GMO TRUST (the "Trust"), 40 Rowes Wharf, Boston, Massachusetts 02110, is an
open-end management investment company offering twenty-five (25) separate
portfolios with this prospectus (collectively, the "Funds"). The Trust offers
one additional portfolio, the Pelican Fund, pursuant to a separate prospectus.
Each Fund has its own investment objective and strategies. Grantham, Mayo, Van
Otterloo & Co. (the "Manager" or "GMO") is the investment manager of all Funds.
The Manager has a Consulting Agreement with Dancing Elephant, Ltd. (the
"Consultant") with respect to management of the GMO Emerging Markets Fund. The
Trust offers "diversified" and "non-diversified" portfolios, as defined in the
Investment Company Act of 1940 (the "1940 Act"). The definition and potential
risks of "non-diversified" portfolios are discussed under "Description and Risks
of Fund Investments -- Non-Diversified Portfolios" on page 46. A Table of
Contents appears on page 6 of this Prospectus. Brief descriptions of the Funds
begin on page 2.
GMO FUNDS
DOMESTIC EQUITY FUNDS INTERNATIONAL EQUITY FUNDS
Core Fund International Core Fund
Tobacco-Free Core Fund Currency Hedged International
Value Fund Core Fund
Growth Fund Foreign Fund
U.S. Sector Fund International Small Companies Fund
Core II Secondaries Fund Japan Fund
Fundamental Value Fund Emerging Markets Fund
REIT Fund
FIXED INCOME FUNDS ASSET ALLOCATION FUNDS
Short-Term Income Fund International Equity Allocation
Global Hedged Equity Fund Fund
Domestic Bond Fund World Equity Allocation Fund
International Bond Fund Global (U.S.+) Equity Allocation
Currency Hedged International Fund
Bond Fund Global Balanced Allocation Fund
Global Bond Fund
Emerging Country Debt Fund
MULTIPLE CLASSES
Each Fund (except the Short-Term Income Fund and the Asset Allocation
Funds) offers three classes of shares: CLASS I, CLASS II AND CLASS III. The
Asset Allocation Funds offer only Class I and Class II Shares and the Short-Term
Income Fund offers only Class III Shares. Eligibility for the classes is
generally based on the total amount of assets that a client has invested with
GMO (with Class I requiring the least total assets and Class III the most), all
as described more fully herein. See "Multiple Classes--Eligibility for Classes"
on pages 60 and 61.
NOTE: CLASS III SHARES ARE THE CONTINUATION OF THE TRUST'S SINGLE CLASS OF
SHARES THAT EXISTED PRIOR TO JUNE 1, 1996, AND BEAR THE SAME TOTAL OPERATING
EXPENSES AS THAT ORIGINAL CLASS OF SHARES.
The classes differ solely with regard to (i) whether GMO or the GMO Funds
Division provides client service and reporting to shareholders of the class and
(ii) the level of Shareholder Service Fee borne by the class. These differences
are described briefly below and in more detail elsewhere in this Prospectus. ALL
CLASSES OF A FUND HAVE AN INTEREST IN THE SAME UNDERLYING ASSETS, ARE MANAGED BY
GMO, AND PAY THE SAME INVESTMENT MANAGEMENT FEE.
INVESTMENT MANAGER
GMO
GRANTHAM, MAYO, VAN OTTERLOO & CO.
CLIENT SERVICE PROVIDER
GMO GMO FUNDS DIVISION
Class III Shares only Class I and Class II Shares
Tel.: (617) 330-7500 Tel.: (617) 790-5000
Fax: (617) 439-4192 Fax: (617) 439-4290
SHAREHOLDER SERVICE FEE
The level of Shareholder Service Fee for each class is set forth at the
bottom of the following page and described more fully under "Multiple Classes
- -Shareholder Service Fees".
- -------------------------
This Prospectus concisely describes the information which investors ought
to know before investing. Please read this Prospectus carefully and keep it for
further reference. A Statement of Additional Information dated May 31, 1996, as
revised from time to time, is available free of charge by writing to GMO Funds
Division, 40 Rowes Wharf, Boston, Massachusetts 02110 or by calling (617) 790-
5000. The Statement, which contains more detailed information about each Fund,
has been filed with the Securities and Exchange Commission ("SEC") and is
incorporated by reference into this Prospectus.
THE EMERGING COUNTRY DEBT FUND MAY INVEST WITHOUT LIMIT, THE INTERNATIONAL
BOND AND CURRENCY HEDGED INTERNATIONAL BOND FUNDS MAY INVEST UP TO 25% OF THEIR
NET ASSETS AND THE DOMESTIC BOND, REIT AND FOREIGN FUNDS MAY INVEST UP TO 5% OF
THEIR NET ASSETS IN LOWER-RATED BONDS, COMMONLY KNOWN AS "JUNK BONDS."
INVESTMENTS OF THIS TYPE ARE SUBJECT TO A GREATER RISK OF LOSS OF PRINCIPAL AND
NON-PAYMENT OF INTEREST. INVESTORS SHOULD CAREFULLY ASSESS THE RISKS ASSOCIATED
WITH AN INVESTMENT IN THESE FUNDS. PLEASE SEE "DESCRIPTION AND RISKS OF FUND
INVESTMENTS -- LOWER RATED SECURITIES."
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED ON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
PROSPECTUS JULY 1, 1996
GMO MUTUAL FUNDS
The Funds offered by this Prospectus are described briefly below and
in more detail throughout this Prospectus. GMO Mutual Funds can generally be
classified as Domestic Equity Funds, International Equity Funds and Fixed Income
Funds. The Trust also offers four Asset Allocation Funds that invest in varying
amounts in other Funds of the Trust.
DOMESTIC EQUITY FUNDS
The Trust offers the following eight domestic equity portfolios which
are collectively referred to as the "DOMESTIC EQUITY FUNDS."
GMO CORE FUND (the "CORE FUND") is a diversified portfolio that seeks
a total return greater than that of the Standard & Poor's 500 Stock Index (the
"S&P 500") through investment of substantially all of its assets in common
stocks chosen from the Wilshire 5000 Index (the "Wilshire 5000") and primarily
in common stocks chosen from among the 1,200 companies with the largest equity
capitalization whose securities are listed on a United States national
securities exchange (the "Large Cap 1200").
GMO TOBACCO-FREE CORE FUND (the "TOBACCO-FREE CORE FUND") is a
diversified portfolio that seeks a total return greater than that of the S&P 500
through investment of substantially all of its assets in common stocks chosen
from the Wilshire 5000 and primarily in common stocks chosen from the Large Cap
1200 which are not Tobacco Producing Issuers. A "Tobacco Producing Issuer" is an
issuer which derives more than 10% of its gross revenues from the production of
tobacco- related products.
GMO VALUE FUND (the"VALUE FUND") is a non-diversified portfolio that
seeks a total return greater than that of the S&P 500 through investment of
substantially all of its assets in common stocks chosen from the Wilshire 5000
and primarily in common stocks chosen from the Large Cap 1200. Strong
consideration is given to common stocks whose current prices, in the opinion of
the Manager, do not adequately reflect the on-going business value of the
underlying company.
GMO GROWTH FUND (the "GROWTH FUND") is a non-diversified portfolio that
seeks long-term growth of capital through investment of substantially all of its
assets in common stocks chosen from the Wilshire 5000 and primarily in the
equity securities of companies chosen from the Large Cap 1200. Current income is
only an incidental consideration.
GMO U.S. SECTOR FUND (the "U.S. SECTOR FUND") is a non-diversified
portfolio that seeks a total return greater than that of the S&P 500 through
investment of substantially all of its assets in common stocks chosen from the
Wilshire 5000 and primarily in common stocks chosen from among the 1,800
companies with the largest equity capitalization whose securities are listed on
a United States national securities exchange.
GMO CORE II SECONDARIES FUND (the "CORE II SECONDARIES FUND") is a
diversified portfolio that seeks long-term growth of capital through investment
primarily in companies whose equity capitalization ranks in the lower two-thirds
of the 1,800 companies with the largest equity capitalization whose securities
are listed on a United States national securities exchange. Current income is
only an incidental consideration.
GMO FUNDAMENTAL VALUE FUND (the "FUNDAMENTAL VALUE FUND") is a
diversified portfolio that seeks long-term capital growth through investment
primarily in equity securities. Consideration of current income is secondary to
this principal objective.
GMO REIT FUND (the "REIT FUND") is a non-diversified portfolio that
seeks maximum total return through investment primarily in real estate
investment trusts ("REITs").
- --------------------------------------------------------------------------------
CLASSES AND FEES
ALL FUNDS (EXCEPT ELIGIBILITY
ASSET ALLOCATION FUNDS) REQUIREMENT* SHAREHOLDER SERVICE FEE**
- ----------------------- ------------ -------------------------
Class I $1 million 0.28%
Class II $10 million 0.22%
Class III $35 million 0.15%
ASSET ALLOCATION FUNDS ONLY
- ---------------------------
Class I $1 million 0.13%***
Class II $10 million 0.07%***
- ----------------------
* More detailed explanation of eligibility criteria is provided on page 5 and
under "Multiple Classes -- Eligibility for Classes."
** As noted above, all classes of shares of a Fund pay the same investment
management fee.
*** The Asset Allocation Funds will invest in Class III Shares of underlying
Funds and will therefore also indirectly bear a Shareholder Service Fee of
0.15%. Thus, the total Shareholder Service Fee borne by Class I and Class
II Shares of the Asset Allocation Funds is the same as that borne by Class
I or Class II Shares, respectively, of the other Funds. See "Asset
Allocation Funds."
-2-
INTERNATIONAL EQUITY FUNDS
The Trust offers the following six international equity portfolios
which are collectively referred to as the "INTERNATIONAL EQUITY FUNDS."
GMO INTERNATIONAL CORE FUND (the "INTERNATIONAL CORE FUND") is a
diversified portfolio that seeks maximum total return through investment in a
portfolio of common stocks of non-U.S. issuers.
GMO CURRENCY HEDGED INTERNATIONAL CORE FUND (the "CURRENCY HEDGED
INTERNATIONAL CORE FUND") is a non-diversified portfolio that seeks maximum
total return through investment in a portfolio of common stocks of non-U.S.
issuers and through management of the Fund's foreign currency positions. The
Fund has similar policies to the International Core Fund, except that the
Currency Hedged International Core Fund will maintain currency hedges with
respect to a substantial portion of the foreign currency exposure represented in
the Fund's benchmark while the International Core Fund will generally hedge only
a limited portion of the currency exposure of that benchmark.
GMO FOREIGN FUND (the "FOREIGN FUND") is a non-diversified portfolio
that seeks maximum total return through investment in a portfolio of equity
securities of non-U.S. issuers.
GMO INTERNATIONAL SMALL COMPANIES FUND (the "INTERNATIONAL SMALL
COMPANIES FUND") is a diversified portfolio that seeks maximum total return
through investment primarily in equity securities of foreign issuers whose
equity securities are traded on a major stock exchange of a foreign country
("foreign stock exchange companies") and whose equity capitalization at the time
of investment, when aggregated with the equity capitalizations of all foreign
stock exchange companies in that country whose equity capitalizations are
smaller than that of such company, is less than 50% of the aggregate equity
capitalization of all foreign stock exchange companies in such country.
GMO JAPAN FUND (the "JAPAN FUND") is a non-diversified portfolio that
seeks maximum total return through investment in Japanese securities, primarily
in common stocks of Japanese companies.
GMO EMERGING MARKETS FUND (the "EMERGING MARKETS FUND") is a
non-diversified portfolio that seeks long term capital appreciation consistent
with what the Manager believes to be a prudent level of risk through investment
in equity and equity-related securities traded in the securities markets of
newly industrializing countries in Asia, Latin America, the Middle East,
Southern Europe, Eastern Europe and Africa.
FIXED INCOME FUNDS
The Trust offers the following seven domestic and international fixed
income portfolios which are collectively referred to as the "Fixed Income
Funds."
GMO SHORT-TERM INCOME FUND (the "SHORT-TERM INCOME FUND") is a
non-diversified portfolio that seeks current income to the extent consistent
with the preservation of capital and liquidity through investment in a portfolio
of high quality short-term instruments. The Short-Term Income Fund intends to
invest in short-term securities, but it is not a "money market fund."
GMO GLOBAL HEDGED EQUITY FUND (the "GLOBAL HEDGED EQUITY FUND") is a
non-diversified portfolio that seeks total return consistent with minimal
exposure to general equity market risk.
GMO DOMESTIC BOND FUND (the "DOMESTIC BOND FUND") is a
non-diversified portfolio that seeks high total return through investment
primarily in U.S. Government Securities. The Fund may also invest a significant
portion of its assets in other investment grade bonds (including convertible
bonds) denominated in U.S. dollars. The Fund's portfolio will generally have a
duration of approximately four to six years (excluding short-term investments).
GMO INTERNATIONAL BOND FUND (the "INTERNATIONAL BOND FUND") is a
non-diversified portfolio that seeks high total return by investing primarily in
investment grade bonds (including convertible bonds) denominated in various
currencies including U.S. dollars or in multicurrency units. The Fund seeks to
provide a total return greater than that provided by the international fixed
income securities market generally.
GMO CURRENCY HEDGED INTERNATIONAL BOND FUND (the "CURRENCY HEDGED
INTERNATIONAL BOND FUND") is a non-diversified portfolio with the same
investment objectives and policies as the International Bond Fund except that
the Currency Hedged International Bond Fund will generally attempt to hedge
substantially all of its foreign currency risk while the International Bond Fund
will generally not hedge any of its foreign currency risk. Despite the otherwise
identical objectives and policies, the composition of the two portfolios may
differ substantially at any given time.
GMO GLOBAL BOND FUND (the "GLOBAL BOND FUND") is a non-diversified
portfolio that seeks high total return by investing primarily in investment
grade bonds (including convertible bonds) denominated in various currencies
including U.S. dollars or in multicurrency units. The Fund seeks to provide a
total return greater than that provided by the global fixed income securities
market generally.
GMO EMERGING COUNTRY DEBT FUND (the "EMERGING COUNTRY DEBT FUND") is
a non-diversified portfolio that seeks high total return by investing primarily
in sovereign debt (bonds and loans) of countries in Asia, Latin America, the
Middle East, Southern Europe, Eastern Europe and Africa.
ASSET ALLOCATION FUNDS
The Trust offers the following four asset allocation portfolios (the
"ALLOCATION FUNDS"). The Allocation Funds operate as "funds-of-funds" in that,
pursuant to management provided by the Manager, these Funds make investments in
other Funds of the Trust.
GMO INTERNATIONAL EQUITY ALLOCATION FUND (the "INTERNATIONAL EQUITY
ALLOCATION FUND") is a diversified portfolio that seeks a total return greater
than the return of the EAFE-lite Extended Index benchmark. The Fund will pursue
its
-3-
objective by investing to varying extents primarily in Class III Shares of the
various International Equity Funds of the Trust.
GMO WORLD EQUITY ALLOCATION FUND (the "WORLD EQUITY ALLOCATION FUND")
is a diversified portfolio that seeks a total return greater than the return of
the World Lite Extended Index benchmark. The Fund will pursue its objective by
investing to varying extents primarily in Class III Shares of the various
Domestic Equity and International Equity Funds of the Trust.
GMO GLOBAL (U.S.+) EQUITY ALLOCATION FUND (the "GLOBAL (U.S.+) EQUITY
ALLOCATION FUND") is a diversified portfolio that seeks a total return greater
than the return of the GMO Global (U.S.+) Equity Index benchmark, which has a
greater weighting of U.S. stocks (S&P 500) than the World Lite Extended Index.
The Fund will pursue its objective by investing to varying extents primarily in
Class III Shares of the various Domestic Equity and International Equity Funds
of the Trust.
GMO GLOBAL BALANCED ALLOCATION FUND (the "GLOBAL BALANCED ALLOCATION
FUND") is a diversified portfolio that seeks a total return greater than the
return of the GMO Global Balanced Index benchmark. The Fund will pursue its
objective by investing to varying extents primarily in Class III Shares of the
various Domestic Equity, International Equity and Fixed Income Funds of the
Trust.
- --------------------------------------------------------------------------------
Investors should consider the risks associated with an investment in
the Funds. For information concerning the types of investment practices in which
a particular Fund may engage, see "Investment Objectives and Policies". For more
information concerning such investment practices and their associated risks, see
"Descriptions and Risks of Fund Investment Practices".
- --------------------------------------------------------------------------------
BENCHMARKS AND INDICES
----------------------
As is evident throughout this Prospectus, many of the Funds are managed,
and/or meant to be measured, relative to a specified index or benchmark. Some
general information about these benchmarks and indices is provided in the table
below. While Funds may be managed relative to these benchmarks or indices, it is
important to note that none of the Funds is managed as an "index fund" or
"index-plus fund", and the actual composition of a Fund's portfolio may differ
substantially from that of its benchmark.
<TABLE>
<CAPTION>
Abbreviation Full Name Sponsor or Publisher Description
- ------------ --------- -------------------- -----------
<S> <C> <C> <C>
S&P 500 Standard & Poor's 500 Stock Index Standard & Poor's Well known, independently maintained
Corporation and published U.S. large
capitalization stock index
Wilshire 5000 Wilshire 5000 Stock Index Wilshire Associates, Inc. Independently maintained and
published broadly populated
U.S. stock index
Lehman Brothers Lehman Brothers Government Bond Lehman Brothers Well known, independently maintained
Government Index and published government bond index,
regularly used as a comparative fixed
income benchmark
EAFE Morgan Stanley Capital International Morgan Stanley Capital Well known, independently maintained
Europe, Australia and Far East Index International and published large capitalization
international stock index
EAFE-Lite GMO EAFE-Lite GMO A modification of EAFE where GMO
reduces the market capitalization of
Japan by 40% relative to EAFE
EAFE-Lite Extended GMO EAFE-Lite Extended GMO A modification of EAFE-Lite where GMO
adds those additional countries
represented in the IFC Investable
Index
MSCI World Morgan Stanley Capital International Morgan Stanley Capital An independently maintained and
World Index International published global(including U.S.)
equity index
World-Lite Extended GMO World-Lite Extended GMO A modification of MSCI World where
GMO reduces the market capitalization
of Japan by 40% relative to MSCI
World and adds those additional
countries represented in the IFC
Investable Index
GMO Global GMO Global (U.S.+) Equity Index GMO A composite benchmark computed by GMO
(U.S.+)Equity and comprised 75% by S&P 500 and 25%
Index by EAFE-Lite Extended
GMO Global GMO Global Balanced Index GMO A composite benchmark computed by GMO
Balanced Index and comprised 48.75% by S&P 500,
16.25% by EAFE-Lite Extended and 35%
by Lehman Brothers
</TABLE>
-4-
CLASS ELIGIBILITY
- -----------------
For full details of the class eligibility criteria summarized below and an
explanation of how conversions between classes will occur, see "Multiple Classes
- - Eligibility for Classes" and "Multiple Classes - Conversions Among Classes",
beginning on page 60.
CLASS I AND CLASS II SHARES:
Recognizing that institutional and individual investors with assets under
GMO's management totalling less than $35 million have different service and
reporting needs than larger client relationships, GMO has created the GMO Funds
Division. GMO Funds Division delivers institutional-quality client services to
clients investing between $1 million and $35 million. These services include
professional and informative reporting, and access to meaningful analysis and
explanation.
CLASS I SHARES. Class I Shares are available to any investor who commits (after
May 31, 1996) assets to GMO management to establish a "Total Investment" (as
defined) with GMO of between $1 million and $10 million. In addition, all
defined contribution retirement or pension plans are eligible only for Class I
shares regardless of the size of their investment. Class I Shares will receive
client service and reporting from GMO Funds Division and will bear a Shareholder
Service Fee of 0.28%.
CLASS II SHARES. Class II Shares are available to any investor who (i) has less
than $7 million (but more than $0) under the management of GMO as of May 31,
1996, or (ii) commits (after May 31, 1996) assets to GMO management to establish
a "Total Investment" (as defined) with GMO of between $10 million and $35
million. Class II Shares will receive client service and reporting from GMO
Funds Division and will bear a Shareholder Service Fee of 0.22%.
Purchasers of Class I and Class II Shares should follow purchase
instructions for such classes described under "Purchase of Shares" and direct
questions to the Trust at (617) 790-5000.
CLASS III SHARES:
GMO provides direct client service and reporting to owners of Class III
Shares. These clients generally must have a "Total Investment" (as defined) with
GMO of at least $35 million. Class eligibility requirements for existing clients
of GMO as of May 31, 1996 are governed by special rules described in this
Prospectus.
CLASS III SHARES. Class III Shares are available to any investor who (i) has at
least $7 million under the management of GMO as of May 31, 1996, or (ii) commits
(after May 31, 1996) assets to GMO management to establish a "Total Investment"
(as defined) with GMO of at least $35 million. Class III Shares will receive
client service and reporting directly from GMO, and will bear a Shareholder
Service Fee of 0.15% of average net assets. Note: Class III Shares are a
redesignation of the single class of shares that has been offered by each Fund
since inception. Class III Shares bear the same rate of total operating expenses
as they did before the redesignation.
Purchasers of Class III Shares should follow purchase instructions
described under "Purchase of Shares" and direct questions to the Trust at (617)
330-7500.
-5-
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
SCHEDULE OF FEES AND EXPENSES.................................................................................................8
FINANCIAL HIGHLIGHTS.........................................................................................................16
Certain Financial Information Relating to the GMO Foreign Fund..........................................................26
INVESTMENT OBJECTIVES AND POLICIES...........................................................................................27
DOMESTIC EQUITY FUNDS.....................................................................................................27
Core Fund...............................................................................................................27
Tobacco-Free Core Fund..................................................................................................27
Value Fund..............................................................................................................28
Growth Fund.............................................................................................................29
U.S. Sector Fund........................................................................................................29
Core II Secondaries Fund................................................................................................30
Fundamental Value Fund..................................................................................................30
REIT Fund...............................................................................................................31
INTERNATIONAL EQUITY FUNDS................................................................................................32
International Core Fund.................................................................................................32
Currency Hedged International Core
Fund..................................................................................................................33
Foreign Fund............................................................................................................34
International Small Companies Fund .....................................................................................35
Japan Fund..............................................................................................................35
Emerging Markets Fund...................................................................................................36
FIXED INCOME FUNDS........................................................................................................37
Short-Term Income Fund..................................................................................................37
Global Hedged Equity Fund...............................................................................................38
Domestic Bond Fund......................................................................................................41
International Bond Fund.................................................................................................42
Currency Hedged International
Bond Fund.............................................................................................................42
Global Bond Fund........................................................................................................43
Emerging Country Debt Fund..............................................................................................44
ASSET ALLOCATION FUNDS....................................................................................................45
International Equity Allocation Fund....................................................................................45
World Equity Allocation Fund............................................................................................45
Global (U.S.+) Equity Allocation Fund...................................................................................46
Global Balanced Allocation Fund.........................................................................................46
DESCRIPTION AND RISKS OF FUND
INVESTMENTS...............................................................................................................46
Portfolio Turnover...........................................................................................................47
Diversified and Non-Diversified Portfolios...................................................................................47
Certain Risks of Foreign Investments.........................................................................................47
General.................................................................................................................47
Emerging Markets........................................................................................................47
Securities Lending...........................................................................................................48
Depository Receipts..........................................................................................................48
Convertible Securities.......................................................................................................48
Futures and Options..........................................................................................................48
Options.................................................................................................................49
Writing Covered Options.................................................................................................49
Futures.................................................................................................................50
Index Futures...........................................................................................................50
Interest Rate Futures...................................................................................................51
Options on Futures Contracts............................................................................................51
Uses of Options, Futures and Options
on Futures.................................................................................................................51
Risk Management.........................................................................................................51
Hedging.................................................................................................................52
Investment Purposes.....................................................................................................52
Synthetic Sales and Purchases.....................................................................................52
Swap Contracts and Other Two-Party Contracts............................................................................53
Swap Contracts....................................................................................................53
Interest Rate and Currency Swap Contracts.........................................................................53
Equity Swap Contracts and Contracts for
Differences.....................................................................................................53
Interest Rate Caps, Floors and Collars............................................................................54
Foreign Currency Transactions ..........................................................................................54
Repurchase Agreements...................................................................................................55
Debt and Other Fixed Income Securities
Generally.............................................................................................................55
Temporary High Quality Cash Items.......................................................................................56
U.S. Government Securities and Foreign
Government Securities.................................................................................................56
Mortgage-Backed and Other Asset-Backed
Securities............................................................................................................56
Collateralized Mortgage Obligations
("CMOs"); Strips and Residuals..................................................................................56
Adjustable Rate Securities..............................................................................................57
Lower Rated Securities..................................................................................................57
Brady Bonds.............................................................................................................57
Zero Coupon Securities..................................................................................................58
Indexed Securities......................................................................................................58
Firm Commitments........................................................................................................58
Loans, Loan Participations and Assignments..............................................................................58
Reverse Repurchase Agreements and Dollar
Roll Agreements.......................................................................................................59
Illiquid Securities.....................................................................................................59
Special Allocation Fund Considerations..................................................................................60
MULTIPLE CLASSES.............................................................................................................60
Shareholder Service Fees................................................................................................60
Client Service - GMO and GMO Funds......................................................................................60
Eligibility for Classes.................................................................................................60
Conversions Between Classes.............................................................................................61
PURCHASE OF SHARES...........................................................................................................61
Purchase Procedures.....................................................................................................62
REDEMPTION OF SHARES.........................................................................................................63
DETERMINATION OF NET ASSET VALUE.............................................................................................64
DISTRIBUTIONS................................................................................................................65
TAXES........................................................................................................................65
Withholding on Distributions to Foreign
Investors.............................................................................................................65
Foreign Tax Credits.....................................................................................................66
Loss of Regulated Investment Company Status.............................................................................66
MANAGEMENT OF THE TRUST......................................................................................................68
ORGANIZATION AND CAPITALIZATION
OF THE TRUST...............................................................................................................67
Appendix A...................................................................................................................69
-6-
RISKS AND LIMITATIONS OF OPTIONS, FUTURES
AND SWAPS...............................................................................................................69
Limitations on the Use of Options and Futures Portfolio
Strategies............................................................................................................69
Risk Factors in Options Transactions....................................................................................69
Risk Factors in Futures Transactions....................................................................................69
Risk Factors in Swap Contracts, OTC Options and other
Two-Party Contracts...................................................................................................70
Additional Regulatory Limitations on the Use of Futures
and Related Options, Interest Rate Floors, Caps
and Collars and Interest Rate and Currency Swap
Contracts.........................................................................................................70
Appendix B...................................................................................................................72
COMMERCIAL PAPER AND CORPORATE DEBT
RATINGS.................................................................................................................72
Commercial Paper Ratings ...............................................................................................72
Corporate Debt Ratings..................................................................................................72
Standard & Poor's Corporation.....................................................................................72
Moody's Investors Service, Inc....................................................................................72
</TABLE>
-7-
SCHEDULE OF FEES AND EXPENSES
-----------------------------
<TABLE>
<CAPTION>
Shareholder
GMO Fund Name Transaction Expenses Annual Operating Expenses
- ----------------------------- --------------------------------------------------------------
Cash Purchase Redemption Inv.
Premium (as a Fees (as a Mgmt. Share-
percentage of percentage of Fees after holder TOTAL
amount amount Fee Service Other OPERATING
invested)1 redeemed)1 Waiver9 Fee3 Expenses9 EXPENSES9
DOMESTIC EQUITY FUNDS
<S> <C> <C> <C> <C> <C> <C>
Core Fund
Class I .14%4 None .30% .28% .03% .61%
Class II .14%4 None .30% .22% .03% .55%
Class III .14%4 None .30% .15% .03% .48%
Tobacco-Free Core Fund
Class I .14%4 None .15% .28% .18% .61%
Class II .14%4 None .15% .22% .18% .55%
Class III .14%4 None .15% .15% .18% .48%
Value Fund
Class I .14%4 None .41% .28% .05% .74%
Class II .14%4 None .41% .22% .05% .68%
Class III .14%4 None .41% .15% .05% .61%
Growth Fund
Class I .14%4 None .28% .28% .05% .61%
Class II .14%4 None .28% .22% .05% .55%
Class III .14%4 None .28% .15% .05% .48%
U.S. Sector Fund
Class I .14%4 None .27% .28% .06% .61%
Class II .14%4 None .27% .22% .06% .55%
Class III .14%4 None .27% .15% .06% .48%
</TABLE>
<TABLE>
<CAPTION>
Examples
-----------------------------------------------------
You would pay the
following expenses on a
$1,000 investment
assuming 5% annual You would pay the
return with redemption following expenses on the
the end of each time same investment assuming
period: no redemption:
1 Yr. 3 Yr. 5 Yr. 10Yr. 1 Yr. 3 Yr.5 Yr. 10Yr.
DOMESTIC EQUITY FUNDS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Core Fund
---------
Class I $8 $21 $35 $78 $8 $21 $35 $78
Class II $7 $19 $32 $70 $7 $19 $32 $70
Class III $6 $17 $28 $62 $6 $17 $28 $62
Tobacco-Free Core Fund
----------------------
Class I $8 $21 $35 $78 $8 $21 $35 $78
Class II $7 $19 $32 $70 $7 $19 $32 $70
Class III $6 $17 $28 $62 $6 $17 $28 $62
Value Fund
----------
Class I $9 $25 $42 $93 $9 $25 $42 $93
Class II $8 $23 $39 $86 $8 $23 $39 $86
Class III $8 $21 $35 $78 $8 $21 $35 $78
Growth Fund
-----------
Class I $8 $21 $35 $78 $8 $21 $35 $78
Class II $7 $19 $32 $70 $7 $19 $32 $70
Class III $6 $17 $28 $62 $6 $17 $28 $62
U.S. Sector Fund
----------------
Class I $8 $21 $35 $78 $8 $21 $35 $78
Class II $7 $19 $32 $70 $7 $19 $32 $70
Class III $6 $17 $28 $62 $6 $17 $28 $62
</TABLE>
Footnotes begin on page 13 and are important to understanding this table.
Unless otherwise noted, Annual Operating Expenses shown are based on actual
expenses for the year ended February 29, 1996.
The purpose of the foregoing tables is to assist in understanding the various
costs and expenses of each Fund that are borne by holders of Fund shares. THE
FIVE PERCENT ANNUAL RETURN AND EXPENSE NUMBERS USED ARE NOT REPRESENTATIONS OF
FUTURE PERFORMANCE OR EXPENSES, SUBJECT TO THE MANAGER'S UNDERTAKING TO WAIVE
ITS FEE AND/OR BEAR CERTAIN EXPENSES FOR EACH FUND AS DESCRIBED IN THE TABLES,
ACTUAL PERFORMANCE AND/OR EXPENSES MAY BE MORE OR LESS THAN SHOWN. Where a
purchase premium and/or redemption fee is indicated as being charged by a Fund
in certain instances, the foregoing examples assume the payment of such purchase
premium and/or redemption fee even though such purchase premium and/or
redemption fee is not applicable in all cases. (See "Purchase of Shares" and
"Redemption of Shares").
-8-
<TABLE>
<CAPTION>
Shareholder
GMO Fund Name Transaction Expenses Annual Operating Expenses
- ----------------------------- ------------------------------------------------------------------
Cash Purchase Redemption Inv.
Premium(as a Fees (as a Mgmt. Share-
percentage of percentage of Fees afterholder Total
amount amount Fee Service Other Operating
invested)1 redeemed)1 Waiver9 Fee3 Expenses9 Expenses9
--------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Core II Secondaries Fund
------------------------
Class I .50%4 .50%4 .22% .28% .11% .61%
Class II .50%4 .50%4 .22% .22% .11% .55%
Class III .50%4 .50%4 .22% .15% .11% .48%
Fundamental Value Fund
----------------------
Class I .15%2 None .55% .28% .05% .88%
Class II .15%2 None .55% .22% .05% .82%
Class III .15%2 None .55% .15% .05% .75%
REIT Fund
---------
Class I .75%4 .75%4 .28% .28% .26%12 .82%
Class II .75%4 .75%4 .28% .22% .26%12 .76%
Class III .75%4 .75%4 .28% .15% .26%12 .69%
International Equity Funds
International Core Fund
-----------------------
Class I .60%4 None .45%14 .28% .10%15 .83%14, 15
Class II .60%4 None .45%14 .22% .10%15 .77%14, 15
Class III .60%4 None .45%14 .15% .10%15 .70%14, 15
Currency Hedged
International Core Fund
-----------------------
Class I .60%4 None .41% .28% .13%12 .82%
Class II .60%4 None .41% .22% .13%12 .76%
Class III .60%4 None .41% .15% .13%12 .69%
</TABLE>
<TABLE>
<CAPTION>
Examples
-------------------------------------------
You would pay the
following expenses on a
$1,000 investment
assuming 5% annual You would pay the
return with redemption following expenses on the
the end of each time same investment assuming
period: no redemption:
1 Yr. 3 Yr. 5 Yr. 10Yr.1 Yr. 3 Yr.5 Yr. 10Yr.
--------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Core II Secondaries Fund
- ------------------------
Class I $16 $30 $45 $88 $11 $24 $39 $81
Class II $16 $28 $42 $81 $11 $23 $36 $74
Class III $15 $26 $38 $73 $10 $20 $32 $65
Fundamental Value Fund
- ----------------------
Class I $10 $30 $50 $110 $10 $30 $50 $110
Class II $10 $28 $47 $103 $10 $28 $47 $100
Class III $9 $25 $43 $94 $9 $25 $43 $94
REIT Fund
- ---------
Class I $24 $42 $16 $33
Class II $23 $40 $15 $32
Class III $22 $38 $15 $29
International Equity Funds
International Core Fund
- -----------------------
Class I $15 $33 $52 $109 $15 $33 $52 $109
Class II $14 $31 $49 $102 $14 $31 $49 $102
Class III $13 $29 $45 $94 $13 $29 $45 $94
Currency Hedged
International Core Fund
-----------------------
Class I $14 $32 $14 $32
Class II $14 $30 $14 $30
Class III $13 $28 $13 $28
</TABLE>
Footnotes begin on page 13 and are important to understanding this table.
Unless otherwise noted, Annual Operating Expenses shown are based on actual
expenses for the year ended February 29, 1996.
The purpose of the foregoing tables is to assist in understanding the various
costs and expenses of each Fund that are borne by holders of Fund shares. THE
FIVE PERCENT ANNUAL RETURN AND EXPENSE NUMBERS USED ARE NOT REPRESENTATIONS OF
FUTURE PERFORMANCE OR EXPENSES, SUBJECT TO THE MANAGER'S UNDERTAKING TO WAIVE
ITS FEE AND/OR BEAR CERTAIN EXPENSES FOR EACH FUND AS DESCRIBED IN THE TABLES,
ACTUAL PERFORMANCE AND/OR EXPENSES MAY BE MORE OR LESS THAN SHOWN. Where a
purchase premium and/or redemption fee is indicated as being charged by a Fund
in certain instances, the foregoing examples assume the payment of such purchase
premium and/or redemption fee even though such purchase premium and/or
redemption fee is not applicable in all cases. (See "Purchase of Shares" and
"Redemption of Shares").
-9-
<TABLE>
<CAPTION>
Shareholder
GMO Fund Name Transaction Expenses Annual Operating Expenses
- ----------------------------- --------------------------------------------------------------
Cash Purchase Redemption Inv.
Premium (as a Fees (as a Mgmt. Share-
percentage ofpercentage ofFees afterholder Total
amount amount Fee Service Other Operating
invested)1 redeemed)1 Waiver9 Fee3 Expenses9 Expenses9
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Foreign Fund
------------
Class I None None .44% .28% .16%12 .88%
Class II None None .44% .22% .16%12 .82%
Class III None None .44% .15% .16%12 .75%
International Small
Companies Fund
--------------
Class I 1.00%4 .60%4 .41% .28% .20%15 .89%15
Class II 1.00%4 .60%4 .41% .22% .20%15 .83%15
Class III 1.00%4 .60%4 .41% .15% .20%15 .76%15
Japan Fund
----------
Class I .40%2 .61%2 .23%11 .28% .31% .82%11
Class II .40%2 .61%2 .23%11 .22% .31% .76%11
Class III .40%2 .61%2 .23%11 .15% .31% .69%11
Emerging Markets Fund
---------------------
Class I 1.60%5 .40%5, 7 .77%16 .28% .37% 1.42%16
Class II 1.60%5 .40%5, 7 .77%16 .22% .37% 1.36%16
Class III 1.60%5 .40%5, 7 .77%16 .15% .37% 1.29%16
FIXED INCOME FUNDS
Short-Term Income Fund
----------------------
Class III None None .00%13 .15% .05% .20%13
Global Hedged Equity Fund
-------------------------
Class I .50%4 1.40%6 .44% .28% .19% .91%
Class II .50%4 1.40%6 .44% .22% .19% .85%
Class III .50%4 1.40%6 .44% .15% .19% .78%
</TABLE>
<TABLE>
<CAPTION>
Examples
--------------------------------------------------
You would pay the
following expenses on a
$1,000 investment
assuming 5% annual You would pay the
return with redemption following expenses on the
the end of each time same investment assumin
period: no redemption:
1 Yr. 3 Yr. 5 Yr. 10Yr.1 Yr. 3 Yr.5 Yr. 10Yr.
-------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Foreign Fund
------------
Class I $9 $28 $9 $28
Class II $8 $26 $8 $26
Class III $8 $24 $8 $24
International Small
Companies Fund
--------------
Class I $25 $45 $66 $127 $19 $38 $59 $119
Class II $25 $43 $63 $120 $18 $36 $56 $112
Class III $24 $41 $59 $112 $18 $34 $52 $103
Japan Fund
----------
Class I $19 $37 $57 $114 $12 $30 $49 $105
Class II $18 $35 $54 $107 $12 $28 $46 $98
Class III $17 $33 $50 $99 $11 $26 $42 $90
Emerging Markets Fund
---------------------
Class I $34 $65 $97 $189 $30 $60 $92 $184
Class II $34 $63 $94 $183 $30 $58 $89 $177
Class III $33 $61 $90 $175 $29 $56 $86 $169
Fixed Income Funds
Short-Term Income Fund
----------------------
Class III $2 $6 $11 $26 $2 $6 $11 $26
Global Hedged Equity Fund
-------------------------
Class I $29 $50 $72 $137 $14 $34 $55 $116
Class II $28 $48 $69 $130 $14 $32 $52 $109
Class III $27 $46 $65 $122 $13 $30 $48 $101
--------------------------------------------
</TABLE>
Footnotes begin on page 13 and are important to understanding this table.
Unless otherwise noted, Annual Operating Expenses shown are based on actual
expenses for the year ended February 29, 1996.
The purpose of the foregoing tables is to assist in understanding the various
costs and expenses of each Fund that are borne by holders of Fund shares. THE
FIVE PERCENT ANNUAL RETURN AND EXPENSE NUMBERS USED ARE NOT REPRESENTATIONS OF
FUTURE PERFORMANCE OR EXPENSES, SUBJECT TO THE MANAGER'S UNDERTAKING TO WAIVE
ITS FEE AND/OR BEAR CERTAIN EXPENSES FOR EACH FUND AS DESCRIBED IN THE TABLES,
ACTUAL PERFORMANCE AND/OR EXPENSES MAY BE MORE OR LESS THAN SHOWN. Where a
purchase premium and/or redemption fee is indicated as being charged by a Fund
in certain instances, the foregoing examples assume the payment of such purchase
premium and/or redemption fee even though such purchase premium and/or
redemption fee is not applicable in all cases. (See "Purchase of Shares" and
"Redemption of Shares").
-10-
<TABLE>
<CAPTION>
Shareholder
GMO Fund Name Transaction Expenses Annual Operating Expenses
- ----------------------------- --------------------------------------------------------------
Cash Purchase Redemption Inv.
Premium (as a Fees (as a Mgmt. Share-
percentage of percentage of Fees after holder Total
amount amount Fee Service Other Operating
invested)1 redeemed)1 Waiver9 Fee3 Expenses9 Expenses9
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Domestic Bond Fund
------------------
Class I None None .04% .28% .06% .38%
Class II None None .04% .22% .06% .32%
Class III None None .04% .15% .06% .25%
International Bond Fund
-----------------------
Class I .15%5 None .12% .28% .13% .53%
Class II .15%5 None .12% .22% .13% .47%
Class III .15%5 None .12% .15% .13% .40%
Currency Hedged International
Bond Fund
---------
Class I .15%5 None .11% .28% .14% .53%
Class II .15%5 None .11% .22% .14% .47%
Class III .15%5 None .11% .15% .14% .40%
Global Bond Fund
----------------
Class I .15%5 None .00% .28% .19%12 .47%
Class II .15%5 None .00% .22% .19%12 .41%
Class III .15%5 None .00% .15% .19%12 .34%
Emerging Country Debt Fund
--------------------------
Class I .50%5 .25%5, 8 .30%10 .28% .16% .74%10
Class II .50%5 .25%5, 8 .30%10 .22% .16% .68%10
Class III .50%5 .25%5, 8 .30%10 .15% .16% .61%10
</TABLE>
<TABLE>
<CAPTION>
Examples
------------------------------------------------
You would pay the
following expenses on a
$1,000 investment
assuming 5% annual You would pay the
return with redemption following expenses on the
the end of each time same investment assuming
period: no redemption:
1 Yr. 3 Yr.5 Yr. 10Yr.1 Yr. 3 Yr.5 Yr. 10Yr.
-----------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Domestic Bond Fund
------------------
Class I $4 $12 $21 $48 $4 $12 $21 $48
Class II $3 $10 $18 $41 $3 $10 $18 $41
Class III $3 $8 $14 $32 $3 $8 $14 $32
International Bond Fund
-----------------------
Class I $7 $18 $31 $68 $7 $18 $31 $68
Class II $6 $17 $28 $61 $6 $17 $28 $61
Class III $6 $14 $24 $52 $6 $14 $24 $52
Currency Hedged International
Bond Fund
---------
Class I $7 $18 $31 $68 $7 $18 $31 $68
Class II $6 $17 $28 $61 $6 $17 $28 $61
Class III $6 $14 $24 $52 $6 $14 $24 $52
Global Bond Fund
----------------
Class I $6 $17 $28 $61 $6 $17 $28 $61
Class II $6 $15 $24 $53 $6 $15 $24 $53
Class III $5 $12 $21 $45 $5 $12 $21 $45
Emerging Country Debt Fund
--------------------------
Class I $15 $31 $49 $100 $13 $29 $46 $96
Class II $15 $29 $46 $93 $12 $27 $43 $89
Class III $14 $27 $42 $85 $11 $24 $39 $81
</TABLE>
Footnotes begin on page 13 and are important to understanding this table.
Unless otherwise noted, Annual Operating Expenses shown are based on actual
expenses for the year ended February 29, 1996.
The purpose of the foregoing tables is to assist in understanding the various
costs and expenses of each Fund that are borne by holders of Fund shares. THE
FIVE PERCENT ANNUAL RETURN AND EXPENSE NUMBERS USED ARE NOT REPRESENTATIONS OF
FUTURE PERFORMANCE OR EXPENSES, SUBJECT TO THE MANAGER'S UNDERTAKING TO WAIVE
ITS FEE AND/OR BEAR CERTAIN EXPENSES FOR EACH FUND AS DESCRIBED IN THE TABLES,
ACTUAL PERFORMANCE AND/OR EXPENSES MAY BE MORE OR LESS THAN SHOWN. Where a
purchase premium and/or redemption fee is indicated as being charged by a Fund
in certain instances, the foregoing examples assume the payment of such purchase
premium and/or redemption fee even though such purchase premium and/or
redemption fee is not applicable in all cases. (See "Purchase of Shares" and
"Redemption of Shares").
-11-
<TABLE>
<CAPTION>
Shareholder
GMO Fund Name Transaction Expenses Annual Operating Expenses
- ----------------------------- -------------------------------------------------------------------
Cash Purchase Redemption Inv.
Premium (as a Fees (as a Mgmt. Share-
percentage of percentage of Fees after holder Total
amount amount Fee Service Other Operating
invested)1 redeemed)1 Waiver9 Fee3 Expenses9 Expenses9
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Asset Allocation Funds
International Equity Allocation
Fund
-----------------------------
Class I None17 None17 .00%18 .13%18 .05%12,18 .18%18
Class II None17 None17 .00%18 .07%18 .05%12,18 .12%18
World Equity Allocation Fund
----------------------------
Class I None17 None17 .00%18 .13%18 .05%12,18 .18%18
Class II None17 None17 .00%18 .07%18 .05%12,18 .12%18
Global (U.S.+) Equity
Allocation Fund
---------------
Class I None17 None17 .00%18 .13%18 .05%12,18 .18%18
Class II None17 None17 .00%18 .07%18 .05%12,18 .12%18
Global Balanced Allocation
Fund
---------------------------
Class I None17 None17 .00%18 .13%18 .05%12, 18.18%18
Class II None17 None17 .00%18 .07%18 .05%12, 18.12%18
</TABLE>
<TABLE>
<CAPTION>
Examples
-------------------------------------------------
You would pay the
following expenses on a
$1,000 investment
assuming 5% annual You would pay the
return with redemption following expenses on the
the end of each time same investment assuming
period: no redemption:
1 Yr. 3 Yr. 5 Yr. 10Yr 1 Yr. 3 Yr. 5 Yr. 10Yr.
------------------------------------------------
ASSET ALLOCATION FUNDS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
International Equity Allocation
Fund
-----------------------------
Class I $2 $6 $2 $6
Class II $1 $4 $1 $4
World Equity Allocation Fund
----------------------------
Class I
Class II $2 $6 $2 $6
Global (U.S.+) Equity $1 $4 $1 $4
Allocation Fund
---------------
Class I
Class II
Global Balanced Allocation $2 $6 $2 $6
Fund $1 $4 $1 $4
----------------------------- -- -- -- --
Class I
Class II
$2 $6 $2 $6
$1 $4 $1 $4
</TABLE>
Footnotes begin on page 13 and are important to understanding this table.
Unless otherwise noted, Annual Operating Expenses shown are based on actual
expenses for the year ended February 29, 1996.
The purpose of the foregoing tables is to assist in understanding the various
costs and expenses of each Fund that are borne by holders of Fund shares. THE
FIVE PERCENT ANNUAL RETURN AND EXPENSE NUMBERS USED ARE NOT REPRESENTATIONS OF
FUTURE PERFORMANCE OR EXPENSES, SUBJECT TO THE MANAGER'S UNDERTAKING TO WAIVE
ITS FEE AND/OR BEAR CERTAIN EXPENSES FOR EACH FUND AS DESCRIBED IN THE TABLES,
ACTUAL PERFORMANCE AND/OR EXPENSES MAY BE MORE OR LESS THAN SHOWN. Where a
purchase premium and/or redemption fee is indicated as being charged by a Fund
in certain instances, the foregoing examples assume the payment of such purchase
premium and/or redemption fee even though such purchase premium and/or
redemption fee is not applicable in all cases. (See "Purchase of Shares" and
"Redemption of Shares").
-12-
NOTES TO SCHEDULE OF FEES AND EXPENSES
1. Purchase premiums and redemption fees apply only to cash transactions
as set forth under "Purchase of Shares" and "Redemption of Shares"
respectively. These fees are paid to and retained by the Fund itself
and are designed to allocate transaction costs caused by shareholder
activity to the shareholder generating the activity, rather than to the
Fund as a whole. As described in greater detail in footnotes below, for
certain Funds only the Manager may reduce purchase premiums and/or
redemption fees if the Manager determines there are minimum brokerage
and/or other transaction costs caused by the purchase or occur under
redemption. Generally, however, these fees are not waivable even when
there are offsetting transactions.
Normally, no purchase premium is charged with respect to in-kind
purchases of Fund shares. However, in the case of in-kind purchases
involving transfers of large positions in markets where the costs of
re-registration and/or other transfer expenses are high, the
International Core Fund, Currency Hedged International Core Fund,
International Small Companies Fund, Japan Fund and Global Hedged Equity
Fund may each charge a premium of 0.10%, and the Emerging Markets Fund
may charge a premium of 0.20%.
2. The Manager may waive purchase premiums and/or redemption fees for this
Fund if there are minimal brokerage and transaction costs incurred in
connection with a transaction.
3. Shareholder Service Fee ("SSF") paid to GMO for providing client
services and reporting services. For Class III Shares, the SSF is .15%
of daily net assets. Class III Shares are simply a redesignation of the
single class of shares that has been offered by each Fund since
inception. Total Operating Expenses for Class III Shares are capped at
the same levels as for the single class of shares that existed prior to
such redesignation and the creation of additional classes. The expense
caps are detailed in footnote 9 below.
The level of SSF is the sole economic distinction between the various
classes of Fund shares. A lower SSF for larger investments reflects
that the cost of servicing client accounts is lower for larger accounts
when expressed as a percentage of the account.
See "Multiple Classes - Shareholder Service Fees" for more information.
4. After May 31, 1996, the purchase premium and/or redemption fee for this
Fund may not be waived in any circumstance. Accordingly, the amount of
the stated purchase premium and/or redemption fee is lower than the
premium or fee charged prior to May 31, 1996, when the charges could be
waived if, generally due to off-setting transactions, a purchase or
redemption resulted in minimal brokerage and/or other transaction
costs. The new approach allows all purchasers or sellers to benefit
proportionately by offsetting transactions and other circumstances that
mitigate transaction costs, rather than tracking the savings back to
the particular buyers and sellers.
5. After May 31, 1996, the stated purchase premium and/or redemption fee
will always be charged in full except that the relevant purchase
premium or redemption fee will be reduced by 50% with respect to any
portion of a purchase or redemption that is offset by a corresponding
redemption or purchase, respectively, occurring on the same day. The
Manager examines each purchase and redemption of shares eligible for
such treatment to determine if circumstances exist to waive a portion
of the purchase premium or redemption fee. Absent a clear determination
that transaction costs will be reduced or absent for the purchase or
redemption, the full premium or fee will be charged.
6. May be eliminated if it is not necessary to incur costs relating to the
early termination of hedging transactions to meet redemption requests.
7. Applies only to shares acquired on or after June 1, 1995 (including
shares acquired by reinvestment of dividends or other distributions on
or after such date).
8. Applies only to shares acquired on or after July 1, 1995 (including
shares acquired by reinvestment of dividends or other distributions on
or after such date).
-13-
9. The Manager has voluntarily undertaken to reduce its management fees
and to bear certain expenses with respect to each Fund until further
notice to the extent that a Fund's total annual operating expenses
(excluding Shareholder Service Fees, brokerage commissions and other
investment-related costs, hedging transaction fees, extraordinary,
non-recurring and certain other unusual expenses (including taxes),
securities lending fees and expenses and transfer taxes; and, in the
case of the Emerging Markets Fund, Emerging Country Debt Fund and
Global Hedged Equity Fund, excluding custodial fees; and, in the case
of the Asset Allocation Funds, excluding expenses indirectly incurred
by investment in other Funds of the Trust) would otherwise exceed the
percentage of that Fund's daily net assets specified below. Therefore,
so long as the Manager agrees so to reduce its fees and bear certain
expenses, total annual operating expenses (subject to such exclusions)
of the Fund will not exceed these stated limitations. Absent such
undertakings, management fees for each Fund and the annual operating
expenses for each class would be as shown below.
<TABLE>
<CAPTION>
TOTAL CLASS
VOLUNTARY MANAGEMENT OPERATING EXPENSES
EXPENSE FEE (ABSENT (ABSENT WAIVER)
FUND LIMIT WAIVER)
- ------------------------------------------------------------------------------------------------------------------------------------
CLASS I CLASS II CLASS III
------- -------- ---------
<S> <C> <C> <C> <C> <C>
Core Fund .33% .525% .835% .775% .705%
Tobacco-Free Core Fund .33% .50% .96% .90% .83%
Value Fund .46% .70% 1.03% .97% .90%
Growth Fund .33% .50% .83% .77% .70%
U.S. Sector Fund .33% .49% .83% .77% .70%
Core II Secondaries Fund .33% .50% .89% .83% .76%
Fundamental Value Fund .60% .75% 1.08% 1.02% .95%
REIT Fund .54% .75% 1.29% 1.23% 1.16%
International Core Fund .54% .75% 1.13% 1.07% 1.00%
Currency Hedged International Core Fund .54% .75% 1.16% 1.10% 1.03%
Foreign Fund .60% .75% 1.19% 1.13% 1.06%
International Small Companies Fund .60% 1.25% 1.73% 1.67% 1.60%
Japan Fund .54% .75% 1.34% 1.28% 1.21%
Emerging Markets Fund .81% 1.00% 1.65% 1.59% 1.52%
Short-Term Income Fund .05% .25% N/A N/A .45%
Global Hedged Equity Fund .50% .65% 1.12% 1.06% .99%
Domestic Bond Fund .10% .25% .59% .53% .46%
International Bond Fund .25% .40% .81% .75% .68%
Currency Hedged International Bond Fund .25% .50% .92% .86% .79%
Global Bond Fund .19% .35% .82% .76% .69%
Emerging Country Debt Fund .35% .50% .94% .88% .81%
International Equity Allocation Fund .05% .00% .29% .23% N/A
World Equity Allocation Fund .05% .00% .29% .23% N/A
Global (U.S.+) Equity Allocation Fund .05% .00% .29% .23% N/A
Global Balanced Allocation Fund .05% .00% .29% .23% N/A
</TABLE>
10. Figure based on actual expenses for the fiscal year ended February 29,
1996, but restated to give effect to a change in the fee waiver and/or
expense limitation of the Fund, which change was effective as of March 1,
1996.
11. Figure based on actual expenses for the fiscal year ended February 29,
1996, but restated to give effect to a change in the fee waiver and/or
expense limitation of the Fund, which change was effective as of March 14,
1996.
-14-
12. Based on estimated amounts for the Fund's first fiscal year.
13. Figure based on actual expenses for the fiscal year ended February 29,
1996, but restated to give effect to a change in the fee waiver and/or
expense limitation of the Fund, which change was effective as of February
7, 1996.
14. Figure based on actual expenses for the fiscal year ended February 29,
1996, but restated to give effect to a change in the fee waiver and/or
expense limitation of the Fund, which change was effective as of June 27,
1995.
15. Includes a nonrecurring expense incurred during the fiscal year ended
February 29, 1996.
16. Figure based on actual expenses for the fiscal year ended February 29,
1996, but restated to give effect to a change in the fee waiver and/or
expense limitation of the Fund, which change was effective as of May 31,
1996.
17. Asset Allocation Funds invest primarily in other Funds of the Trust
(referred to in this footnote as "underlying Funds"). Therefore, although
none of the Asset Allocation Funds directly charge a purchase premium or
redemption fee, the Asset Allocation Funds will indirectly bear the
purchase premiums and redemption fees charged, if any, in connection with
purchases or redemptions, as the case may be, of shares of the underlying
Funds. For more information concerning which underlying Funds a particular
Asset Allocation Fund may invest in, see "Investment Objectives and
Policies -- Asset Allocation Funds."
18. Asset Allocation Funds invest primarily in other Funds of the Trust
(referred to here as "underlying Funds"). Therefore, in addition to the
fees and expenses directly incurred by the Asset Allocation Funds (which
are shown in the Schedule of Fees and Expenses), the Asset Allocation
Funds will also incur fees and expenses indirectly as shareholders of the
underlying Funds. Because the underlying Funds have varied expense and fee
levels and the Allocation Funds may own different proportions of
underlying Funds at different times, the amount of fees and expenses
indirectly incurred by the Asset Allocation Funds will vary. The Manager
believes that, under normal market conditions, the total amount of fees
and expenses that will be indirectly incurred by the Asset Allocation
Funds because of investment in underlying Funds will fall within the
ranges set forth below:
Fund Low Typical High
- --------------------------------------------------------------------------------
International Equity Allocation Fund .76% .83% .89%
World Equity Allocation Fund .68% .75% .85%
Global (U.S.+) Equity Allocation Fund .57% .63% .74%
Global Balanced Allocation Fund .48% .57% .69%
-15-
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
DOMESTIC EQUITY FUNDS
CORE FUND Year Ended February 28/29,
----------------------------------------------------------------------------------------
Class III Shares
1996 1995 1994 1993 1992 19911 19901
-------- -------- -------- -------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of
period $ 15.45 $ 15.78 $ 15.73 $ 15.96 $ 15.13 $ 13.90 $ 14.47
----------- ----------- ----------- ----------- ----------- ----------- ------------
Income (loss) from investment
operations:
Net investment income2 0.41 0.41 0.42 0.45 0.43 0.43 0.65
Net realized and unrealized
gain (loss) on investments 5.49 0.66 1.59 1.13 1.55 1.74 2.43
---- ---- ---- ---- ---- ---- ----
Total from investment operations 5.90 1.07 2.01 1.58 1.98 2.17 3.08
---- ---- ---- ---- ---- ---- ----
Less distributions to shareholders:
From net investment income (0.42) (0.39) (0.43) (0.46) (0.42) (0.51) (0.70)
From net realized gains (1.47) (1.01) (1.53) (1.35) (0.73) (0.43) (2.95)
----- ----- ----- ----- ----- ----- -----
Total distributions (1.89) (1.40) (1.96) (1.81) (1.15) (0.94) (3.65)
----- ----- ----- ----- ----- ----- -----
Net asset value, end of period $ 19.46 $ 15.45 $ 15.78 $ 15.73 $ 15.96 $ 15.13 $ 13.90
=========== =========== =========== =========== =========== =========== ============
Total Return3 39.08% 7.45% 13.36% 10.57% 13.62% 16.52% 21.19%
Ratios/Supplemental Data:
Net assets, end of period
(000's) $3,179,314 $2,309,248 $1,942,005 $1,892,955 $2,520,710 $1,613,945 $1,016,965
Net expenses to average
daily net assets2 0.48% 0.48% 0.48% 0.49% 0.50% 0.50% 0.50%
Net investment income to
average daily net assets2 2.25% 2.63% 2.56% 2.79% 2.90% 3.37% 3.84%
Portfolio turnover rate 77% 99% 40% 54% 39% 55% 72%
</TABLE>
<TABLE>
<CAPTION>
19891 19881 19871
--------- ------- -------
<S> <C> <C> <C>
Net asset value, beginning of
period $ 13.43 $ 15.24 $ 12.64
---------- ------------ ------------
Income (loss) from investment
operations:
Net investment income2 0.54 0.45 0.34
Net realized and unrealized
gain (loss) on investments 0.96 (0.92) 3.15
---- ----- ----
Total from investment operations 1.50 (0.47) 3.49
---- ----- ----
Less distributions to shareholders:
From net investment income (0.46) (0.38) (0.46)
From net realized gains -.- (0.96) (0.43)
------ ----- -----
Total distributions (0.46) (1.34) (0.89)
----- ----- -----
Net asset value, end of period $ 14.47 $ 13.43 $ 15.24
======= ============ ============
Total Return3 11.49% (3.20%) 28.89
Ratios/Supplemental Data:
Net assets, end of period
(000's) $1,222,115 $1,010,014 $909,394
Net expenses to average
daily net assets2 0.50% 0.52% 0.53%
Net investment income to
average daily net assets2 4.02% 3.23% 3.06%
Portfolio turnover rate 51% 46% 75%
1 The per share amounts and the number of shares outstanding have been
restated to reflect a ten for one split effective December 31, 1990.
2 Net of fees and expenses voluntarily waived or borne by the Manager of
$.01 per share for each period presented.
3 Calculation excludes subscription fees. The total returns would have
been lower had certain expenses not been waived during the periods
shown.
</TABLE>
<TABLE>
<CAPTION>
TOBACCO - FREE CORE FUND Year Ended February 28/29,
-----------------------------------------------------------------
Class III Shares
1996 1995 1994 1993 19921
---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of
period $10.65 $11.07 $11.35 $10.50 $10.00
------ ------ ------ ------ ------
Income from investment
operations:
Net investment income2 0.28 0.23 0.34 0.31 0.12
Net realized and unrealized
gain (loss) on investments 3.71 0.50 1.18 0.84 0.44
---- ---- ---- ---- ----
Total from investment operations 3.99 0.73 1.52 1.15 0.56
---- ---- ---- ---- ----
Less distributions to shareholders:
From net investment income (0.25) (0.28) (0.35) (0.30) (0.06)
From net realized gains (1.46) (0.87) (1.45) -.- -.-
----- ----- -----
Total distributions (1.71) (1.15) (1.80) (0.30) (0.06)
----- ----- ----- ----- -----
Net asset value, end of period $12.93 $10.65 $11.07 $11.35 $10.50
====== ====== ====== ====== ======
Total Return3 38.64% 7.36% 14.12% 11.20% 5.62%
Ratios/Supplemental Data:
Net assets, end of period (000's) $57,485 $47,969 $55,845 $85,232 $75,412
Net expenses to average
daily net assets2 0.48% 0.48% 0.48% 0.49% 0.49%4
Net investment income to
average daily net assets2 2.25% 2.52% 2.42% 2.88% 3.77%4
Portfolio turnover rate 81% 112% 38% 56% 0%
1 For the period from the commencement of operations, October 31, 1991 to
February 29, 1992.
2 Net of fees and expenses voluntarily waived or borne by the Manager of
$.03, $.03, $.03, $.02 and $.01 per share for the fiscal years ended
1996, 1995, 1994, and 1993 and for the period ended February 29, 1992,
respectively.
3 Calculation excludes subscription fees. The total returns would have
been lower had certain expenses not been waived during the periods
shown.
4 Annualized.
</TABLE>
Except as otherwise noted, the above information has been audited by Price
Waterhouse LLP, independent accountants. This statement should be read in
conjunction with the other audited financial statements and related notes which
are included in the Trust's Annual Reports, which are incorporated by reference
in the Trust's Annual Reports, which are incorporated by reference in the
Statement of Additional Information. Information is presented for each Fund, and
class thereof, of the Trust which had investment operations during the reporting
periods. Information regarding Class III Shares of each Fund reflects the
operational history for each such Fund's sole outstanding class prior to the
creation of multiple classes of such Funds on May 31, 1996.
- 16 -
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
VALUE FUND Year Ended February 28/29,
--------------------------------------------------------------------
Class III Shares
1996 1995 1994 1993 1992 19911
---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period $12.05 $13.48 $13.50 $12.94 $12.25 $10.00
------ ------ ------ ------ ------ ------
Income from investment operations:
Net investment income2 0.39 0.41 0.43 0.38 0.40 0.12
Net realized and unrealized gain
on investments 3.71 0.32 1.27 0.98 1.11 2.16
---- ---- ---- ---- ---- ----
Total from investment operations 4.10 0.73 1.70 1.36 1.51 2.28
---- ---- ---- ---- ---- ----
Less distributions to shareholders:
From net investment income (0.39) (0.45) (0.40) (0.38) (0.41) (0.03)
From net realized gains (1.51) (1.71) (1.32) (0.42) (0.41) -.-
----- ----- ----- ----- ----- -----
Total distributions (1.90) (2.16) (1.72) (0.80) (0.82) (0.03)
----- ----- ----- ----- ----- -----
Net asset value, end of period $14.25 $12.05 $13.48 $13.50 $12.94 $12.25
====== ====== ====== ====== ====== ======
Total Return3 35.54% 6.85% 13.02% 11.01% 12.96% 22.85%
Ratios/Supplemental Data:
Net assets, end of period (000's) $317,612 $350,694 $679,532 $1,239,536 $644,136 $190,664
Net expenses to average daily net
assets2 0.61% 0.61% 0.61% 0.62% 0.67% 0.70%4
Net investment income to average
daily net assets2 2.66% 2.86% 2.70% 3.15% 3.75% 7.89%4
Portfolio turnover rate 65% 77% 35% 50% 41% 23%
1 For the period from the commencement of operations, November 14, 1990
to February 28, 1991.
2 Net of fees and expenses voluntarily waived or borne by the Manager of
$.02, $.02, $.02, $.01, $.01 and $.01 per share for the fiscal years
ended 1996, 1995, 1994, 1993, and 1992 and for the period ended
February 28, 1991, respectively.
3 Calculation excludes subscription fees. The total returns would have
been lower had certain expenses not been waived during the periods
shown.
4 Annualized.
</TABLE>
<TABLE>
<CAPTION>
GROWTH FUND Year Ended February 28/29,
---------------------------------------------------------------------------------
Class III Shares
1996 1995 1994 1993 1992 1991 1990 19891
---- ---- ---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period $4.45 $4.14 $4.55 $5.82 $14.54 $12.64 $10.49 $10.00
----- ----- ----- ----- ------ ------ ------ ------
Income from investment operations:
Net investment income2 0.08 0.06 0.06 0.07 0.19 0.25 0.26 0.03
Net realized and unrealized gain
on investments 1.54 0.38 0.11 0.17 1.63 2.61 2.40 0.46
---- ---- ---- ---- ---- ---- ---- ----
Total from investment operations 1.62 0.44 0.17 0.24 1.82 2.86 2.66 0.49
---- ---- ---- ---- ---- ---- ---- ----
Less distributions to shareholders:
From net investment income (0.07) (0.06) (0.06) (0.08) (0.23) (0.25) (0.23) -.-
From net realized gains (0.35) (0.07) (0.52) (1.43) (10.31) (0.71) (0.28) -.-
----- ----- ----- ----- ------ ----- ----- -----
Total distributions (0.42) (0.13) (0.58) (1.51) (10.54) (0.96) (0.51) -.-
----- ----- ----- ----- ------ ----- ----- -----
Net asset value, end of period $5.65 $4.45 $4.14 $4.55 $5.82 $14.54 $12.64 $10.49
===== ===== ===== ===== ===== ====== ====== ======
Total Return3 37.77% 10.86% 4.13% 3.71% 20.47% 24.24% 25.35% 4.90%
Ratios/Supplemental Data:
Net assets, end of period (000's) $391,366 $239,006 $230,698 $168,143 $338,439$1,004,345 $823,891 $291,406
Net expenses to average daily net
assets 20.48% 0.48% 0.48% 0.49% 0.50% 0.50% 0.50% 0.08%
Net investment income to average
daily net assets2 1.54% 1.50% 1.38% 1.15% 1.38% 1.91% 2.34% 0.52%
Portfolio turnover rate 76% 139% 57% 36% 46% 45% 57% 0%
1 For the period from the commencement of operations, December 28, 1988
to February 28, 1989.
2 Net of fees and expenses voluntarily waived or borne by the Manager of
less than $.01 per share for each period presented.
3 Calculation excludes subscription fees. The total returns would have
been lower had certain expenses not been waived during the periods
shown.
</TABLE>
Except as otherwise noted, the above information has been audited by Price
Waterhouse LLP, independent accountants. This statement should be read in
conjunction with the other audited financial statements and related notes which
are included in the Trust's Annual Reports, which are incorporated by reference
in the Trust's Statement of Additional Information. Information is presented for
each Fund, and class thereof, of the Trust which had investment operations
during the reporting periods. Information regarding Class III Shares of each
Fund reflects the operational history for each such Fund's sole outstanding
class prior to the creation of multiple classes of such Funds on May 31, 1996.
- 17 -
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
U.S. SECTOR FUND
Class III Shares Year Ended February 28/29,
------------------------------------------------
1996 1995 1994 19931
---- ---- ---- -----
<S> <C> <C> <C> <C>
Net asset value, beginning of period $11.06 $11.26 $10.38 $10.00
------ ------ ------ ------
Income from investment operations:
Net investment income2 0.29 0.28 0.29 0.05
Net realized and unrealized
gain on investments 3.90 0.49 1.21 0.33
---- ---- ---- ----
Total from investment operations 4.19 0.77 1.50 0.38
---- ---- ---- ----
Less distributions to shareholders:
From net investment income (0.29) (0.27) (0.30) --.--
From net realized gains (1.33) (0.70) (0.32) --.--
----- ----- -----
Total distributions (1.62) (0.97) (0.62) --.--
----- ----- -----
Net asset value, end of period $13.63 $11.06 $11.26 $10.38
====== ====== ====== ======
Total Return3 38.90% 7.56% 14.64% 3.80%
Ratios/Supplemental Data:
Net assets, end of period (000's) $211,319 207,291 $167,028 $169,208
Net expenses to average
daily net assets2 0.48% 0.48% 0.48% 0.48%4
Net investment income to
average daily net assets2 2.27% 2.61% 2.56% 3.20%4
Portfolio turnover rate 84% 101% 53% 9%
1 For the period from the commencement of operations, January 4, 1993 to
February 28, 1993.
2 Net of fees and expenses voluntarily waived or borne by the Manager of
$.01 per share for each period presented.
3 Calculation excludes subscription fees. The total returns would have
been lower had certain expenses not been waived during the periods
shown.
4 Annualized.
</TABLE>
<TABLE>
<CAPTION>
CORE II SECONDARIES FUND Year Ended February 28/29,
-------------------------------------------------------
Class III Shares
1996 1995 1994 1993 19921
---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period $13.61 $14.31 $12.68 $11.12 $10.00
------ ------ ------ ------ ------
Income from investment operations:
Net investment income2 0.23 0.20 0.21 0.22 0.04
Net realized and unrealized
gain on investments 3.20 0.34 2.14 1.59 1.08
---- ---- ---- ---- ----
Total from investment operations 3.43 0.54 2.35 1.81 1.12
----- ----- ----- ----- -----
Less distributions to shareholders:
From net investment income (0.23) (0.20) (0.22) (0.21) --.--
From net realized gains (2.92) (1.04) (0.50) (0.04) --.--
----- ----- ----- ----- -----
Total distributions (3.15) (1.24) (0.72) (0.25) --.--
----- ----- ----- -----
Net asset value, end of period $13.89 $13.61 $14.31 $12.68 $11.12
====== ====== ====== ====== ======
Total Return3 27.18% 4.48% 18.97% 16.46% 11.20%
Ratios/Supplemental Data:
Net assets, end of period (000's) $231,533 $235,781 $151,286 $102,232 $58,258
Net expenses to average
daily net assets2 0.48% 0.48% 0.48% 0.49% 0.49%4
Net investment income to
average daily net assets2 1.67% 1.55% 1.66% 2.02% 2.19%4
Portfolio turnover rate 135% 54% 30% 3% 0%
1 For the period from the commencement of operations, December 31, 1991
to February 29, 1992.
2 Net of fees and expenses voluntarily waived or borne by the Manager of
$.02, $.01, $.02, $.02 and $.01 per share for the fiscal years ended
1996, 1995, 1994, and 1993 and for the period ended February 29, 1992,
respectively.
3 Calculation excludes subscription and redemption fees. The total
returns would have been lower had certain expenses not been waived
during the periods shown.
4 Annualized.
</TABLE>
Except as otherwise noted, the above information has been audited by Price
Waterhouse LLP, independent accountants. This statement should be read in
conjunction with the other audited financial statements and related notes which
are included in the Trust's Annual Reports, which are incorporated by reference
in the Trust's Statement of Additional Information. Information is presented for
each Fund, and class thereof, of the Trust which had investment operations
during the reporting periods. Information regarding Class III Shares of each
Fund reflects the operational history for each such Fund's sole outstanding
class prior to the creation of multiple classes of such Funds on May 31, 1996.
- 18 -
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
FUNDAMENTAL VALUE FUND Year Ended February 28/29,
--------------------------------------------------------------
Class III Shares
1996 1995 1994 1993 19921
---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period $12.54 $12.49 $11.71 $10.82 $10.00
------ ------ ------ ------ ------
Income from investment operations:
Net investment income2 0.37 0.34 0.27 0.30 0.11
Net realized and unrealized gain
on investments 3.26 0.55 1.64 1.32 0.77
---- ---- ---- ---- ----
Total from investment operations 3.63 0.89 1.91 1.62 0.88
---- ---- ---- ---- ----
Less distributions to shareholders:
From net investment income (0.37) (0.32) (0.28) (0.30) (0.06)
From net realized gains (0.76) (0.52) (0.85) (0.43) --
----- ----- ----- ----- -----
Total distributions (1.13) (0.84) (1.13) (0.73) (0.06)
----- ----- ----- ----- -----
Net asset value, end of period $15.04 $12.54 $12.49 $11.71 $10.82
====== ====== ====== ====== ======
Total Return3 29.95% 7.75% 16.78% 15.66% 8.87%
Ratios/Supplemental Data:
Net assets, end of period (000's) $212,428 $182,871 $147,767 $62,339 $32,252
Net expenses to average daily net
assets2 0.75% 0.75% 0.75% 0.73% 0.62%4
Net investment income to average
daily net assets2 2.61% 2.84% 2.32% 2.77% 3.43%4
Portfolio turnover rate 34% 49% 65% 83% 33%
1 For the period from the commencement of operations, October 31, 1991 to
February 29, 1992.
2 Net of fees and expenses voluntarily waived or borne by the Manager of
$.01, $.01, $.01, $.03 and $.03 per share for the fiscal years ended
1996, 1995, 1994, and 1993 and for the period ended February 29, 1992,
respectively.
3 Calculation excludes subscription fees. The total returns would have
been lower had certain expenses not been waived during the periods
shown.
4 Annualized.
</TABLE>
<TABLE>
<CAPTION>
INTERNATIONAL EQUITY FUNDS
Year Ended February 28/29,
-------------------------------------------------------------------------------------
INTERNATIONAL CORE FUND
Class III Shares
1996 1995 1994 1993 1992 1991 1990 1989 19881
---- ---- ---- ---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period $22.32 $25.56 $18.51 $18.80 $18.73 $18.79 $17.22 $14.76 $15.00
------ ------ ------ ------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income2 0.36 0.27 0.29 0.29 0.29 0.55 0.49 0.45 0.18
Net realized and unrealized gain (loss)
on investments 3.09 (1.57) 7.44 (0.04) 0.22 0.69 1.93 3.37 (0.03)
---- ----- ---- ----- ---- ---- ---- ---- -----
Total from investment operations 3.45 (1.30) 7.73 0.25 0.51 1.24 2.42 3.82 0.15
---- ----- ---- ---- ---- ---- ---- ---- ----
Less distributions to shareholders:
From net investment income (0.39) (0.35) (0.27) (0.20) (0.28) (0.54) (0.55) (0.45) (0.05)
From net realized gains (0.76) (1.59) (0.41) (0.34) (0.16) (0.76) (0.30) (0.91) (0.34)
----- ----- ----- ----- ----- ----- ----- ----- -----
Total distributions (1.15) (1.94) (0.68) (0.54) (0.44) (1.30) (0.85) (1.36) (0.39)
----- ----- ----- ----- ----- ----- ----- ----- -----
Net asset value, end of period $24.62 $22.32 $25.56 $18.51 $18.80 $18.73 $18.79 $17.22 $14.76
====== ====== ====== ====== ====== ====== ====== ====== ======
Total Return3 15.72% (5.31%) 42.10% 1.43% 2.84% 7.44% 13.99% 26.35% 1.07%
Ratios/Supplemental Data:
Net assets, end of period (000's) $4,538,036 $2,591,646 $2,286,431 $918,332 $414,341 $173,792 $101,376 $35,636 $11,909
Net expenses to average daily
net assets2 0.71%4 0.70% 0.71%4 0.70% 0.70% 0.78% 0.80% 0.88% 0.70%
Net investment income to average
daily net assets2 1.93% 1.48% 1.48% 2.36% 2.36% 3.32% 3.17% 3.19% 1.27%
Portfolio turnover rate 14% 53% 23% 23% 35% 81% 45% 37% 129%
1 For the period from the commencement of operations, April 7, 1987 to
February 29, 1988.
2 Net of fees and expenses voluntarily waived or borne by the Manager of
$.03, $.03, $.03, $.03, $.02, $.01, $.02, $.05 and $.08 per share for
the fiscal years ended 1996, 1995, 1994, 1993, 1992, 1991, 1990, and
1989 and for the period ended February 29, 1988, respectively.
3 Calculation excludes subscription fees. The total returns would have
been lower had certain expenses not been waived during the periods
shown.
4 Includes stamp duties and transfer taxes not waived or borne by the
Manager, which approximate .01% of average daily net assets.
</TABLE>
Except as otherwise noted, the above information has been audited by Price
Waterhouse LLP, independent accountants. This statement should be read in
conjunction with the other audited financial statements and related notes which
are included in the Trust's Annual Reports, which are incorporated by reference
in the Trust's Statement of Additional Information. Information is presented for
each Fund, and class thereof, of the Trust which had investment operations
during the reporting periods. Information regarding Class III Shares of each
Fund reflects the operational history for each such Fund's sole outstanding
class prior to the creation of multiple classes of such Funds on May 31, 1996.
- 19 -
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
CURRENCY HEDGED
INTERNATIONAL CORE FUND Period from June 30, 1995
Class III Shares (commencement of operations)
to February 29, 1996
--------------------
<S> <C>
Net asset value, beginning of period $10.00
-----
Income from investment operations:
Net investment income1 0.23
Net realized and unrealized gain 1.44
on investments ----
Total from investment operations 1.67
----
Less distributions to shareholders from:
Net investment income (0.06)
Net realized gains (0.07)
-----
Total distributions (0.13)
-----
Net asset value, end of period $11.54
======
Total Return2 16.66%
Ratios/Supplemental Data:
Net assets, end of period (000's) $407,277
Net expenses to average daily net assets1 0.69%3
Net investment income to average daily net assets1 1.89%3
Portfolio turnover rate 7%
1 Net of fees and expenses voluntarily waived or borne by the Manager of
$.05 per share.
2 Calculation excludes subscription fees. The total return would have
been lower had certain expenses not been waived during the period
shown.
3 Annualized.
</TABLE>
<TABLE>
<CAPTION>
Year Ended February 28/29,
----------------------------------------------------
INTERNATIONAL SMALL
COMPANIES FUND
Class III Shares
1996 1995 1994 1993 19921
---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period $11.95 $14.45 $8.91 $9.62 $10.00
------ ------ ----- ----- ------
Income (loss) from investment operations:
Net investment income2 0.18 0.18 0.15 0.35 0.06
Net realized and unrealized gain
(loss) on investments 1.16 (1.52) 5.59 (0.68) (0.43)
---- ----- ---- ----- -----
Total from investment operations 1.34 (1.34) 5.74 (0.33) (0.37)
---- ----- ---- ----- -----
Less distributions to shareholders:
From net investment income (0.17) (0.20) (0.12) (0.38) (0.01)
In excess of net investment income (0.02) --.-- --.-- --.-- --.--
From net realized gains (0.15) (0.96) (0.08) --.-- --.--
----- ----- -----
Total distributions (0.34) (1.16) (0.20) (0.38) (0.01)
----- ----- ----- ----- -----
Net asset value, end of period $12.95 $11.95 $14.45 $8.91 $9.62
====== ====== ====== ===== =====
Total Return3 11.43% (9.66%) 64.67% (3.30%) (3.73%)
Ratios/Supplemental Data:
Net assets, end of period (000's) 218,964 $186,185 $132,645 $35,802 $24,467
Net expenses to average daily net
assets2 0.76%4 0.76%4 0.75% 0.75% 0.85%5
Net investment income to average
daily net assets2 1.84% 1.45% 1.50% 4.02% 1.91%5
Portfolio turnover rate 13% 58% 38% 20% 1%
1 For the period from the commencement of operations, October 15, 1991 to
February 29, 1992.
2 Net of fees and expenses voluntarily waived or borne by the Manager of
$.07, $.08, $.09, $.09 and $.05 per share for the fiscal years ended
1996, 1995, 1994, and 1993 and for the period ended February 29, 1992,
respectively.
3 Calculation excludes subscription and redemption fees. The total
returns would have been lower had certain expenses not been waived
during the periods shown
4 Includesstamp duties and transfer taxes not waived or borne by the
Manager, which approximate .01% of average daily net assets.
5 Annualized.
</TABLE>
Except as otherwise noted, the above information has been audited by Price
Waterhouse LLP, independent accountants. This statement should be read in
conjunction with the other audited financial statements and related notes which
are included in the Trust's Annual Reports, which are incorporated by reference
in the Trust's Statement of Additional Information. Information is presented for
each Fund, and class thereof, of the Trust which had investment operations
during the reporting periods. Information regarding Class III Shares of each
Fund reflects the operational history for each such Fund's sole outstanding
class prior to the creation of multiple classes of such Funds on May 31, 1996.
- 20 -
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
Year Ended February 28/29,
-------------------------------------------------------------
JAPAN FUND
Class III Shares
1996 1995 1994 1993 1992 19911
---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period $9.12 $11.13 $7.37 $7.73 $ 9.48 $10.00
----- ------ ----- ----- ------ ------
Income (loss) from investment operations:
Net investment income (loss)2 (0.01)3 --.--3 --.-- 0.01 --.-- (0.01)
Net realized and unrealized gain
(loss) on investments 0.79 (1.08) 3.94 (0.36) (1.74) (0.39)
---- ----- ---- ----- ----- -----
Total from investment operations 0.78 (1.08) 3.94 (0.35) (1.74) (0.40)
---- ----- ---- ----- ----- -----
Less distributions to shareholders:
From net investment income --.-- --.-- --.-- (0.01) --.-- --.--
In excess of net investment income --.-- --.-- (0.01) --.-- --.-- --.--
From net realized gains (1.38) (0.93) (0.17) --.-- --.-- --.--
From paid-in capital 4 --.-- --.-- --.-- --.-- (0.01) (0.12)
----- ----- ----- ----- ----- -----
Total distributions (1.38) (0.93) (0.18) (0.01) (0.01) (0.12)
----- ----- ----- ----- ----- -----
Net asset value, end of period $8.52 $9.12 $11.13 $7.37 $7.73 $9.48
===== ===== ====== ===== ===== =====
Total Return5 8.29% (10.62%) 53.95% (4.49%) (18.42%) (3.79%)
Ratios/Supplemental Data:
Net assets, end of period (000's) $126,107 $60,123 $450,351 $306,423 $129,560 $60,509
Net expenses to average daily net
assets2 0.92% 0.83% 0.87% 0.88% 0.93% 0.95%6
Net investment income to average
daily net assets2 (0.13%) (0.02%) (0.01%) 0.12% (0.11%) (0.32%)6
Portfolio turnover rate 23% 60% 8% 17% 25% 11%
1 For the period from the commencement of operations, June 8, 1990 to
February 28, 1991.
2 Net of fees and expenses voluntarily waived or borne by the Manager of
$.01 per share for the fiscal year ended 1996, less than $.01 per share
for the fiscal year ended 1995, and $.01 per share for the fiscal years
ended 1994, 1993, 1992.
3 Based on average month-end shares outstanding.
4 Return of capital for book purposes only. A distribution was required
for tax purposes to avoid the payment of federal excise tax.
5 Calculation excludes subscription and redemptions fees. The total
returns would have been lower had certain expenses not been waived
during the periods shown.
6 Annualized.
</TABLE>
<TABLE>
<CAPTION>
Period from
December 9, 1993
(commencement of
Year Ended February 28/29, operations) to
1996 1995 February 28, 1994
---- ---- -----------------
EMERGING MARKETS FUND
Class III Shares
<S> <C> <C> <C>
Net asset value, beginning of period $9.52 $12.13 $10.00
----- ------ ------
Income (loss) from investment operations:
Net investment income1 0.10 0.05 0.02
Net realized and unrealized gain
(loss) on investments 1.06 (2.37) 2.11
---- ----- ----
Total from investment operations 1.16 (2.32) 2.13
---- ----- ----
Less distributions to shareholders:
From net investment income (0.01) (0.07) (0.00)2
From net realized gains (0.13) (0.22) -.-
----- -----
Total distributions (0.14) (0.29) (0.00)
----- ----- -----
Net asset value, end of period $10.54 $9.52 $12.13
====== ===== ======
Total Return3 12.24% (19.51%) 21.35%
Ratios/Supplemental Data:
Net assets, end of period (000's) $907,180 $384,259 $114, 409
Net expenses to average daily net
assets1 1.35% 1.58% 1.64%4
Net investment income to average1
daily net assets 1.31% 0.85% 0.87%4
Portfolio turnover rate 35% 50% 2%
1 Net of fees and expenses voluntarily waived or borne by the Manager of
less than $.01 per share for the fiscal year ended 1996 and for the
period ended February 28, 1994.
2 The per share income distribution was $0.004.
3 Calculation excludes subscription and redemption fees. The total
returns would have been lower had certain expenses not been waived
during the periods shown.
4 Annualized.
</TABLE>
Except as otherwise noted, the above information has been audited by Price
Waterhouse LLP, independent accountants. This statement should be read in
conjunction with the other audited financial statements and related notes which
are included in the Trust's Annual Reports, which are incorporated by reference
in the Trust's Statement of Additional Information. Information is presented for
each Fund, and class thereof, of the Trust which had investment operations
during the reporting periods. Information regarding Class III Shares of each
Fund reflects the operational history for each such Fund's sole outstanding
class prior to the creation of multiple classes of such Funds on May 31, 1996.
- 21 -
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
FIXED INCOME FUNDS
<TABLE>
<CAPTION>
Year Ended February 28/29,
---------------------------------------------------------------------
SHORT-TERM INCOME FUND
Class III Shares
1996 1995 1994 1993 19923 19911,2,3
---- ---- ---- ---- ----- ---------
<S> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period $9.56 $9.79 $10.05 $10.11 $10.00 $10.00
----- ----- ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income4 0.57 0.63 0.44 0.46 0.56 0.67
Net realized and unrealized gain (loss)
on investments 0.20 (0.28) (0.09) 0.30 0.11 --.--
---- ----- ----- ---- ----
Total from investment operations 0.77 0.35 0.35 0.76 0.67 0.67
---- ---- ---- ---- ---- ----
Less distributions to shareholders:
From net investment income (0.56) (0.58) (0.46) (0.38) (0.56) (0.67)
From net realized gains -- . -- -- . -- (0.15) (0.44) -- . -- -- . --
----- ----- ----- ----- ----- -----
Total distributions (0.56) (0.58) (0.61) (0.82) (0.56) (0.67)
----- ----- ----- ----- ----- -----
Net asset value, end of period $9.77 $9.56 $9.79 $10.05 $10.11 $10.00
===== ===== ===== ====== ====== ======
Total Return5 8.32% 3.78% 3.54% 8.25% 11.88% 3.83%
Ratios/Supplemental Data:
Net assets, end of period (000's) $11,066 $8,193 $8.095 $10,499 $9,257 $40,850
Net expenses to average daily ne
assets4 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%6
Net investment income to average
daily net assets4 6.49% 5.02% 4.35% 4.94% 5.83% 7.88%6
Portfolio turnover rate 139% 335% 243% 649% 135% --.--
1 For the period from the commencement of operations, April 17, 1990 to
February 28, 1991.
2 The per share amounts and the number of shares outstanding have been
restated to reflect a one for ten reverse stock split effective
December 1, 1991.
3 The Fund operated as a money market fund from April 17, 1990 until June
30, 1991. Subsequently, the Fund became a short-term income fund.
4 Net of fees and expenses voluntarily waived or borne by the manager of
$.03, $.02, $.02, $.03, $.03 and $.09 per share for the fiscal years
ended 1996, 1995, 1994, 1993, and 1992 and for the period ended
February 28, 1991, respectively.
5 The total returns would have been lower had certain expenses not been
waived during the periods shown.
6 Annualized.
</TABLE>
<TABLE>
<CAPTION>
GLOBAL HEDGED EQUITY
FUND
Class III Shares
Year Ended Period Ended
February 29, 1996 February 28, 19954
----------------- ------------------
<S> <C> <C>
Net asset value, beginning of period $10.12 $10.00
------ ------
Income from investment operations:
Net investment income1 0.21 0.11
Net realized and unrealized gain
on investments 0.55 0.08
---- ----
Total from investment operations 0.76 0.19
---- ----
Less distributions to shareholders:
From net investment income (0.24) (0.07)
----- -----
Net asset value, end of period $10.64 $10.12
====== ======
Total Return2 7.54% 1.92%
Ratios/Supplemental Data:
Net assets, end of period (000's) $382,934 $214,638
Net expenses to average daily net
assets1 0.78% 0.92%3
Net investment income to average
daily net assets1 2.44% 2.85%3
Portfolio turnover rate 214% 194%
1 Net of fees and expenses voluntarily waived or borne by the Manager of
$.005 and $.006 per share for the fiscal year ended 1996 and for the
period ended February 28, 1995, respectively.
2 Calculation excludes subscription and redemption fees. The total
returns would have been lower had certain expenses not been waived
during the periods shown.
3 Annualized.
4 Period from the commencement of operations, July 29, 1994 to February
28, 1995.
</TABLE>
Except as otherwise noted, the above information has been audited by Price
Waterhouse LLP, independent accountants. This statement should be read in
conjunction with the other audited financial statements and related notes which
are included in the Trust's Annual Reports, which are incorporated by reference
in the Trust's Statement of Additional Information. Information is presented for
each Fund, and class thereof, of the Trust which had investment operations
during the reporting periods. Information regarding Class III Shares of each
Fund reflects the operational history for each such Fund's sole outstanding
class prior to the creation of multiple classes of such Funds on May 31, 1996.
- 22 -
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
DOMESTIC BOND FUND Period from
Class III Shares August 18, 1994
(commencement of
Year Ended operations) to
February 29, 1996 February 28, 1995
----------------- -----------------
<S> <C> <C>
Net asset value, beginning of period $10.13 $10.00
------ ------
Income from investment operations:
Net investment income1 0.66 0.24
Net realized and unrealized gain
on investments 0.58 0.07
---- ----
Total from investment operations 1.24 0.31
---- ----
Less distributions to shareholders:
From net investment income (0.60) (0.18)
From net realized gains (0.37) --.--
----- -----
Total distributions (0.97) (0.18)
----- -----
Net asset value, end of period $10.40 $10.13
====== ======
Total Return2 12.50% 3.16%
Ratios/Supplemental Data:
Net assets, end of period (000's) $310,949 $209,377
Net expenses to average daily net
assets1 0.25% 0.25%3
Net investment income to average
daily net assets1 6.52% 6.96%3
Portfolio turnover rate 70% 65%
1 Net of fees and expenses voluntarily waived or borne by the Manager of
$.01 per share for each period presented.
2 The total returns would have been lower had certain expenses not been
waived during the periods shown.
3 Annualized.
</TABLE>
<TABLE>
<CAPTION>
INTERNATIONAL BOND FUND
Class III Shares
Period from
December 22, 1993
(commencement of
Year Ended February 28/29, operations) to
1996 1995 February 28, 1994
---- ---- -----------------
<S> <C> <C> <C>
Net asset value, beginning of period $9.64 $9.96 $10.00
----- ----- ------
Income (loss) from investment operations:
Net investment income1 0.62 0.98 0.08
Net realized and unrealized gain (loss)
on investments 1.55 (0.21) (0.12)
---- ----- -----
Total from investment operations 2.17 0.77 (0.04)
---- ---- -----
Less distributions to shareholders:
From net investment income (0.59) (0.75) --.--
From net realized gains (0.30) (0.34) --.--
----- ----- -----
Total distributions (0.89) (1.09) --.--
----- ----- -----
Net asset value, end of period $10.92 $9.64 $9.96
====== ===== =====
Total Return2 22.72% 8.23% (0.40%)
Ratios/Supplemental Data:
Net assets, end of period (000's) $193,920 $151,189 $39,450
Net expenses to average daily net
assets1 0.40% 0.40% 0.40%3
Net investment income to average
daily net assets1 8.17% 7.51% 5.34%3
Portfolio turnover rate 99% 141% 14%
1 Net of fees and expenses voluntarily waived or borne by the Manager of
$.01, $.02 and $.01 per share for the fiscal years ended 1996 and 1995
and for the period ended February 28, 1994, respectively.
2 Calculation excludes subscription fees. The total returns would have
been lower had certain expenses not been waived during the periods
shown.
3 Annualized.
</TABLE>
Except as otherwise noted, the above information has been audited by Price
Waterhouse LLP, independent accountants. This statement should be read in
conjunction with the other audited financial statements and related notes which
are included in the Trust's Annual Reports, which are incorporated by reference
in the Trust's Statement of Additional Information. Information is presented for
each Fund, and class thereof, of the Trust which had investment operations
during the reporting periods. Information regarding Class III Shares of each
Fund reflects the operational history for each such Fund's sole outstanding
class prior to the creation of multiple classes of such Funds on May 31, 1996.
- 23 -
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
CURRENCY HEDGED
INTERNATIONAL BOND FUND Period from
Class III Shares September 30, 1994
(commencement of
Year Ended operations)
February 29, 1996 to February 28, 1995
----------------- --------------------
<S> <C> <C>
Net asset value, beginning of period $9.99 $10.00
----- ------
Income (loss) from investment operations:
Net investment income1 1.05 0.24
Net realized and unrealized gain (loss)
on investments 1.62 (0.09)
---- -----
Total from investment operations 2.67 0.15
---- ----
Less distributions to shareholders:
From net investment income (1.04) (0.16)
From net realized gains (0.42) --.--
In excess of net realized gains (0.28) --.--
-----
Total distributions (1.74) (0.16)
----- -----
Net asset value, end of period $10.92 $9.99
====== =====
Total Return2 27.36% 1.49%
Ratios/Supplemental Data:
Net assets, end of period (000's) $236,162 $238,664
Net expenses to average daily net assets1 0.40% 0.40%3
Net investment income to average
daily net assets1 8.54% 8.46%3
Portfolio turnover rate 85% 64%
1 Net of fees and expenses voluntarily waived or borne by the Manager of
$.03 and $.01 per share for the fiscal year ended 1996 and for the
period ended February 28, 1995, respectively.
2 Calculation excludes subscription fees. The total returns would have
been lower had certain expenses not been waived during the periods
shown.
3 Annualized.
</TABLE>
<TABLE>
<CAPTION>
GLOBAL BOND FUND Period from December 28, 1995
Class III Shares (commencement of operations)
to February 29, 1996
--------------------
<S> <C>
Net asset value, beginning of period $10.00
------
Income (loss) from investment operations:
Net investment income1 0.05
Net realized and unrealized gain (loss) (0.16)
-----
on Investments
Total from investment operations (0.11)
-----
Net asset value, end of period $ 9.89
=======
Total Return2 (1.10%)
Ratios/Supplemental Data:
Net assets, end of period (000's) $31,072
Net expenses to average daily net assets1 0.34%3
Net investment income to average daily net assets1 6.16%3
Portfolio turnover rate 0%
1 Net of fees and expenses voluntarily waived or borne by the Manager of
$.01 per share.
2 Calculation excludes subscription fees. The total return would have
been lower had certain expenses not been waived during the period
shown.
3 Annualized.
</TABLE>
Except as otherwise noted, the above information has been audited by Price
Waterhouse LLP, independent accountants. This statement should be read in
conjunction with the other audited financial statements and related notes which
are included in the Trust's Annual Reports, which are incorporated by reference
in the Trust's Statement of Additional Information. Information is presented for
each Fund, and class thereof, of the Trust which had investment operations
during the reporting periods. Information regarding Class III Shares of each
Fund reflects the operational history for each such Fund's sole outstanding
class prior to the creation of multiple classes of such Funds on May 31, 1996.
- 24 -
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
Period from April 19, 1994
(commencement of
Year Ended operations)
February 29, 1996 to February 28, 1995
----------------- --------------------
EMERGING COUNTRY DEBT FUND
Class III Shares
<S> <C> <C>
Net asset value, beginning of period $8.39 $10.00
----- ------
Income (loss) from investment operations:
Net investment income1 1.35 0.48
Net realized and unrealized gain (loss)
on investments 3.84 (1.59)
---- -----
Total from investment operations 5.19 (1.11)
---- -----
Less distributions to shareholders:
From net investment income (1.17) (0.40)
From net realized gains (0.65) --.--
In excess of net realized gains --.-- (0.10)
----- -----
Total distributions (1.82) (0.50)
----- -----
Net asset value, end of period $11.76 $8.39
====== =====
Total Return2 63.78% (11.65%)
Ratios/Supplemental Data:
Net assets, end of period (000's) $615,485 $243,451
Net expenses to average daily net assets1 0.50% 0.50%3
Net investment income to average
daily net assets1 12.97% 10.57%3
Portfolio turnover rate 158% 104%
1 Net of fees and expenses voluntarily waived or borne by the Manager of
$.02 and $.01 per share for the fiscal year ended 1996 and for the
period ended February 28, 1995, respectively.
2 Calculation excludes subscription and redemption fees. The total
returns would have been lower had certain expenses not been waived
during the periods shown.
3 Annualized.
</TABLE>
Except as otherwise noted, the above information has been audited by Price
Waterhouse LLP, independent accountants. This statement should be read in
conjunction with the other audited financial statements and related notes which
are included in the Trust's Annual Reports, which are incorporated by reference
in the Trust's Statement of Additional Information. Information is presented for
each Fund, and class thereof, of the Trust which had investment operations
during the reporting periods. Information regarding Class III Shares of each
Fund reflects the operational history for each such Fund's sole outstanding
class prior to the creation of multiple classes of such Funds on May 31, 1996.
Investors in Class I or Class II Shares should be aware that the above financial
highlight tables reflect performance based on Class III expense ratios. In the
future, investors in Class I and Class II Shares will experience slightly lower
total returns than investors in Class III Shares of the same Fund as a result of
higher overall expense ratios for Class I and Class II Shares.
The Manager's discussion of the performance of each Fund in fiscal 1996, as well
as a comparison of each Fund's performance over the life of the Fund with that
of a benchmark securities index elected by the Manager, is included in each
Fund's Annual Report for the fiscal year ended February 29, 1996. Copies of the
Annual Reports are available upon request without charge.
- 25 -
CERTAIN FINANCIAL INFORMATION RELATING TO THE GMO FOREIGN FUND
The GMO Foreign Fund (the "Foreign Fund") commenced operations on June
28, 1996 subsequent to a transaction involving, in essence, the reorganization
of the GMO International Equities Pool of The Common Fund for Nonprofit
Organizations (the "GMO Pool") as the Foreign Fund, pursuant to an Agreement and
Plan of Reorganization which provided that (i) the GMO Pool be discontinued and
its assets and liabilities distributed pro rata to the unitholders of the GMO
Pool as a liquidating distribution, and (ii) such assets and liabilities
immediately thereafter be transferred by the unitholders to the Foreign Fund in
exchange for shares of the Foreign Fund. The Foreign Fund's portfolio of
investments on June 28, 1996 was the same as the portfolio of the GMO Pool
immediately prior to the transfer, and the Foreign Fund will operate under
investment policies, objectives, guidelines and restrictions that are in all
material respects equivalent to those of the GMO Pool.
The GMO Pool was not a registered investment company as it was exempt
from registration under the 1940 Act. Since, in a practical sense, the GMO Pool
constitutes a predecessor of the Foreign Fund, the Trust calculates the
performance for the Foreign Fund for periods prior to June 28, 1996 by including
the total return of the GMO Pool.
<TABLE>
<CAPTION>
Year Ended (a)
Period Ended June 30,
3/31/96 1995 1994 1993 1992 1991 1990
------- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of
period $5,362.04 $5,128.96 $4,145.16 $4,047.89 $3,575.10 $4,238.06 $3,437.09
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from investment
operations:
Net investment income (b) 105.62 161.11 87.70 140.35 126.74 177.66 172.93
Net realized and unrealized
gain (loss) on investments 558.43 225.66 995.43 88.19 475.66 (675.60) 793.25
------ ------ ------ ----- ------ -------- ------
Total from investment operations 664.05 386.77 1,083.13 228.54 602.40 (479.64) 966.18
------ ------ -------- ------ ------ -------- ------
Less distributions to unitholders:
From net investment income (84.88) (153.69) (99.33) (131.28) (129.60) (183.32) (166.02)
Net asset value, end of period $5,941.21 $5,362.04 $5,128.96 $4,145.16 $4,047.89 $3,575.10 $4,238.06
========= ========= ========= ========= ========= ========= =========
Total Return (c) 11.82% 6.82% 25.43% 5.10% 16.22% (11.99%) 27.53%
Year Ended (a)
June 30,
1989 1988 1987 1986
---- ---- ---- ----
Net asset value, beginning of
period $3,041.34 $3,069.65 $2,305.17 $1,272.93
--------- --------- --------- ---------
Income (loss) from investment
operations:
Net investment income (b) 141.11 110.27 84.77 70.66
Net realized and unrealized
gain (loss) on investments 395.95 (24.76) 764.50 1,031.73
------ ------- ------ --------
Total from investment operations 537.06 85.51 849.27 1,101.79
------ ----- ------ --------
Less distributions to unitholders:
From net investment income (140.50) (113.82) (84.79) (69.55)
Net asset value, end of period $3,437.90 $3,041.34 $3,069.65 $2,305.17
========= ========= ========= =========
Total Return (c) 17.04% 1.96% 36.38% 86.92%
</TABLE>
(a) The fiscal year end of the Fund's predecessor was June 30.
(b) Expenses for the Fund's predecessor were paid directly by its unitholders.
(c) Net of annual total GMO Pool expenses of 0.83% paid directly by
unitholders. As indicated in the text below, anticipated expenses for the
Foreign Fund's Class I Shares (0.88% per annum) are expected to be higher
than the historical expenses of the GMO Pool (0.83% per annum) and
therefore had the GMO Pool been subject to such higher expenses, the total
return for the periods indicated would have been lower.
AVERAGE ANNUAL TOTAL RETURN. The Foreign Fund from time to time may
advertise certain investment performance figures. These figures are based on
historical earnings but past performance data is not necessarily indicative of
future performance of the Fund. All performance information will be provided net
of Fund and GMO Pool expenses. The Fund may, in conformance with SEC guidelines,
advertise its total return for various periods of time by determining, over a
period of time stated in the advertisement, the average annual compounded rate
of return that an investment in the Fund earned over that period, assuming
reinvestment of all distributions.
The performance data quoted below includes the performance of the GMO Pool
for periods before the commencement of operations of the Foreign Fund.
Performance data relating to Class II and Class III Shares of the Foreign Fund
has not been restated because the historical level of expenses for the GMO Pool
(0.83% per annum) was higher than the expenses anticipated for Class II and
Class III Shares of the Foreign Fund (0.75% and 0.82% per annum). Performance
data relating to Class I Shares of the Foreign Fund has been restated because
the historical level of expenses for the GMO Pool (0.83% per annum) was lower
than the expenses anticipated for the Class I Shares of the Foreign Fund (0.88%
per annum). The GMO Pool was not registered under the 1940 Act and therefore was
not subject to certain investment restrictions imposed by the 1940 Act. If the
GMO Pool had been registered under the 1940 Act, its performance may have been
adversely affected.
Average Annual Total Return for the periods ended December 31, 1995:
<TABLE>
<CAPTION>
Class II and III Shares Class I Shares
----------------------- --------------
<S> <C> <C>
1-year return 13.85% 13.80%
3-year return 19.63% 19.57%
5-year return 12.87% 12.81%
10-year return 15.94% 15.88%
Since inception (9/1/84) 19.73% 19.67%
</TABLE>
-26-
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of each of the Core Fund, the Value Fund, the
Growth Fund, the Short-Term Income Fund, the International Core Fund, and the
Japan Fund is fundamental and may not be changed without shareholder approval.
The investment objective of each other Fund may be changed without shareholder
approval. Unless specifically noted herein, the investment policies of the Funds
may be changed without shareholder approval. There can be no assurance that the
investment objective of any Fund will be achieved.
As noted in the following Fund descriptions, many of the Funds seek
total returns greater than, or select securities that are represented in,
certain indices or benchmarks. These benchmarks or indices may be commercially
developed and published, modifications of commercially available indices
maintained by the Manager, or composite benchmarks maintained by the Manager
that blend commercially available indices. A description of the various
benchmarks and indices is set forth on page 4.
DOMESTIC EQUITY FUNDS
CORE FUND
The Core Fund seeks a total return greater than that of the S&P 500
through investment in common stocks. The Core Fund expects that substantially
all of its assets will be invested in or exposed to the equity securities of at
least 125 companies chosen from among the Wilshire 5000 Index (the "WILSHIRE
5000") and that it will be invested primarily in the approximately 1,200
companies with the largest equity capitalization (i.e., number of shares
outstanding multiplied by the market price per share) at the time of investment
which are also listed on a United States national securities exchange (the
"LARGE CAP 1200"). The Core Fund may, from time to time, invest in fewer issuers
if, in the opinion of the Manager, there are not at least 125 attractive
investment opportunities from among such companies.
The Manager will select which issuers to invest in based on its
assessment of whether the common stock of the issuer is likely to perform better
than the S&P 500. Since the Core Fund's portfolio investments will not be chosen
and proportionately weighted to approximate the total return of the S&P 500, the
total return of the Core Fund may be more or less than the total return of the
S&P 500. An investment in the Fund involves risks similar to investing in common
stocks directly.
In pursuing its objective, the Fund may invest in securities of foreign
issuers traded principally on U.S. securities exchanges, invest without limit in
depository receipts of foreign issuers, and purchase convertible securities. The
Fund may also purchase interests in real estate investment trusts ("REITs"),
which are described under the description of the GMO REIT Fund in this
Prospectus. The Fund may also invest up to 15% of its net assets in illiquid
securities, lend portfolio securities valued at up to one-third of total assets,
and enter into repurchase agreements.
In addition, the Fund may purchase index futures on the S&P 500 and
other domestic indices for investment, anticipatory hedging and risk management
and to effect synthetic sales and purchases. The Fund may also buy exchange
traded or over-the-counter put and call options, sell (write) covered options
and enter into futures contracts and options on futures contracts for hedging
and risk management. The Fund may also use equity swap contracts and contracts
for differences for these purposes.
It is a policy of the Fund to stay fully invested in common stocks,
index futures, equity swap contracts and contracts for differences even when the
Manager believes that equity securities generally may underperform other types
of investments. The Fund expects that, not including the margin deposits or the
segregated accounts created in connection with index futures and other
derivatives, less than 5% of its total net assets will be invested in high
quality money market instruments such as securities issued by the U.S.
government and agencies thereof, bankers' acceptances, commercial paper, and
bank certificates of deposit. The Fund will at all times invest at least 65% of
its total assets in domestic common stocks. The Fund does not expect to invest
in long or short-term fixed income securities for temporary defensive purposes.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
TOBACCO-FREE CORE FUND
The Tobacco-Free Core Fund seeks a total return greater than that of
the S&P 500 through investment in common stocks. Substantially all of the Fund's
assets will be invested in or exposed to equity securities chosen from among the
Wilshire 5000 and selected primarily from Large Cap 1200 issuers which are not
Tobacco Producing Issuers (as defined below). The Tobacco-Free Core Fund expects
that substantially all of its assets will be invested in the securities of at
least 125 companies. The Tobacco-Free Core Fund may, from time to time, invest
in fewer issuers if, in the opinion of the Manager, there are not at least 125
attractive investment opportunities from among such companies.
The Manager will select which issuers to invest in based on its
assessment of whether the common stock of the issuer is likely to perform better
than the S&P 500. Since the Tobacco- Free Core Fund's portfolio investments will
not be chosen and proportionately weighted to approximate the total return of
the S&P 500, the total return of the Tobacco-Free Core Fund may be more or less
than the total return of the S&P 500. An investment in the Fund involves risks
similar to investing in common stocks directly.
-27-
The Manager has instituted procedures to avoid investment by the
Tobacco-Free Core Fund in the securities of issuers which, at the time of
purchase, derive more than 10% of their gross revenues from the production of
tobacco-related products ("TOBACCO PRODUCING ISSUERS"). For this purpose the
Manager will subscribe to and generally rely on information services provided by
third parties, although the Manager may cause the Tobacco-Free Core Fund to
purchase securities of issuers which are identified by those third parties as
Tobacco Producing Issuers if, at the time of purchase, the Manager has received
information from the issuer to the effect that it is no longer a Tobacco
Producing Issuer.
The Tobacco-Free Core Fund is required to have a fundamental policy,
which cannot be changed without shareholder approval, that under normal market
conditions at least 65% of its assets will be invested in the securities of
issuers other than Tobacco Producing Issuers. This policy is not expected to
affect the Manager's overall goal of not investing in Tobacco Producing Issuers.
In pursuing its objective, the Fund may invest in securities of foreign
issuers traded principally on U.S. securities exchanges, invest without limit in
depository receipts of foreign issuers, and purchase convertible securities. The
Fund may also purchase interests in REITs. The Fund may also invest up to 15% of
its net assets in illiquid securities, lend portfolio securities valued at up to
one-third of total assets, and enter into repurchase agreements.
In addition, the Fund may purchase index futures on the S&P 500 and
other domestic indices for investment, anticipatory hedging and risk management
and to effect synthetic sales and purchases. The Fund may also buy exchange
traded or over-the-counter put and call options, sell (write) covered options
and enter into futures contracts and options on futures contracts for hedging
and risk management. The Fund may also use equity swap contracts and contracts
for differences for these purposes.
It is a policy of the Fund to stay fully invested in common stocks,
index futures, equity swap contracts and contracts for differences even when the
Manager believes that equity securities generally may underperform other types
of investments. The Fund expects that, not including the margin deposits or the
segregated accounts created in connection with index futures and other
derivatives, less than 5% of its total net assets will be invested in high
quality money market instruments such as securities issued by the U.S.
government and agencies thereof, bankers' acceptances, commercial paper, and
bank certificates of deposit. The Fund will at all times invest at least 65% of
its total assets in domestic common stocks. The Fund does not expect to invest
in long or short-term fixed income securities for temporary defensive purposes.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
VALUE FUND
The Value Fund (formerly, the Value Allocation Fund) seeks a total
return greater than that of the S&P 500 through investment in a broadly
diversified and liquid portfolio of common stocks. Substantially all of the
Fund's investments will be chosen from among the Wilshire 5000 and primarily
from among the Large Cap 1200. The Fund expects that any income it derives will
be from dividends on common stock. The Manager will select which issuers to
invest in based on its assessment of whether the common stock of the issuer is
likely to perform better than the S&P 500. Strong consideration is given to
common stocks whose current prices do not adequately reflect, in the opinion of
the Manager, the ongoing business value of the underlying company.
The Fund's investments are made in securities of companies which, in
the opinion of the Manager, are of average or above average investment quality.
Investment quality is evaluated using fundamental analysis emphasizing each
issuer's historic financial performance, balance sheet strength, management
capability and competitive position. Various valuation parameters are examined
to determine the attractiveness of individual securities. Since the Fund's
portfolio investments will not be chosen and proportionately weighted to
approximate the total return of the S&P 500, at times the total return of the
Value Fund may be more or less than the total return of the S&P 500.
In pursuing its objective, the Fund may invest in securities of foreign
issuers traded principally on U.S. securities exchanges, invest without limit in
depository receipts of foreign issuers, and purchase convertible securities. The
Fund may also purchase interests in REITs. The Fund may also invest up to 15% of
its net assets in illiquid securities, lend portfolio securities valued at up to
one-third of total assets, and enter into repurchase agreements.
In addition, the Fund may purchase index futures on the S&P 500 and
other domestic indices for investment, anticipatory hedging and risk management
and to effect synthetic sales and purchases. The Fund may also buy exchange
traded or over-the-counter put and call options, sell (write) covered options
and enter into futures contracts and options on futures contracts for hedging
and risk management. The Fund may also use equity swap contracts and contracts
for differences for these purposes.
It is a policy of the Fund to stay fully invested in common stocks,
index futures, equity swap contracts and contracts for differences even when the
Manager believes that equity securities generally may underperform other types
of investments. The Fund expects that, not including the margin deposits or the
segregated accounts created in connection with index futures and other
derivatives, less than 5% of its total net assets will be invested in high
quality money market instruments such as securities issued by the U.S.
government and agencies thereof, bankers' acceptances, commercial paper, and
bank certificates of deposit. The Fund will at all times invest at least
-28-
65% of its total assets in domestic common stocks. The Fund does not expect to
invest in long or short-term fixed income securities for temporary defensive
purposes.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
GROWTH FUND
The Growth Fund (formerly the Growth Allocation Fund) seeks long-term
growth of capital. Current income is only an incidental consideration. The
Growth Fund attempts to achieve its objective by investing in companies whose
earnings per share are expected by the Manager to grow at a rate faster than the
average of the Large Cap 1200. The Fund is designed for investors who wish to
allocate a portion of their assets to investment in growth-oriented stocks.
The Fund expects that substantially all of the Fund's investments will
be chosen from among the Wilshire 5000, and at least 65% of its assets will be
invested in the common stocks (and securities convertible into common stocks) of
issuers chosen from the Large Cap 1200. Such companies may include foreign
issuers, although the Fund does not intend to invest in securities which are
principally traded outside of the United States. The balance of the common
stocks (and securities convertible into common stocks) held by the Fund may be
less liquid investments since the companies in question will have smaller equity
capitalization and/or the securities may not be listed on a national securities
exchange.
In pursuing its objective, the Fund may invest in securities of foreign
issuers traded principally on U.S. securities exchanges, invest without limit in
depository receipts of foreign issuers, and purchase convertible securities. The
Fund may also purchase interests in REITs. The Fund may also invest up to 15% of
its net assets in illiquid securities, lend portfolio securities valued at up to
one-third of total assets, and enter into repurchase agreements.
In addition, the Fund may purchase index futures on the S&P 500 and
other domestic indices for investment, anticipatory hedging and risk management
and to effect synthetic sales and purchases. The Fund may also buy exchange
traded or over-the-counter put and call options, sell (write) covered options
and enter into futures contracts and options on futures contracts for hedging
and risk management. The Fund may also use equity swap contracts and contracts
for differences for these purposes.
It is a policy of the Fund to stay fully invested in common stocks,
index futures, equity swap contracts and contracts for differences even when the
Manager believes that equity securities generally may underperform other types
of investments. The Fund expects that, not including the margin deposits or the
segregated accounts created in connection with index futures and other
derivatives, less than 5% of its total net assets will be invested in the high
quality money market instruments such as securities issued by the U.S.
government and agencies thereof, bankers' acceptances, commercial paper, and
bank certificates of deposit. The Fund will at all times invest at least 65% of
its total assets in domestic common stocks. The Fund does not expect to invest
in long or short-term fixed income securities for temporary defensive purposes.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
U.S. SECTOR FUND
The U.S. Sector Fund (formerly the U.S. Sector Allocation Fund) seeks a
total return greater than that of the S&P 500 through investment in common
stocks. Substantially all of the Fund's investments will be chosen from among
the Wilshire 5000 and primarily from among the 1,800 companies with the largest
equity capitalization whose securities are listed on United States national
securities exchanges.
The Fund will allocate its assets, as directed by the Manager, among
major U.S. sectors (including value, growth, small/large capitalization and
defensive stocks, stocks in individual industries, etc.) and will overweight
those sectors which the Manager believes may outperform the S&P 500 generally.
The Fund may place varying degrees of emphasis on different types of companies
depending on the Manager's assessment of economic and market conditions,
including companies with superior growth prospects and/or companies whose common
stock does not, in the opinion of the Manager, adequately reflect the companies'
ongoing business value. The Fund may invest in companies with smaller equity
capitalization than the companies whose securities are purchased by the Value
Fund and the Growth Fund. The securities of small capitalization companies may
be less liquid and their market prices more volatile than those issued by
companies with larger equity capitalizations. Since the Fund's portfolio
investments will not be chosen and proportionately weighted to approximate the
S&P 500, the total return of the U.S. Sector Fund may be more or less than the
total return of the S&P 500.
In pursuing its objective, the Fund may invest in securities of foreign
issuers traded principally on U.S. securities exchanges, invest without limit in
depository receipts of foreign issuers, and purchase convertible securities. The
Fund may also purchase interests in REITs. The Fund may also invest up to 15% of
its net assets in illiquid securities, lend portfolio securities valued at up to
one-third of total assets, and enter into repurchase agreements.
In addition, the Fund may purchase index futures on the S&P 500 and
other domestic indices for investment, anticipatory hedging and risk management
and to effect synthetic sales and purchases. The Fund may also buy exchange
traded or over-the-counter put and call options, sell (write) covered options
and
-29-
enter into futures contracts and options on futures contracts for hedging and
risk management. The Fund may also use equity swap contracts and contracts for
differences for these purposes.
It is a policy of the Fund to stay fully invested in common stocks,
index futures, equity swap contracts and contracts for differences even when the
Manager believes that equity securities generally may underperform other types
of investments. The Fund expects that, not including the margin deposits or the
segregated accounts created in connection with index futures and other
derivatives, less than 5% of its total net assets will be invested in high
quality money market instruments such as securities issued by the U.S.
government and agencies thereof, bankers' acceptances, commercial paper, and
bank certificates of deposit. The Fund will at all times invest at least 65% of
its total assets in domestic common stocks. The Fund does not expect to invest
in long or short-term fixed income securities for temporary defensive purposes.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments".
CORE II SECONDARIES FUND
The investment objective of the Core II Secondaries Fund is long-term
growth of capital. Current income is only an incidental consideration. The Core
II Secondaries Fund attempts to achieve its objective by selecting its
investments primarily from domestic second tier companies. For these purposes,
"second tier companies" are those companies whose equity capitalization at the
time of investment by the Core II Secondaries Fund ranks in the lower two-thirds
of the 1800 publicly-held issuers with the largest equity capitalization.
The Core II Secondaries Fund invests primarily in common stocks,
although the Fund may on rare occasions hold securities convertible into common
stocks such as convertible bonds, convertible preferred stocks and warrants. The
Fund expects that at least 65% of its assets will be invested in the securities
of second tier companies, as defined above. The Fund may also hold the common
stocks (and securities convertible into common stocks) of companies with smaller
equity capitalizations. Such investments may be less liquid, as the securities
may not be listed on a national securities exchange and their market prices may
be more volatile than those issued by companies with larger equity
capitalizations.
In pursuing its objective, the Fund may invest in securities of foreign
issuers traded principally on U.S. securities exchanges, invest without limit in
depository receipts of foreign issuers, and purchase convertible securities. The
Fund may also purchase interests in REITs. The Fund may also invest up to 15% of
its net assets in illiquid securities, lend portfolio securities valued at up to
one-third of total assets, and enter into repurchase agreements.
In addition, the Fund may purchase index futures on the S&P 500 and
other domestic indices for investment, anticipatory hedging and risk management
and to effect synthetic sales and purchases. The Fund may also buy exchange
traded or over-the-counter put and call options, sell (write) covered options
and enter into futures contracts for hedging and risk management. The Fund may
also use equity swap contracts and contracts for differences for these purposes.
It is a policy of the Fund to stay fully invested in common stocks,
index futures, equity swap contracts and contracts for differences even when the
Manager believes that equity securities generally may underperform other types
of investments. The Fund expects that, not including the margin deposits or the
segregated accounts created in connection with index futures and other
derivatives, less than 5% of its total net assets will be invested in high
quality money market instruments such as securities issued by the U.S.
government and agencies thereof, bankers' acceptances, commercial paper, and
bank certificates of deposit. The Fund will at all times invest at least 65% of
its total assets in domestic common stocks. The Fund does not expect to invest
in long or short-term fixed income securities for temporary defensive purposes.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments".
FUNDAMENTAL VALUE FUND
The Fundamental Value Fund seeks long-term capital growth through
investment primarily in equity securities. Current income is only a secondary
consideration. It is anticipated that at least 90% of the Fund's assets will be
invested in common stocks and securities convertible into common stocks.
Although the Fund invests primarily in securities traded in the United States,
it may invest up to 25% of its assets in securities of foreign issuers and
securities traded principally outside of the United States.
The Fund invests primarily in common stocks of domestic corporations
that, in the opinion of the Manager, represent favorable values relative to
their market prices. Under normal conditions, the Fund generally, but not
exclusively, looks for companies with low price/earnings ratios and rising
earnings. The Fund focuses on established firms with capitalizations of more
than $100 million and generally does not buy issues of companies with less than
three years of operating history. The Fund seeks to maintain lower than average
equity risk levels relative to the potential for return through a portfolio with
an average historic volatility (beta) below 1.0. The S&P 500, which serves as a
standard for measuring volatility, always has average volatility (beta) of 1.0.
The Fund's beta may change with market conditions.
The Fund's Manager analyzes key economic variables to identify general
trends in the stock markets. World economic
-30-
indicators, which are tracked regularly, include U.S. industry and trade
indicators, interest rates, international stock market indices, and currency
levels. Under normal conditions, investments are made in a variety of economic
sectors, industry segments, and individual securities to reduce the effects of
price volatility in any one area.
In making investments, the Manager takes into account, among other
things, a company's source of earnings, competitive edge, management strength,
and level of industry dominance as measured by market share. At the same time,
the Manager analyzes the financial condition of each company. The Manager
examines current and historical measures of relative value to find corporations
that are selling at discounts relative to both underlying asset values and
market pricing. The Manager then selects those companies with financial and
business characteristics that it believes will produce above-average growth in
earnings. Sell decisions are triggered when, in the opinion of the Manager, the
stock price and other fundamental considerations make further appreciation less
likely.
The Manager generally selects equities that normally trade in
sufficient volume to provide liquidity. Domestic equities are usually traded on
the New York Stock Exchange or the American Stock Exchange or in the
over-the-counter markets.
The Fund's investments in foreign securities will generally consist of
equity securities traded in principal European and Pacific Basin markets. The
Manager evaluates the economic strength of a country, which includes its
resources, markets, and growth rate. In addition, it examines the political
climate of a country as to its stability and business policies. The Manager then
assesses the strength of the country's currency and considers foreign exchange
issues in general. The Fund aims for diversification not only among countries
but also among industries in order to enable shareholders to participate in
markets that do not necessarily move in concert with U.S.
markets.
Once the Fund has identified a rapidly expanding foreign economy, the
Fund attempts to search out growing industries and corporations, focusing on
companies with established records. Individual securities are selected based on
value indicators, such as low price to earnings ratio. Foreign securities in the
portfolio are generally listed on principal overseas exchanges.
In pursuing its objective, the Fund may invest without limit in
depository receipts of foreign issuers, and purchase convertible securities. The
Fund may also invest up to 15% of its net assets in illiquid securities, lend
portfolio securities valued at up to one-third of total assets, and enter into
repurchase agreements.
In addition, the Fund may purchase index futures on the S&P 500 and
other domestic indices for investment, anticipatory hedging and risk management
and to effect synthetic sales and purchases. The Fund may also buy exchange
traded or over-the-counter put and call options, sell (write) covered options
and enter into futures contracts and options on futures contracts for hedging
and risk management. The Fund may also use equity swap contracts and contracts
for differences for these purposes.
It is a policy of the Fund to stay fully invested in common stocks,
index futures, equity swap contracts and contracts for differences even when the
Manager believes that equity securities generally may underperform other types
of investments. The Fund expects that, not including the margin deposits or the
segregated accounts created in connection with index futures and other
derivatives, less than 5% of its total net assets will be invested in high
quality money market instruments such as securities issued by the U.S.
government and agencies thereof, bankers' acceptances, commercial paper, and
bank certificates of deposit. The Fund will at all times invest at least 65% of
its total assets in domestic common stocks. The Fund does not expect to invest
in long or short-term fixed income securities for temporary defensive purposes.
For a detailed description of the investment practices described in the
preceding five paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
REIT FUND
The investment objective of the REIT Fund is to maximize total return
through investment primarily in real estate investment trusts ("REITs"), which
are managed vehicles that invest in real estate or real estate-related assets.
REITs purchased by the Fund will include equity REITs, which own real estate
directly, mortgage REITs, which make construction, development or long-term
mortgage loans, and hybrid REITs, which share characteristics of equity REITs
and mortgage REITs. Equity REITs will be affected by, among other things,
changes in the value of the underlying property owned by the REITs, while
mortgage REITs will be affected by, among other things, the value of the
properties to which they have extended credit.
Since the Fund's investments are concentrated in real estate-related
securities, the value of its shares can be expected to change in light of
factors affecting the real estate industry, and may fluctuate more widely than
the value of shares of a portfolio that invests in a broader range of
industries. Factors affecting the performance of real estate may include excess
supply of real property in certain markets, changes in zoning laws, completion
of construction, changes in real estate value and property taxes, sufficient
level of occupancy, adequate rent to cover operating expenses, and local and
regional markets for competing assets. The performance of real estate may also
be affected by changes in interest rates, prudent management of insurance risks
and social and economic trends. Also, REITs are dependent upon the skill of each
REIT's management.
The Fund could under certain circumstances own real estate directly as
a result of a default on debt securities it owns or from an in-kind distribution
of real estate from a REIT. Risks
-31-
associated with such ownership could include potential liabilities under
environmental laws and the costs of other regulatory compliance. If the Fund has
rental income or income from the direct disposition of real property, the
receipt of such income may adversely affect its ability to retain its tax status
as a regulated investment company and thus its ability to avoid taxation on its
income and gains distributed to its shareholders. REITs are also subject to
substantial cash flow dependency, defaults by borrowers, self-liquidation and
the risk of failing to qualify for tax-free pass-through of income under the
Internal Revenue Code and/or to maintain exempt status under the 1940 Act. By
investing in REITs indirectly through the Fund, investors bear not only a
proportionate share of the expenses of the Fund, but also, indirectly, expenses
of the REITs.
Because of its name, the REIT Fund is required to have a policy of
investing at least 65% of its total assets in securities of REITs under normal
conditions, although the Fund intends to invest a greater portion of its assets
in REIT securities. The Fund may also invest in common and preferred stock,
fixed income securities including lower-rated fixed income securities (commonly
known as "junk bonds"), invest in securities principally traded in foreign
markets and foreign currency exchange transactions. The Fund may lend portfolio
securities valued at up to one-third of total assets, and invest in adjustable
rate securities, zero coupon securities and depository receipts of foreign
issuers. The Fund may also enter into repurchase agreements, reverse repurchase
agreements and dollar roll agreements. In addition, the Fund may invest in
mortgage-backed and other non-government issuers, including collateral mortgage
obligations ("CMO's"), strips and residuals. The Fund may also invest in indexed
securities the redemption values and/or coupons of which are indexed to the
prices of other securities, securities indices, currencies, precious metals or
other commodities, or other financial indicators. The Fund may also enter into
firm commitment agreements with banks or broker-dealers, and may invest up to
15% of its net assets in illiquid securities. The Fund may hold a portion of its
assets in high quality money market instruments.
The Fund may buy and sell options and enter into futures contracts and
options on futures contracts for hedging, investment and risk management. In
particular, the Fund may purchase futures contracts on the S&P 500 and interest
rate futures contracts for anticipatory hedging purposes and otherwise to
provide investment exposure for cash balances. In addition, the Fund may use
interest rate and currency swap contracts, contracts for differences and
interest rate caps, floors and collars for hedging and for risk management.
For a detailed description of the investment practices described in the
two preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments" later in this Prospectus.
INTERNATIONAL EQUITY FUNDS
The International Equity Funds, together with the Global Hedged Equity
Fund, International Bond Fund, Currency Hedged International Bond Fund, Global
Bond Fund and Emerging Country Debt Fund are sometimes collectively referred to
as the "INTERNATIONAL FUNDS."
INTERNATIONAL CORE FUND
The investment objective of the International Core Fund is to maximize
total return through investment in a portfolio of common stocks of non-U.S.
issuers. The Fund will usually invest primarily in common stocks, including
dividend-paying common stocks. Capital appreciation may be sought through
investment in common stocks, convertible bonds, convertible preferred stocks,
warrants or rights. Income may be sought through investment in dividend-paying
common stocks, convertible bonds, money market instruments or fixed income
securities such as long and medium term corporate and government bonds and
preferred stocks. Some of these fixed income securities may have speculative
qualities and the values of these securities generally fluctuate more than those
of other, less speculative fixed income securities. See "Description and Risks
of Fund Investments -- Lower Rated Securities."
The relative emphasis of the Fund on capital appreciation or income
will depend upon the views of the Manager with respect to the opportunities for
capital appreciation relative to the opportunities for income. There are no
prescribed limits on geographic asset distribution and the Fund has the
authority to invest in securities traded in securities markets of any country in
the world, although under normal market conditions the Fund will invest in
securities traded in the securities markets of at least three foreign countries.
The responsibility for allocating the Fund's assets among the various securities
markets of the world is borne by the Manager. In making these allocations, the
Manager will consider such factors as the condition and growth potential of the
various economic and securities markets, currency and taxation considerations
and other pertinent financial, social, national and political factors. The Fund
generally will not invest in securities of U.S. issuers, except that for
temporary defensive purposes the Fund may invest up to 100 percent of its assets
in United States securities.
The Fund may use forward foreign currency contracts, currency futures
contracts, currency swap contracts, options on currencies and buy and sell
foreign currencies for hedging and for currency risk management, although the
Fund's foreign currency exposure will not generally vary by more than 30% from
the foreign currency exposure of a benchmark index (the "EAFE-LITE INDEX"),
which is a modification of the Morgan Stanley Capital International EAFE Index
(the "EAFE INDEX") developed by the Manager so as to reduce the weighting of
Japan in the EAFE Index. The put and call options on currency futures written by
the Fund will always be covered. For more information on foreign currency
transactions, see "Descriptions
-32-
and Risks of Fund Investments -- Foreign Currency Transactions." The stocks held
by the Fund will not be chosen to approximate the weightings of the EAFE-lite
Index.
The Fund may also invest in securities of investment companies, such as
closed-end investment management companies which invest in foreign markets or
other of the International Equity Funds to the extent permitted under the 1940
Act. As a shareholder of an investment company, the Fund may indirectly bear
service fees which are in addition to the fees the Fund pays its service
providers.
In addition, the Fund may invest in securities of foreign issuers
traded on U.S. exchanges and securities traded abroad, American Depositary
Receipts, European Depository Receipts and other similar securities convertible
into securities of foreign issuers. The Fund may also enter repurchase
agreements, lend portfolio securities valued at up to 25% of total assets, and
may invest up to 15% of its net assets in illiquid securities. The Fund expects
that, not including the margin deposits or the segregated accounts created in
connection with index futures and other derivatives, less than 5% of its total
net assets will be invested in cash or high quality money market instruments
such as securities issued by the U.S. government and agencies thereof, bankers'
acceptances, commercial paper, and bank certificates of deposit.
The Fund may also buy put and call options, sell (write) covered
options and enter into futures contracts and options on futures contracts for
hedging and risk management. The Fund's use of options on particular securities
(as opposed to market indices) is limited such that the premiums paid by the
Fund on all outstanding options it has purchased may not exceed 5% of its total
assets. The Fund may also write options in connection with buy-and-write
transactions, and use index futures (on foreign stock indices), options on
futures, equity swap contracts and contracts for differences for investment,
anticipatory hedging and risk management and to effect synthetic sales and
purchases.
For a detailed description of the investment practices described in the
four preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
CURRENCY HEDGED INTERNATIONAL CORE FUND
The investment objective of the Currency Hedged International Core Fund
is to maximize total return through investment in a portfolio of common stocks
of non-U.S. issuers and through management of the Fund's currency positions. The
Fund has policies that are similar to the International Core Fund, except that
the Currency Hedged International Core Fund will employ a different strategy
with respect to foreign currency exposure. While the International Core Fund's
foreign currency exposure will not generally differ from that of the EAFE-lite
Index by more than 30%, the Currency Hedged International Core Fund's foreign
currency exposure will generally vary no more than 30% from the currency
exposure of a fully hedged EAFE-lite Index. That is, the Currency Hedged
International Core Fund will hedge a substantial portion (generally at least
70%) of the EAFE-lite foreign currency exposure while the International Core
Fund will generally hedge only a limited portion (generally less than 30%) of
EAFE-lite currency exposure. The Currency Hedged International Core Fund may use
forward foreign currency contracts, currency futures contracts, currency swap
contracts, options on currencies and buy and sell foreign currencies for hedging
and for currency risk management. The put and call options on currency futures
written by the Fund will always be covered. For more information on foreign
currency transactions, see "Description and Risks of Fund Investments -- Foreign
Currency Transactions." Because of its name, the Currency Hedged International
Core Fund is required to have a policy that it will maintain short currency
positions with respect to at least 65% of the foreign currency exposure
represented by the common stocks owned by the Fund.
The Fund will usually invest primarily in common stocks, including
dividend-paying common stocks. The stocks held by the Fund will not be chosen to
approximate the weightings of the EAFE-lite Index. Capital appreciation may be
sought through investment in common stocks, convertible bonds, convertible
preferred stocks, warrants or rights. Income may be sought through investment in
dividend-paying common stocks, convertible bonds, money market instruments or
fixed income securities such as long and medium term corporate and government
bonds and preferred stocks. Some of these fixed income securities may have
speculative qualities and the values of these securities generally fluctuate
more than those of other, less speculative fixed income securities. See
"Description and Risks of Fund Investments -- Lower Rated Securities."
The relative emphasis of the Fund on capital appreciation or income
will depend upon the views of the Manager with respect to the opportunities for
capital appreciation relative to the opportunities for income. There are no
prescribed limits on geographic asset distribution and the Fund has the
authority to invest in securities traded in securities markets of any country in
the world, although under normal market conditions the Fund will invest in
securities traded in the securities markets of at least three foreign countries.
The responsibility for allocating the Fund's assets among the various securities
markets of the world is borne by the Manager. In making these allocations, the
Manager will consider such factors as the condition and growth potential of the
various economic and securities markets, currency and taxation considerations
and other pertinent financial, social, national and political factors. The Fund
generally will not invest in securities of U.S. issuers, except that for
temporary defensive purposes the Fund may invest up to 100 percent of its assets
in United States securities.
The Fund may also invest in securities of investment companies, such as
closed-end investment management companies which invest in foreign markets or
other of the International Equity Funds to the extent permitted under the 1940
Act. As a shareholder of an investment company, the Fund may
-33-
indirectly bear service fees which are in addition to the fees the Fund pays its
service providers.
In addition, the Fund may invest in securities of foreign issuers
traded on U.S. exchanges and securities traded abroad, American Depositary
Receipts, European Depository Receipts and other similar securities convertible
into securities of foreign issuers. The Fund may also enter repurchase
agreements, and lend portfolio securities valued at up to 25% of total assets.
The Fund may also invest up to 15% of its net assets in illiquid securities and
temporarily invest in cash and high quality money market instruments such as
securities issued by the U.S. government and agencies thereof, bankers'
acceptances, commercial paper, and bank certificates of deposit. The Fund
expects that, not including the margin deposits or the segregated accounts
created in connection with index futures and other derivatives, less than 5% of
its total net assets will be invested in such high quality cash items.
The Fund may also buy put and call options, sell (write) covered
options and enter into futures contracts and options on futures contracts for
hedging and risk management. The Fund's use of options on particular securities
(as opposed to market indices) is limited such that the premiums paid by the
Fund on all outstanding options it has purchased may not exceed 5% of its total
assets. The Fund may also write options in connection with buy-and-write
transactions, and use index futures (on foreign stock indices), options on
futures, equity swap contracts and contracts for differences for investment,
anticipatory hedging and risk management and to effect synthetic sales and
purchases.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
FOREIGN FUND
The investment objective of the Foreign Fund is to maximize total
return through investment primarily in equity securities of non-U.S. issuers.
The Fund's investment strategy is based on a fundamental analysis of issuers and
country economics. The Fund will usually invest primarily in common stocks,
including dividend-paying common stocks. Capital appreciation may be sought
through investment in common stocks, convertible bonds, convertible preferred
stocks, warrants or rights. Income may be sought through investment in
dividend-paying common stocks, convertible bonds, money market instruments or
fixed income securities such as long and medium term corporate and government
bonds and preferred stocks. Some of these fixed income securities may have
speculative qualities and the values of these securities generally fluctuate
more than those of other, less speculative fixed income securities. See
"Description and Risks of Fund Investments -- Lower Rated Securities".
The relative emphasis of the Fund on capital appreciation or income
will depend upon the views of the Manager with respect to the opportunities for
capital appreciation relative to the opportunities for income. There are no
prescribed limits on geographic asset distribution and the Fund has the
authority to invest in securities traded in securities markets of any country in
the world other than the United States, although under normal market conditions
the Fund will invest in securities principally traded in the securities markets
of at least three countries. The responsibility for allocating the Fund's assets
among the various securities markets of the world is borne by the Manager. In
making these allocations, the Manager will consider such factors as the
condition and growth potential of the various economic and securities markets,
currency and taxation considerations and other pertinent financial, social,
national and political factors.
The Fund may use forward foreign currency contracts and currency
futures contracts for the purpose of hedging the currency exposure of its
portfolio securities. The Fund is not required to hedge its currency risk and
will not normally hedge more than 90% of such risks. The Fund will not buy and
sell foreign currencies for investment purposes, but may hold foreign currencies
pending investments consistent with the Fund's investment program. The Fund will
not invest in options on foreign currencies.
The Fund may also invest in securities of investment companies, such as
closed-end investment management companies which invest in foreign markets or
other of the International Equity Funds to the extent permitted under the 1940
Act. As a shareholder of an investment company, the Fund may indirectly bear
service fees which are in addition to the fees the Fund pays its service
providers.
In addition, the Fund may invest in securities of foreign issuers
traded on U.S. exchanges and securities traded abroad, American Depositary
Receipts, European Depository Receipts and other similar securities convertible
into securities of foreign issuers. The Fund may also enter into repurchase
agreements, lend portfolio securities valued at up to one-third of total assets,
and may invest up to 10% of its net assets in illiquid securities. The Fund may
invest up to 20% of its assets in securities of issuers in newly industrialized
countries of the type invested in by the Emerging Markets Fund.
The Fund may also buy put and call options, sell (write) covered
options and enter into futures contracts and options on futures contracts for
hedging and risk management. The Fund may also write options in connection with
buy-and-write transactions and use index futures (on foreign stock).
For a detailed description of the investment practices described in the
four preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
-34-
INTERNATIONAL SMALL COMPANIES FUND
The International Small Companies Fund seeks to maximize total return
through investment primarily in equity securities of foreign issuers whose
equity securities are traded on a major stock exchange of a foreign country
("foreign stock exchange companies") and whose equity capitalization at the time
of investment, when aggregated with the equity capitalizations of all foreign
stock exchange companies in that country whose equity capitalizations are
smaller than that of such company, is less than 50% of the aggregate equity
capitalization of all foreign stock exchange companies in such country ("small
capitalization foreign companies"). With the exception of the International
Small Companies Fund's policy of investing in securities of small capitalization
foreign companies, and except as otherwise disclosed in this Prospectus and the
related Statement of Additional Information, the International Small Companies
Fund's investment objectives and policies are the same as those described above
with respect to the International Core Fund.
It is currently expected that at least 65% of the International Small
Companies Fund's assets will be invested in common stocks of small
capitalization foreign companies. Such companies may present greater
opportunities for capital appreciation because of high potential earnings
growth, but may also involve greater risk. Small capitalization foreign
companies tend to be smaller and newer than other foreign companies and may be
dependent upon a single proprietary product or market niche. They may have
limited product lines, markets or financial resources, or may depend on a
limited management group. Typically, small capitalization foreign companies have
fewer securities outstanding and are less liquid than large companies. Their
common stock and other securities may trade less frequently and in limited
volume. The securities of small capitalization foreign companies are generally
more sensitive to purchase and sale transactions and, therefore, the prices of
such securities tend to be more volatile than the securities of larger
companies.
The Fund also may invest in securities of foreign issuers traded on
U.S. exchanges and securities traded abroad, American Depositary Receipts,
European Depository Receipts and other similar securities convertible into
securities of foreign issuers. The Fund may also enter repurchase agreements,
and lend portfolio securities valued at up to one-third of total assets. The
Fund may also invest up to 15% of its net assets in illiquid securities and
temporarily invest in cash and high quality money market instruments such as
securities issued by the U.S. government and agencies thereof, bankers'
acceptances, commercial paper, and bank certificates of deposit. The Fund
expects that, not including the margin deposits or the segregated accounts
created in connection with index futures and other derivatives, less than 5% of
its total net assets will be invested in such high quality cash items.
The Fund may also buy put and call options, sell (write) covered
options and enter into futures contracts and options on futures contracts for
hedging and risk management. The Fund's use of options on particular securities
(as opposed to market indices) is limited such that the premiums paid by the
Fund on all outstanding options it has purchased may not exceed 5% of its total
assets. The Fund may also write options in connection with buy-and-write
transactions, and use index futures (on foreign stock indices), options on
futures, equity swap contracts and contracts for differences for investment,
anticipatory hedging and risk management and to effect synthetic sales and
purchases.
The Fund may use forward foreign currency contracts, currency futures
contracts, currency swap contracts, options on currencies and buy and sell
foreign currencies for hedging and for currency risk management. The put and
call options on currency futures written by the Fund will always be covered.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
JAPAN FUND
The Japan Fund seeks to maximize total return through investment in a
portfolio of Japanese securities, consisting primarily of common stocks of
Japanese companies. It is currently expected that at least 90% of the net assets
of the Japan Fund will be invested in or exposed to "Japanese Securities," that
is, securities issued by entities that are organized under the laws of Japan and
that either have 50% or more of their assets in Japan or derive 50% or more of
their revenues from Japan ("Japanese Companies"). Although the Japan Fund will
invest primarily in common stocks of Japanese Companies, it may also invest in
other Japanese Securities, such as convertible preferred stock, warrants or
rights as well as short-term government debt securities or other short-term
prime obligations (i.e., high quality debt obligations maturing not more than
one year from the date of issuance). The Japan Fund expects that any income it
derives will be from dividend or interest payments on securities.
Unlike mutual funds which invest in the securities of many other
countries, the Japan Fund will be invested almost exclusively in Japanese
Securities. No effort will be made by the Manager to assess the Japanese
economic, political or regulatory developments or changes in currency exchange
rates for purposes of varying the portion of the Fund's assets invested in
Japanese Securities. This means that the Fund's performance will be directly
affected by political, economic, market and exchange rate conditions in Japan.
Also, since the Japanese economy is dependent to a significant extent on foreign
trade, the relationships between Japan and its trading partners and between the
yen and other currencies are expected to have a significant impact on particular
Japanese Companies and on the Japanese economy generally. Also, the Japan Fund's
investments are denominated in yen, whose value continually changes in relation
to the dollar. This varying relationship will also directly affect the value of
the Japan Fund's shares. The Japan Fund is designed for investors who are
willing to accept the risks associated with changes in such conditions and
relationships.
-35-
To achieve its objectives, the Fund may invest in securities of foreign
issuers traded on U.S. exchanges and securities traded abroad, American
Depositary Receipts, European Depository Receipts and other similar securities
convertible into securities of foreign issuers. The Fund may also enter
repurchase agreements, and lend portfolio securities valued at up to one-third
of total assets. The Fund may also invest up to 15% of its net assets in
illiquid securities and temporarily invest in cash and high quality money market
instruments such as securities issued by the U.S. government and agencies
thereof, bankers' acceptances, commercial paper, and bank certificates of
deposit. The Fund expects that, not including the margin deposits or the
segregated accounts created in connection with index futures or other
derivatives, less than 5% of its total net assets will be invested in such high
quality cash items.
The Fund may also buy put and call options, sell (write) covered
options and enter into futures contracts and options on futures contracts for
hedging and risk management. The Fund's use of options on particular securities
(as opposed to market indices) is limited such that the premiums paid by the
Fund on all outstanding options it has purchased may not exceed 5% of its total
assets. The Fund may also write options in connection with buy-and-write
transactions, and use index futures (on foreign stock indices), options on
futures, equity swap contracts and contracts for differences for investment,
anticipatory hedging and risk management and to effect synthetic sales and
purchases.
The Fund may use forward foreign currency contracts, currency futures
contracts, currency swap contracts, options on currencies and buy and sell
foreign currencies for hedging and for currency risk management. The put and
call options on currency futures written by the Fund will always be covered.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
EMERGING MARKETS FUND
The Emerging Markets Fund seeks long-term capital appreciation
consistent with what the Manager believes to be a prudent level of risk through
investment in equity and equity- related securities traded in the securities
markets of newly industrializing countries in Asia, Latin America, the Middle
East, Southern Europe, Eastern Europe and Africa. The Manager has appointed
Dancing Elephant, Ltd. to serve as Consultant to the Fund.
The Consultant's efforts focus on asset allocation among the selected
emerging markets. (See "Description and Risks of Fund Investments -- Certain
Risks of Foreign Investments.") In addition to considerations relating to a
particular market's investment restrictions and tax barriers, asset allocation
is based on certain other relevant factors including the outlook for economic
growth, currency exchange rates, commodity prices, interest rates, political
factors and the stage of the local market cycle in such emerging market. The
Consultant expects to allocate the Fund's investments over geographic as well as
economic sectors.
There are currently over 50 newly industrializing and developing
countries with equity markets. A number of these markets are not yet easily
accessible to foreign investors and have unattractive tax barriers or
insufficient liquidity to make significant investments by the Fund feasible or
attractive. However, many of the largest of the emerging markets have, in recent
years, liberalized access and more are expected to do so over the coming few
years if the present trend continues.
Emerging markets in which the Fund intends to invest may include the
following emerging markets ("EMERGING MARKETS"):
Asia: Bangladesh, China, India, Indonesia, Korea,
Malaysia, Mynanmar, Mongolia, Pakistan,
Philippines, Sri Lanka, Republic of China
(Taiwan), Thailand, Vietnam
Latin
America: Argentina, Bolivia, Brazil, Chile, Colombia,
Costa Rica, Ecuador, Jamaica, Mexico, Peru,
Uruguay, Venezuela,
Europe/
Middle East/
Africa: Botswana, Czech Republic, Ghana, Greece,
Hungary, Israel, Jordan, Kazakstan, Kenya,
Morocco, Namibia, Nigeria, Poland, Portugal,
Russia, Slovakia, Slovenia, South Africa,
Turkey, Ukraine, Zimbabwe
The Emerging Markets Fund has a fundamental policy that, under normal
conditions, at least 65% of its total assets will be invested in equity and
equity-related securities which are predominantly traded on Emerging Market
exchanges ("Emerging Market Securities"). The Fund invests predominantly in
individual stocks listed on Emerging Market stock exchanges or in depository
receipts of such stocks listed on markets in industrialized countries or traded
in the international equity market. The Fund may also invest in shares of
companies which are not presently listed but are in the process of being
privatized by the government and, subject to a maximum aggregate investment
equal to 25% of the total assets of the Fund, shares of companies that are
traded in unregulated over-the-counter markets or other types of unlisted
securities markets. The Fund may also invest through investment funds, pooled
accounts or other investment vehicles designed to permit investments in a
portfolio of stocks listed in a particular developing country or region subject
to obtaining any necessary local regulatory approvals, particularly in the case
of countries in which such an investment vehicle is the exclusive or main
vehicle for foreign portfolio investment. Such investments may result in
additional
-36-
costs, as the Fund may be required to bear a pro rata share of the expenses of
each such fund in which it invests. The Fund may also invest in companies listed
on major markets outside of the emerging markets that, based on information
obtained by the Consultant, derive at least half of their revenues from trade
with or production in developing countries. In addition, the Fund's assets may
be invested on a temporary basis in debt securities issued by companies or
governments in developing countries or money market securities of high-grade
issuers in industrialized countries denominated in various currencies.
The Fund may also invest in bonds and money market instruments in
Canada, the United States and other markets of industrialized nations and
emerging securities markets, and, for temporary defensive purposes, may invest
without limit in cash and high quality money market instruments such as
securities issued by the U.S. government and agencies thereof, bankers'
acceptances, commercial paper, and bank certificates of deposit. The Fund
expects that, not including the margin deposits or the segregated accounts
created in connection with index futures and other derivatives, less than 5% of
its total net assets will be invested in such high quality cash items. The Fund
may also invest in indexed securities, the redemption value and/or coupons of
which are indexed to the prices of other securities, securities indices,
currencies, precious metal, or other commodities, as well as other technical
indicators.
The Fund may also invest up to 10% of its total assets through
debt-equity conversion funds established to exchange foreign bank debt of
countries whose principal repayments are in arrears into a portfolio of listed
and unlisted equities, subject to certain repatriation restrictions. The Fund
may also invest in convertible securities, enter repurchase agreements and lend
portfolio securities valued at up to one-third of total assets. The Fund may
invest up to 15% of its net assets in illiquid securities.
The Fund may also buy put and call options, sell (write) covered
options and enter into futures contracts and options on futures contracts for
hedging and risk management. The Fund's use of options on particular securities
(as opposed to market indices) is limited such that the premiums paid by the
Fund on all outstanding options it has purchased may not exceed 5% of its total
assets. The Fund may also write options in connection with buy-and-write
transactions, and use index futures (on foreign stock indices), options on
futures, equity swap contracts and contracts for differences for investment,
anticipatory hedging and risk management and to effect synthetic sales and
purchases.
The Fund may use forward foreign currency contracts, currency futures
contracts, currency swap contracts, options on currencies and buy and sell
foreign currencies for hedging and for currency risk management. The put and
call options on currency futures written by the Fund will always be covered.
For a detailed description of the investment practices described in the
five preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
FIXED INCOME FUNDS
As used in several of the Fixed Income Funds' investment objectives
below, "BOND" means any fixed income obligation with an original maturity of two
years or more, as well as "synthetic" bonds created by combining a futures
contract or option on a fixed income security with cash, a cash equivalent
investment or another fixed income security. (See "Description and Risks of Fund
Investments -- Uses of Options, Futures and Options on Futures -- Investment
Purposes".) Under normal market conditions, each of the Emerging Country Debt
Fund, the International Bond Fund, the Currency Hedged International Bond Fund
and the Global Bond Fund will invest at least 65% of its assets in bonds of
issuers of at least three countries (excluding the United States). However, up
to 100% of these Fixed Income Fund's assets may be denominated in U.S. dollars,
and for temporary defensive purposes, each such Fixed Income Fund may invest as
much as 100% of its assets in issuers from one or two countries, which may
include the United States. The Global Hedged Equity Fund is referred to as a
"Fixed Income Fund" despite its substantial investment in equity securities
because, as described more fully in the description of that Fund, the Global
Hedged Equity attempts to hedge the general equity market risk of its equity
investments, producing a theoretical fixed income return, plus or minus the
performance of the Fund's equity holdings relative to equity markets generally.
SHORT-TERM INCOME FUND
The Short-Term Income Fund seeks current income to the extent
consistent with the preservation of capital and liquidity through investment in
a portfolio of fixed income instruments rated high quality by Standard & Poor's
Corporation ("S&P") or by Moody's Investors Service, Inc. ("MOODY'S") or
considered by the Manager to be of comparable quality. While the Short- Term
Income Fund intends to invest in short-term securities, it is not a money market
fund. Debt securities held by the Fund which have a remaining maturity of 60
days or less will be valued at amortized cost unless circumstances dictate
otherwise. See "Determination of Net Asset Value." It is the present policy of
the Short-Term Income Fund, which may be changed without shareholder approval,
to maintain at least 65% of the Fund's assets invested in securities with
remaining maturities of two years or less.
In determining whether a security is a suitable investment for the
Short-Term Income Fund, reference will be made to the quality of the security,
including its rating, at the time of purchase. The Manager may or may not
dispose of a portfolio security as a result of a change in the securities'
rating, depending on its evaluation of the security in light of the Fund's
investment objectives and policies.
The Fund may invest in prime commercial paper and master demand notes
(rated "A-1" by S&P or "Prime-1" by Moody's or, if not rated, issued by
companies having an outstanding debt issue rated at least "AA" by S&P or at
least
-37-
"Aa" by Moody's), high-quality corporate debt securities (rated at least "AA" by
S&P or at least "Aa" by Moody's), and high-quality debt securities backed by
pools of commercial or consumer finance loans (rated at least "AA" by S&P or
"Aa" by Moody's) and certificates of deposit, bankers' acceptances and other
bank obligations (when and if such other bank obligations become available in
the future) issued by banks having total assets of at least $2 billion as of the
date of the bank's most recently published financial statement.
In addition to the foregoing, the Short-Term Income Fund may also
invest in certificates of deposit of $100,000 or less of domestic banks and
savings and loan associations, regardless of total assets, if the certificates
of deposit are fully insured as to principal by the Federal Deposit Insurance
Corporation or the Federal Savings and Loan Insurance Corporation. The Short-
Term Income Fund may invest up to 100% of its assets in obligations issued by
banks, and up to 15% of its assets in obligations issued by any one bank. If the
bank is a domestic bank, it must be a member of the Federal Deposit Insurance
Corporation. This does not prevent the Short-Term Income Fund from investing in
obligations issued by foreign branches of domestic banks and there is currently
no limit on the Fund's ability to invest in these obligations. If the bank is
foreign, the obligation must, in the opinion of the Manager, be of a quality
comparable to the other debt securities which may be purchased by the Short-Term
Income Fund. There are special risks associated with investments in such foreign
bank obligations, including the risks associated with foreign political,
economic and legal developments and the fact that foreign banks may not be
subject to the same or similar regulatory requirements that apply to domestic
banks. (See "Description and Risks of Fund Investments - Certain Risks of
Foreign Investments.") The Short-Term Income Fund will invest in these
securities only when the Manager believes the risks are minimal. In addition, to
the extent the Short-Term Income Fund concentrates its assets in the banking
industry, including the domestic banking industry, adverse events affecting the
industry may also have an adverse effect on the Fund. Such adverse events
include, but are not limited to, rising interest rates which affect a bank's
ability to maintain the "spread" between the cost of money and any fixed return
earned on money, as well as industry-wide increases in loan default rates and
declines in the value of loan collateral such as real estate. The Fund may also
invest in U.S. Government Securities.
The Short-Term Income Fund may purchase any of the foregoing
instruments through firm commitment arrangements with domestic commercial banks
and registered broker-dealers and may enter into repurchase agreements with such
banks and broker-dealers with respect to any of the foregoing money market
instruments, longer term U.S. Government Securities or corporate debt securities
rated at least "AA" by S&P or at least "Aa" by Moody's. The Fund will only enter
into firm commitment arrangements and repurchase agreements with banks and
broker-dealers which the Manager determines present minimal credit risks.
All of the Short-Term Income Fund's investments will, at the time of
investment, have remaining maturities of five years or less and the average
maturity of the Short-Term Income Fund's portfolio securities based on their
dollar value will not exceed two years at the time of each investment. When the
Fund has purchased a security subject to a repurchase agreement, the amount and
maturity of the Fund's investment will be determined by reference to the amount
and term of the repurchase agreement, not by reference to the underlying
security. When the Fund purchases an adjustable rate security, the security's
maturity will be determined with reference to the frequency with which the rate
is adjusted. If the disposition of a portfolio security results in a
dollar-weighted average portfolio maturity in excess of two years for the Fund,
it will invest its available cash in such a manner as to reduce its
dollar-weighted average maturity to two years or less as soon as reasonably
practicable.
The Fund may also invest in foreign securities when the Manager
believes the risks are minimal, and lend portfolio securities valued at up to
one-third of total assets.
For a detailed description of the investment practices described in the
preceding paragraphs and the risks associated with them, see "Description and
Risks of Fund Investments."
GLOBAL HEDGED EQUITY FUND
The Global Hedged Equity Fund seeks total return consistent with
minimal exposure to general equity market risk. Although at least 65% of the
Fund's total assets will be invested in equity securities, as a result of the
Fund's hedging techniques, the Fund expects to create a return more similar to
that received by an investment in fixed income securities. The Fund will pursue
its investment objective by investing substantially all of its assets in a
combination of (i) equity securities, (ii) derivative instruments intended to
hedge the value of the Fund's equity securities against substantially all of the
general movements in the relevant equity market(s), including hedges against
substantially all of the changes in the value of the U.S. dollar relative to the
currencies represented in the indices used to hedge general equity market risk
and (iii) long interest rate futures contracts intended to adjust the duration
of the theoretical fixed income security embedded in the pricing of the
derivatives used for hedging the Fund's equity securities (the "THEORETICAL
FIXED INCOME SECURITY"). The Fund may also buy exchange traded or
over-the-counter put and call options and sell (write) covered options for
hedging or investment. To the extent that the Fund's portfolio strategy is
successful, the Fund is expected to achieve a total return consisting of (i) the
performance of the Fund's equity securities, relative to the relevant equity
market indices (including appreciation or depreciation of any overweighted
currency relative to the currency weighting of the equity hedge), plus or minus
(ii) short-term capital gains or losses approximately equal to the total return
on the Theoretical Fixed Income Security, plus or minus (iii) capital gains or
losses on the Fund's interest rate futures positions minus (iv) transaction
costs and other Fund expenses. Investors should understand that, as opposed to
-38-
conventional equity portfolios, to the extent that the Fund's hedging positions
are effective, the performance of the Fund is not expected to correlate with the
movements of equity markets generally. Rather, the performance of the Fund will
tend to be a function of the total return on fixed income securities and the
performance of the Fund's equity securities relative to broad market indices,
including changes in overweighted currencies relative to the currency weighting
of those indices.
The Global Hedged Equity Fund has a fundamental policy that, under
normal market conditions, at least 65% of its total assets will be invested in
equity securities. In addition, under normal market conditions, the Fund will
invest in securities principally traded in the securities markets of at least
three countries. The Global Hedged Equity Fund will generally invest in at least
125 different common stocks chosen from among (i) U.S. stocks in which the Core
Fund is permitted to invest and (ii) stocks traded primarily outside of the
United States in which the International Core Fund is permitted to invest. The
Fund may invest up to 20% of its assets in securities of issuers in newly
industrializing countries of the type invested in by the Emerging Markets Fund.
The Manager will select which common stocks to purchase based on its assessment
of whether the common stock of an issuer (and/or the currency in which the stock
is traded) is likely to perform better than the broad global equity market index
(the "SELECTED EQUITY INDEX") selected by the Manager to serve as a hedge for
the Fund's portfolio as a whole.
As indicated above, the Fund will seek to hedge fully the value of its
equity holdings (measured in U.S. dollars) against substantially all movements
in the global equity markets (measured in U.S. dollars). This means that, if the
hedging strategy is successful, when the world equity markets and/or the U.S.
dollar go up or down, the Fund's net asset value will not be materially affected
by those movements in the relevant equity or currency markets generally, but
will rise or fall based primarily on whether the Fund's selected equity
securities perform better or worse than the Selected Equity Index. Those changes
will include the changes in any overweighted currency relative to the currency
weighting of the Selected Equity Index.
The Fund may use a variety of equity hedging instruments. It is
currently anticipated that the Fund will primarily use a combination of short
equity swap contracts and Index Futures for the purpose of hedging equity market
exposure, including, to the extent permitted by regulations of the Commodity
Futures Trading Commission, those traded on foreign markets. Derivative short
positions represented by the Fund's equity swap contracts will generally relate
to modified versions of the market capitalization weighted U.S., Europe,
Australia and Far East Index (or "GLOBAL INDEX") calculated by Morgan Stanley
Capital International. These modified indices ("MODIFIED GLOBAL INDEX"), which
are maintained by the Manager, generally reduce the size of the Japanese equity
markets for purposes of the country weighting by 40% or more. The Fund generally
expects to build its currency hedging into its equity swap contracts, although
it may also attempt to hedge directly its foreign currency-denominated portfolio
securities against an appreciation in the U.S. dollar relative to the foreign
currencies in which such securities are denominated.
The Manager expects to select specific equity investments without
regard to the country weightings of the Modified Global Index and in some cases
may intentionally emphasize holdings in a particular market or traded in a
particular currency. Because the country market and currency weighting of the
Modified Global Index will generally not precisely mirror the country market
weightings represented by the Fund's equity securities, there will be an
imperfect correlation between the Fund's equity securities and the hedging
position(s). Consequently, the Fund's hedging strategies using those equity swap
contracts are expected to be somewhat imperfect. This means there is a risk that
if the Fund's equity securities decline in value as a result of general market
conditions, the hedging position(s) may not appreciate enough to offset that
decline (or may actually depreciate). Likewise, if the Fund's equity securities
increase in value, that value may be more than offset by a decline in the value
of the hedging position(s). Also, because the Manager may conclude that a
particular currency is likely to appreciate relative to the currencies
represented by the Selected Equity Index, securities traded in that particular
currency may be overweighted relative to the Selected Equity Index. Such an
overweighted position may result in a loss or reduced gain to the Fund (even
when the security appreciates in local currency) if the relevant currency
depreciates relative to the currencies represented by the Modified Global Index.
The Fund's hedging positions are also expected to increase or decrease
the Fund's gross total return by an amount approximating the total return on
relevant short-term fixed income securities referred to above as the Theoretical
Fixed Income Security. For example, as the holder of a short derivative position
on an equity index, the Fund will be obligated to pay the holder of the long
position (the "counterparty") the total return on that equity index. The Fund's
contractual obligation eliminates for the counterparty the opportunity cost that
would be associated with actually owning the securities underlying that equity
index. That opportunity cost would generally be considered the total return that
a counterparty could achieve if the counterparty's capital were invested in a
short-term fixed income security (i.e., up to 2 years maturity) rather than in
the securities underlying the Relevant Equity Index. Because the counterparty is
relieved of this cost, the pricing of the hedging instruments is designed to
compensate the holder of the short position (in this case the Fund) by paying to
the holder the total return on the Theoretical Fixed Income Security. (Another
way of thinking about this is that the holder of the short position must, in
theory, be compensated for the cost of borrowing money over some relatively
short term (generally up to 2 years) to purchase an equity portfolio matching
that holder's obligations under the hedging instrument.)
In practice, the Manager has represented that generally, if there is no
movement in the Relevant Equity Index during the
-39-
term of the derivative instrument, the Fund as the holder of the short (hedging)
position would be able to close out that position with a gain or loss equal to
the total return on a Theoretical Fixed Income Security with a principal amount
equal to the face or notional amount of the hedging instrument.
The total return on the Theoretical Fixed Income Security would be
accrued interest plus or minus the capital gain or loss on that security. In the
case of Index Futures, the Fund would expect the Theoretical Fixed Income
Security would be one with a term equal to the remaining term of the Index
Future and bearing interest at a rate approximately equal to the weighted
average interest rate for money market obligations denominated in the currency
or currencies used to settle the Index Futures (generally LIBOR if settled in
U.S. dollars). In the case of equity swap contracts, the Manager can specify the
Theoretical Fixed Income Security whose total return will be paid to (or payable
by) the Fund. In cases where the Manager believes the implicit "duration" of the
Fund's theoretical fixed income securities is too short to provide an acceptable
total return, the Fund may enter into long interest rate futures (or purchase
call options on longer maturity fixed-income securities) which, together with
the Theoretical Fixed Income Security, creates a synthetic Theoretical Fixed
Income Security with a longer duration (but never with a duration causing the
Fund's overall duration to exceed that of 3-year U.S. Treasury obligations) (See
"Description and Risks of Fund Investments -- Use of Options, Futures and
Options on Futures -- Investment Purposes"). The Fund will segregate cash, U.S.
Treasury obligations and other high grade debt obligations in an amount equal,
on a marked-to- market basis, to the Fund's obligations under the interest rate
futures. Duration is the average time until payment (or anticipated payment in
the case of a callable security) of interest and principal on a fixed income
security, weighted according to the present value of each payment.
If interest rates rise, the Fund would expect that the value of any
long interest rate future owned by the Fund would decline and that amounts
payable to the Fund under an equity swap contract in respect of the Theoretical
Fixed Income Security would decrease or that amounts payable by the Fund
thereunder would increase. Any such decline (and/or the amount of any such
decrease or increase under a short equity swap contract) could be greater than
the derivative "interest" received on the Fund's Theoretical Fixed Income
Securities. The Fund's gross return is also expected to be reduced by
transaction costs and other Fund expenses. Those expenses will generally include
currency hedging costs if interest rates outside the U.S. are higher than those
in the U.S.
For the equity swap contracts entered into by the Fund, the
counterparty will typically be a bank, investment banking firm or broker/dealer.
The counterparty will generally agree to pay the Fund (i) interest on the
Theoretical Fixed Income Security with a principal amount equal to the notional
amount of the equity swap contract plus (ii) the amount, if any, by which that
notional amount would have decreased in value (measured in U.S. Dollars) had it
been invested in the stocks comprising the equity index agreed to by the Fund
(the "Contract Index") in proportion to the composition of the Contract Index.
(The Contract Index will be the Modified Global Index except that, to the extent
short futures contracts on a particular country's equity securities are also
used by the Fund, the Contract Index may be the Modified Global Index with a
reduced weighting for that country to reflect the futures position.) The Fund
will agree to pay the counterparty (i) any negative total return on the
Theoretical Fixed Income Security plus (ii) the amount, if any, by which the
notional amount of the equity swap contract would have increased in value
(measured in U.S. Dollars) had it been invested in the stocks comprising the
Contract Index plus (iii) the dividends that would have been received on those
stocks. Therefore, the return to the Fund on any equity swap contract should be
the total return on the Theoretical Fixed Income Security reduced by the gain
(or increased by the loss) on the notional amount as if invested in the Contract
Index and reduced by the dividends on the stocks comprising the Contract Index.
The Fund will only enter into equity swap contracts on a net basis, i.e., the
two parties' obligations are netted out, with the Fund paying or receiving, as
the case may be, only the net amount of any payments. Payments under the equity
swap contracts may be made at the conclusion of the contract or periodically
during its term.
The Fund may from time to time enter into the opposite side of equity
swap contracts (i.e., where the Fund is obligated to pay the decrease (or
receive the increase) on the Contract Index increased by any negative total
return (and decreased by any positive total return) on the Theoretical Fixed
Income Security) to reduce the amount of the Fund's equity market hedging
consistent with the Fund's objective. These positions are sometimes referred to
as "long equity swap contracts." The Fund may also take long positions in index
futures for similar purposes.
The Fund may also take a long position in index futures to reduce the
amount of the Fund's equity market hedging consistent with the Fund's objective.
When hedging positions are reduced using index futures, the Fund will also be
exposed to the risk of imperfect correlations between the index futures and the
hedging positions being reduced.
The Fund will use a combination of long and short equity swap contracts
and long and short positions in index futures in an attempt to hedge generally
its equity securities against substantially all movements in the relevant equity
markets generally. The Fund will not use equity swap contracts or Relevant
Equity Index Futures to leverage the Fund.
The Fund's actual exposure to an equity market or markets will not be
completely hedged if the aggregate of the notional amount of the long equity
swap contracts (less the notional amount of any short equity swap contracts)
relating to the relevant equity index plus the face amount of the short Index
Futures (less the face amount of any long Index Futures) is less than the Fund's
total net assets invested in common stocks principally traded on such market or
markets and will tend to be
-40-
overhedged if such aggregate is more than the Fund's total net assets so
invested. Under normal conditions, the Manager expects the Fund's total net
assets invested in equity securities generally to be up to 5% more or less than
this aggregate because purchases and redemptions of Fund shares will change the
Fund's total net assets frequently, because Index Futures can only be purchased
in integral multiples of an equity index and because the Funds' positions may
appreciate or depreciate over time. Also, the ability of the Fund to hedge risk
may be diminished by imperfect correlations between price movements of the
underlying equity index with the price movements of Index Futures relating to
that index and by lack of correlation between the market weightings of the
Modified Global Index, on the one hand, and, on the other, the market weightings
represented by the common stocks selected for purchase by the Fund.
In theory, the Fund will only be able to achieve its objective with
precision if (i) the aggregate face amount of the net short Index Futures plus
the notional amount of the long equity swap contracts (less the notional amount
of any short equity swap contracts) relating to the Selected Equity Index is
precisely equal to a Fund's total net assets, (ii) there is exact price movement
correlation between any Index Futures and the relevant equity index, (iii) there
is exact price correlation between the Modified Global Index and the overall
movements of the relevant equity markets and (iv) the Fund's currency hedging
strategies are effective. As noted, in practice there are a number of risks and
cash flows which will tend to undercut these assumptions.
The purchase and sale of common stocks and Index Futures involve
transaction costs and reverse equity swap contracts require the Fund to pay
interest on the notional amount of the contract.
In addition to the practices described above, in order to pursue its
objective the Fund may invest in securities of foreign issuers traded on U.S.
exchanges and securities traded abroad, American Depositary Receipts, European
Depository Receipts and other similar securities convertible into securities of
foreign issuers. The Fund may also invest up to 15% of its net assets in
illiquid securities and temporarily invest up to 50% of its assets in cash and
high quality money market instruments such as securities issued by the U.S.
government and agencies thereof, bankers' acceptances, commercial paper, and
bank certificates of deposit.
The Fund may also enter repurchase agreements, and lend portfolio
securities valued at up to one-third of total assets.
In addition, for hedging purposes only the Fund may use forward foreign
currency contracts, currency futures contracts, related options and options on
currencies, and buy and sell foreign currencies.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments" later in this Prospectus.
DOMESTIC BOND FUND
The Domestic Bond Fund seeks to earn high total return through
investment primarily in U.S. Government Securities. The Fund may also invest a
significant portion of its assets in other investment grade bonds (including
convertible bonds) denominated in U.S. dollars. The Fund's portfolio will
generally have a duration of approximately four to six years (excluding
short-term investments). The duration of a fixed income security is the weighted
average maturity, expressed in years, of the present value of all future cash
flows, including coupon payments and principal repayments. The Fund will attempt
to provide a total return greater than that generally provided by the U.S.
government securities market as measured by an index selected from time to time
by the Manager. The Fund may invest in fixed income securities of any maturity,
although the Fund expects that at least 65% of its total assets will be
comprised of "bonds" (as such term is defined earlier) of U.S. issuers. Fixed
income securities include securities issued by federal, state, local and foreign
governments, and a wide range of private issuers.
The Fund may lend portfolio securities valued at up to one-third of
total assets, invest up to 5% of its assets in lower rated securities (also
known as "junk bonds"), and invest in adjustable rate securities, zero coupon
securities and depository receipts. The Fund may also enter into repurchase
agreements, reverse repurchase agreements and dollar roll transactions. The Fund
may also enter into loan participation agreements and invest in other direct
debt instruments. In addition, the Fund may invest in mortgage-backed and other
asset-backed securities issued by the U.S. government, its agencies and by
non-government issuers, including collateral mortgage obligations ("CMO's"),
strips and residuals. The Fund may also invest in indexed securities the
redemption values and/or coupons of which are indexed to the prices of other
securities, securities indices, currencies, precious metals or other
commodities, or other financial indicators. The Fund may also enter into firm
commitment agreements with banks or broker-dealers, and may invest up to 15% of
its net assets in illiquid securities.
In addition, the Fund may buy put and call options, sell (write)
covered options, and enter into futures contracts and options on futures
contracts for hedging, investment and risk management and to effect synthetic
sales and purchases. The Fund's use of options on particular securities (as
opposed to market indices) is limited such that the premiums paid by the Fund on
all outstanding options it has purchased may not exceed 5% of its total assets.
The Fund may also use interest rate swap contracts, contracts for differences
and interest rate caps, floors and collars for hedging, investment and risk
management.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
-41-
INTERNATIONAL BOND FUND
The International Bond Fund seeks to earn high total return through
investment primarily in investment-grade bonds (including convertible bonds)
denominated in various currencies, including U.S. dollars, or in multicurrency
units. The Fund will attempt to provide a total return greater than that
generally provided by the international fixed income securities markets as
measured by an index selected from time to time by the Manager. Because the Fund
will not generally attempt to hedge against an appreciation in the U.S. dollar
relative to the foreign currency in which its portfolio securities are
denominated, investors should expect that the Fund's performance will be
adversely affected by appreciation of the U.S. dollar and will be positively
affected by a decline in the U.S. dollar relative to the currencies in which the
Funds' portfolio securities are denominated.
The Fund may invest in fixed income securities of any maturity,
although the Fund expects that at least 65% of its total assets will be
comprised of "bonds" as such term is defined above. Fixed income securities
include securities issued by federal, state, local and foreign governments, and
a wide range of private issuers.
The Fund may enter into loan participation agreements and other direct
investments, forward foreign exchange agreements, and purchase or sell
securities on a when-issued or delayed delivery basis. The Fund may also invest
a portion of its assets in sovereign debt (bonds, including convertible bonds
and Brady bonds, and loans) of countries in Asia, Latin America, the Middle
East, Southern Europe, Eastern Europe and Africa (see "Emerging Country Debt
Fund") and, to the extent permitted by the 1940 Act, may invest in shares of the
Emerging Country Debt Fund.
The Fund may lend portfolio securities valued at up to one-third of
total assets, invest up to 25% of its assets in lower rated securities (also
known as "junk bonds"), and invest in adjustable rate securities, zero coupon
securities and depositary receipts of foreign issuers. The Fund may also enter
into repurchase agreements, reverse repurchase agreements and dollar roll
agreements. In addition, the Fund may invest in mortgage-backed and other
asset-backed securities issued by the U.S. government, its agencies and by
non-government issuers, including collateral mortgage obligations ("CMO's"),
strips and residuals. The Fund may also invest in indexed securities the
redemption values and/or coupons of which are indexed to the prices of other
securities, securities indices, currencies, precious metals or other
commodities, or other financial indicators. The Fund may also enter into firm
commitment agreements with banks or broker-dealers, and may invest up to 15% of
its net assets in illiquid securities.
The Fund may buy put and call options, sell (write) covered options,
and enter into futures contracts and options on futures contracts for hedging,
investment and risk management and to effect synthetic sales and purchases. The
Fund's use of options on particular securities (as opposed to market indices) is
limited such that the premiums paid by the Fund on all outstanding options it
has purchased may not exceed 10% of its total assets. The Fund may also write
options in connection with buy-and-write transactions, and use index futures on
foreign indices for investment, anticipatory hedging and risk management. In
addition, the Fund may use forward foreign currency contracts, currency futures
contracts and related options, currency swap contracts, options on currencies,
and buy and sell currencies for hedging, and for currency risk management. The
Fund may also use synthetic bonds and synthetic foreign currency denominated
securities to approximate desired risk/return profiles where the desired profile
is either unavailable or possesses undesirable characteristics.
In addition, the Fund may use interest rate swap contracts, contracts
for differences and interest rate caps, floors and collars for hedging,
investment and risk management.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
CURRENCY HEDGED INTERNATIONAL BOND FUND
The Currency Hedged International Bond Fund seeks to earn high total
return through investment primarily in investment- grade bonds (including
convertible bonds) denominated in various currencies including U.S. dollars or
in multicurrency units. The Fund will attempt to provide a total return greater
than that generally provided by the international fixed income securities
markets as measured by an index selected from time to time by the Manager. The
Fund has the same objectives and policies as the International Bond Fund, except
that the Currency Hedged International Bond Fund will generally attempt to hedge
at least 75% of its foreign currency-denominated portfolio securities against an
appreciation in the U.S. dollar relative to the foreign currencies in which the
portfolio securities are denominated. However, there can be no assurance that
the Fund's hedging strategies will be totally effective.
The Fund may invest in fixed income securities of any maturity,
although the Fund expects that at least 65% of its total assets will be
comprised of "bonds" as such term is defined above. Fixed income securities
include securities issued by federal, state, local and foreign governments, and
a wide range of private issuers.
The Fund may enter into loan participation agreements and other direct
investments, forward foreign exchange agreements and purchase or sell securities
on a when-issued or delayed delivery basis. The Fund may also invest a portion
of its assets in sovereign debt (bonds, including convertible bonds and Brady
Bonds, and loans) of countries in Asia, Latin America, the Middle East, Southern
Europe, Eastern Europe and Africa (see "Emerging Country Debt Fund") and, to the
extent permitted by the 1940 Act, may invest in shares of the Emerging Country
Debt Fund.
-42-
The Fund may lend portfolio securities valued at up to one-third of
total assets, invest up to 25% of its assets in lower rated securities (also
known as "junk bonds"), and invest in adjustable rate securities, zero coupon
securities and depositary receipts of foreign issuers. The Fund may also enter
into repurchase agreements, reverse repurchase agreements and dollar roll
agreements. In addition, the Fund may invest in mortgage-backed and other
asset-backed securities issued by the U.S. government, its agencies and by
non-government issuers, including collateral mortgage obligations ("CMO's"),
strips and residuals. The Fund may also invest in indexed securities the
redemption values and/or coupons of which are indexed to the prices of other
securities, securities indices, currencies, precious metals or other
commodities, or other financial indicators. The Fund may also enter into firm
commitment agreements with banks or broker-dealers, and may invest up to 15% of
its net assets in illiquid securities.
The Fund may buy put and call options, sell (write) covered options,
and enter into futures contracts and options on futures contracts for hedging,
investment and risk management and to effect synthetic sales and purchases. The
Fund's use of options on particular securities (as opposed to market indices) is
limited such that the premiums paid by the Fund on all outstanding options it
has purchased may not exceed 10% of its total assets. The Fund may also write
options in connection with buy-and-write transactions, and use index futures on
foreign indices for investment, anticipatory hedging and risk management. In
addition, the Fund may use forward foreign currency contracts, currency futures
contracts and related options, currency swap contracts, options on currencies,
and buy and sell currencies for hedging, and for currency risk management. The
Fund may also use synthetic bonds and synthetic foreign currency denominated
securities to approximate desired risk/return profiles where the desired profile
is either unavailable or possesses undesirable characteristics.
In addition, the Fund may use interest rate swap contracts, contracts
for differences and interest rate caps, floors and collars for hedging,
investment and risk management.
For a detailed description of the investment practices described in the
three preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments."
GLOBAL BOND FUND
The Global Bond Fund seeks to earn high total return through investment
primarily in investment-grade bonds (including convertible bonds) denominated in
various currencies, including U.S. dollars, or in multicurrency units. The Fund
will attempt to provide a total return greater than that generally provided by
the global fixed income securities markets as measured by an index selected from
time to time by the Manager. The Fund will invest in fixed income securities of
both United States and foreign issuers. Because the Fund will not generally
attempt to hedge against an appreciation in the U.S. dollar relative to the
foreign currencies in which some of its portfolio securities are denominated,
investors should expect that the Fund's performance will be adversely affected
by appreciation of the U.S. dollar and will be positively affected by a decline
in the U.S. dollar relative to the currencies in which the Funds' portfolio
securities are denominated.
The Fund may invest in fixed income securities of any maturity,
although the Fund expects that at least 65% of its total assets will be
comprised of "bonds" as such term is defined above. Fixed income securities
include securities issued by federal, state, local and foreign governments, and
a wide range of private issuers.
Under certain adverse investment conditions, the Fund may restrict the
number of securities markets in which assets will be invested, although under
normal market circumstances it is expected that the Fund's investments will
involve securities principally traded in at least three different countries. For
temporary defensive purposes, the Fund may invest up to 100% of its assets in
securities principally traded in the United States and/or denominated in U.S.
dollars.
The Fund may enter into loan participation agreements and other direct
investments, forward foreign exchange agreements, and purchase or sell
securities on a when-issued or delayed delivery basis. The Fund may also invest
a portion of its assets in sovereign debt (bonds, including convertible bonds
and Brady bonds, and loans) of countries in Asia, Latin America, the Middle
East, Southern Europe, Eastern Europe and Africa (See "Emerging Country Debt
Fund") and, to the extent permitted by the 1940 Act, may invest in shares of the
Emerging Country Debt Fund, the Domestic Bond Fund and/or the International Bond
Fund.
The Fund may lend portfolio securities valued at up to one-third of
total assets, invest up to 25% of its assets in lower rated securities (also
known as "junk bonds"), and invest in adjustable rate securities, zero coupon
securities and depository receipts of foreign issuers. The Fund may also enter
into repurchase agreements, reverse repurchase agreements and dollar roll
transactions. In addition, the Fund may invest in mortgage-backed and other
asset-backed securities issued by the U.S. government, its agencies and by
non-government issuers, including collateral mortgage obligations ("CMO's"),
strips and residuals. The Fund may also invest in indexed securities the
redemption values and/or coupons of which are indexed to the prices of other
securities, securities indices, currencies, precious metals or other
commodities, or other financial indicators. The Fund may also enter into firm
commitment agreements with banks or broker-dealers, and may invest up to 15% of
its net assets in illiquid securities.
The Fund may buy put and call, sell (write) covered options, and enter
into futures contracts and options on futures contracts for hedging, investment
and risk management and to effect synthetic sales and purchases. The Fund's use
of options on particular securities (as opposed to market indices) is limited
-43-
such that the premiums paid by the Fund on all outstanding options it has
purchased may not exceed 10% of its total assets. The Fund may also write
options in connection with buy-and- write transactions, and use index futures on
foreign indices for investment, anticipatory hedging and risk management. In
addition, the Fund may use forward foreign currency contracts, currency futures
contracts and related options, currency swap contracts, options on currencies,
and buy and sell currencies for hedging and for currency risk management. The
Fund may also use futures contracts and foreign currency forward contracts to
create synthetic bonds and synthetic foreign currency denominated securities to
approximate desired risk/return profiles where the non-synthetic security having
the desired risk/return profile is either unavailable or possesses undesirable
characteristics.
In addition, the Fund may use interest rate and currency swap
contracts, contracts for differences and interest rate caps, floors and collars
for hedging, investment and risk management. The use of unsegregated futures
contracts, related options, interest rate floors, caps and collars and interest
rate swap contracts for risk management is limited to no more than 10% of the
Fund's total net assets when aggregated with the Fund's traditional borrowings.
This 10% limitation applies to the face amount of unsegregated futures contracts
and related options and to the amount of a Fund's net payment obligation that is
not segregated against in the case of interest rate floors, caps and collars and
interest rate swap contracts.
For a more detailed description of the investment practices described
above and the risks associated with them, see "Description and Risks of Fund
Investments" later in this Prospectus.
EMERGING COUNTRY DEBT FUND
The Emerging Country Debt Fund seeks to earn high total return by
investing primarily in sovereign debt (bonds, including convertible bonds, and
loans) of countries in Asia, Latin America, the Middle East and Africa, as well
as any country located in Europe which is not in the European Community
("EMERGING COUNTRIES"). In addition to considerations relating to investment
restrictions and tax barriers, allocation of the Fund's investments among
selected emerging countries will be based on certain other relevant factors
including the outlook for economic growth, currency exchange rates, interest
rates, political factors and the stage of the local market cycle. The Fund will
generally have at least 50% of its assets denominated in hard currencies such as
the U.S. dollar, Japanese yen, Italian lira, British pound, Deutchmark, French
franc and Canadian dollar. The Fund will attempt to provide a total return
greater than that generally provided by the international fixed income
securities markets as measured by an index selected from time to time by the
Manager.
The Fund has a fundamental policy that, under normal market conditions,
at least 65% of its total assets will be invested in debt securities of Emerging
Countries. In addition, the Fund may invest in fixed income securities of any
maturity, although the Fund expects that at least 65% of its total assets will
be comprised of "bonds" as such term is defined above. Fixed income securities
include securities issued by federal, state, local and foreign governments, and
a wide range of private issuers.
The Emerging Country Debt Fund's investments in Emerging Country debt
instruments are subject to special risks that are in addition to the usual risks
of investing in debt securities of developed foreign markets around the world,
and investors are strongly advised to consider those risks carefully. See
"Description and Risks of Fund Investments -- Certain Risks of Foreign
Investments."
The Fund may enter into loan participation agreements and other direct
investments, forward foreign exchange agreements, invest in Brady bonds and
purchase or sell securities on a when-issued or delayed delivery basis. The Fund
may also lend portfolio securities valued at up to one-third of total assets,
invest without limit in lower rated securities (also known as "junk bonds"), and
invest in adjustable rate securities, zero coupon securities and depository
receipts of foreign issuers. The Fund may also enter into repurchase agreements,
reverse repurchase agreements and dollar roll agreements. In addition, the Fund
may invest in mortgage-backed and other asset-backed securities issued by the
U.S. government, its agencies and by non-government issuers, including
collateral mortgage obligations ("CMO's"), strips and residuals. The Fund may
also invest in indexed securities the redemption values and/or coupons of which
are indexed to the prices of other securities, securities indices, currencies,
precious metals or other commodities, or other financial indicators. The Fund
may also enter into firm commitment agreements with banks or broker-dealers, and
may invest up to 15% of its net assets in illiquid securities.
The Fund may buy put and call options, sell (write) covered options,
and enter into futures contracts and options on futures contracts for hedging,
investment and risk management and to effect synthetic sales and purchases. The
Fund's use of options on particular securities (as opposed to market indices) is
limited such that the premiums paid by the Fund on all outstanding options it
has purchased may not exceed 10% of its total assets. The Fund may also write
options in connection with buy-and-write transactions, and use index futures on
foreign indices for investment, anticipatory hedging and risk management. In
addition, the Fund may use forward foreign currency contracts, currency futures
contracts and related options, currency swap contracts, options on currencies,
and buy and sell currencies for hedging, and for currency risk management. The
Fund may also use synthetic bonds and synthetic foreign currency denominated
securities to approximate desired risk/return profiles where the desired profile
is either unavailable or possesses undesirable characteristics.
In addition, the Fund may use interest rate swap contracts, contracts
for differences and interest rate caps, floors and collars for hedging,
investment and risk management.
-44-
For a detailed description of the investment practices described in the
four preceding paragraphs and the risks associated with them, see "Description
and Risks of Fund Investments" later in this Prospectus.
ASSET ALLOCATION FUNDS
The Asset Allocation Funds are mutual funds that invest in other Funds
of the Trust (referred to in this section as "underlying Funds") and, in doing
so, seek to outperform a specified benchmark. The Manager decides and manages
the allocation of the assets of each Asset Allocation Fund among a permitted
subset of underlying Funds, as set forth below. Thus, an investor in an Asset
Allocation Fund receives investment management within each of the underlying
Funds and receives management with respect to the allocation of the investment
among the underlying Funds as well.
The Manager does not charge an advisory fee for asset allocation advice
provided to the Asset Allocation Funds, but receives such fees only from the
underlying Funds in which the Asset Allocation Funds invest. Stated otherwise,
there are no investment advisory fees at the Asset Allocation Fund level.
Because the underlying Funds have differing fees, certain allocations will
produce greater overall fees for GMO than others. Certain expenses, such as
custody, transfer agency and audit fees, will be incurred at the Asset
Allocation Fund level.
Each Asset Allocation Fund will invest in Class III Shares of the
underlying Funds and will bear the .15% Shareholder Service Fees assessed
against those Class III shares.
Each Asset Allocation Fund offers only Class I and Class II Shares with
special lower Shareholder Service Fees that are designed to mitigate the
indirect cost of Shareholder Servicing Fees of the Class III shares of the
Underlying Funds in which the Asset Allocation Funds invest. Thus, Class I and
Class II shareholders of the Asset Allocation Funds will bear in the aggregate,
direct and indirect Shareholder Service Fees that are the same as those borne
directly by Class I and Class II shares of the other Funds (i.e., an aggregate
of .28% and .22% per annum, respectively). Investors should refer to "Multiple
Classes" herein for greater detail concerning the eligibility requirements and
other differences among the classes.
Investors in the Asset Allocation Funds should consider both the direct
risks associated with an investment in a "fund-of- funds," and the indirect
risks associated with an investment in the underlying Funds. See "Description
and Risks of Fund Investments -- Special Allocation Fund Considerations" for a
discussion of the risks directly associated with an investment in the Asset
Allocation Funds. Investors should also carefully review the "Investment
Objectives and Policies" description of each underlying Fund in which the
relevant Asset Allocation Fund may invest, as well as each corresponding
"Description and Risks of Fund Investments" section associated with each such
underlying Fund's investment practices.
INTERNATIONAL EQUITY ALLOCATION FUND
The International Equity Allocation Fund seeks a total return greater
than the return of its benchmark index - the "EAFE-LITE EXTENDED INDEX." This
index has been developed by the Manager and is a modification of the EAFE-lite
Index which includes a weighting for emerging countries. See "Investment
Objectives and Policies - International Core Fund" for a description of the
EAFE-lite Index. The Fund will pursue its objective by investing to varying
extents, as determined by Manager, primarily in Class III Shares of the
International Core Fund, Currency Hedged International Core Fund, Foreign Fund,
International Small Companies Fund, Japan Fund and Emerging Markets Fund.
Although the Fund is designed to be measured in comparison to the EAFE-lite
Extended Index, it is not an index fund or an "index-plus" fund, but rather
seeks to add total return in excess of the EAFE-lite Extended Index benchmark
both by making bets relative to that benchmark with respect to the allocation
among the underlying Funds, and by participating indirectly in the attempt that
each of the underlying Funds makes to outperform its own respective benchmark
index.
While the Fund's assets will be primarily invested in the Funds listed
above, the Fund may also hold cash and invest in short-term fixed income
securities, including shares of the Short- Term Income Fund and Global Hedged
Equity Fund and high quality money market instruments such as securities issued
by the U.S. government and agencies thereof, bankers' acceptances, commercial
paper and bank certificates of deposit.
For a detailed description of the objective and policies of each
underlying Fund, see "Investment Objectives and Policies" herein. For a detailed
description of the investment practices referred to therein, see "Description
and Risks of Fund Investments" later in this Prospectus.
WORLD EQUITY ALLOCATION FUND
The World Equity Allocation Fund seeks a total return greater than the
return of its benchmark index - the "WORLD LITE EXTENDED INDEX." This index has
been developed by the Manager and is a modification of the Morgan Stanley
Capital International World Index that reduces the weighting of Japan and
includes a weighting for emerging countries. The Fund will pursue its objective
by investing to varying extents, as determined by the Manager, in Class III
Shares of the Core Fund, Value Fund, Growth Fund, U.S. Sector Fund, Fundamental
Value Fund, Core II Secondaries Fund, REIT Fund, International Core Fund,
Currency Hedged International Core Fund, Foreign Fund, International Small
Companies Fund, Japan Fund and Emerging Markets Fund. Although the Fund is
designed to be measured in comparison to the World Lite Extended Index, it is
not an index fund or an "index-plus" fund, but rather seeks to add total return
in excess of the World Lite Extended Index benchmark both by making bets
relative to that benchmark with respect to the allocation among the underlying
Funds, and by participating
-45-
indirectly in the attempt that each of the underlying Funds makes to outperform
its own respective benchmark index.
While the Fund's assets will be primarily invested in the Funds listed
above, the Fund may also hold cash and invest in short-term fixed income
securities, including shares of the Short- Term Income Fund and Global Hedged
Equity Fund and high quality money market instruments such as securities issued
by the U.S. government and agencies thereof, bankers' acceptances, commercial
paper and bank certificates of deposit.
For a detailed description of the objective and policies of each
underlying Fund, see "Investment Objectives and Policies" herein. For a detailed
description of the investment practices referred to therein, see "Description
and Risks of Fund Investments" later in this Prospectus.
GLOBAL (U.S.+) EQUITY ALLOCATION FUND
The Global (U.S.+) Equity Allocation Fund seeks a total return greater
than the return of its benchmark index - the "GMO GLOBAL EQUITY INDEX." This
index has been developed by the Manager and is a weighted index comprised 75% by
the S&P 500 Index and 25% by the EAFE-lite Extended Index. The Fund will pursue
its objective by investing to varying extents, as determined by the Manager, in
Class III Shares of the Core Fund, Value Fund, Growth Fund, U.S. Sector Fund,
REIT Fund, Fundamental Value Fund, Core II Secondaries Fund, International Core
Fund, Currency Hedged International Core Fund, Foreign Fund, International Small
Companies Fund, Japan Fund and Emerging Markets Fund. Although the Fund is
designed to be measured in comparison to the GMO Global Equity Index, it is not
an index fund or an "index-plus" fund, but rather seeks to add total return in
excess of the GMO Global Equity Index benchmark both by making bets relative to
that benchmark with respect to the allocation among the underlying Funds, and by
participating indirectly in the attempt that each of the underlying Funds makes
to outperform its own respective benchmark index.
While the Fund's assets will be primarily invested in the Funds listed
above, the Fund may also hold cash and invest in short-term fixed income
securities, including shares of the Short- Term Income Fund and Global Hedged
Equity Fund and high quality money market instruments such as securities issued
by the U.S. government and agencies thereof, bankers' acceptances, commercial
paper and bank certificates of deposit.
For a detailed description of the objective and policies of each
underlying Fund, see "Investment Objectives and Policies" herein. For a detailed
description of the investment practices referred to therein, see "Description
and Risks of Fund Investments" later in this Prospectus.
GLOBAL BALANCED ALLOCATION FUND
The Global Balanced Allocation Fund seeks a total return greater than
the return of its benchmark index - the "GMO GLOBAL BALANCED INDEX." This index
has been developed by the Manager and is a weighted index comprised 48.75% by
the S&P 500, 16.25% by the EAFE-Lite Extended Index and 35% by the Lehman
Brothers Government Bond Index. The Fund will pursue its objective by investing
to varying extents, as determined by the Manager, in Class III Shares of the
Core Fund, Value Fund, Growth Fund, U.S. Sector Fund, Fundamental Value Fund,
Core II Secondaries Fund, REIT Fund, International Core Fund, Currency Hedged
International Core Fund, Foreign Fund, International Small Companies Fund, Japan
Fund, Emerging Markets Fund, Domestic Bond Fund, International Bond Fund,
Currency Hedged International Bond Fund and Emerging Country Debt Fund. The Fund
has a fundamental policy that it will, under normal market conditions, invest in
equity securities of underlying Funds such that, under normal market conditions,
at least 25% of the Fund's total assets will indirectly be invested in fixed
income senior securities. Although the Fund is designed to be measured in
comparison to the GMO Global Balanced Index, it is not an index fund or an
"index-plus" fund, but rather seeks to add total return in excess of the GMO
Global Balanced Index benchmark both by making bets relative to that benchmark
with respect to the allocation among the underlying Funds, and by participating
indirectly in the attempt that each of the underlying Funds makes to outperform
its own respective benchmark index.
While the Fund's assets will be primarily invested in the Funds listed
above, the Fund may also hold cash and invest in short-term fixed income
securities, including shares of the Short- Term Income Fund and Global Hedged
Equity Fund and high quality money market instruments such as securities issued
by the U.S. government and agencies thereof, bankers' acceptances, commercial
paper and bank certificates of deposit.
For a detailed description of the objective and policies of each
underlying Fund, see "Investment Objectives and Policies" herein. For a detailed
description of the investment practices referred to therein, see "Description
and Risks of Fund Investments" below.
DESCRIPTION AND RISKS OF FUND
INVESTMENTS
The following is a detailed description of the various investment
practices in which the Funds may engage and the risks associated with their use.
Not all Funds may engage in all practices described below. Please refer to the
"Investment Objectives and Policies" section above for determination of which
practices a particular Fund may engage in. Investors in Asset Allocation Funds
should be aware that the Asset Allocation Funds will indirectly engage in the
practices engaged in by the underlying Funds in which they are invested.
-46-
PORTFOLIO TURNOVER
Portfolio turnover is not a limiting factor with respect to investment
decisions for the Funds. The portfolio turnover rate of those Funds with at
least five months of operational history is shown under the heading "Financial
Highlights."
In any particular year, market conditions may well result in greater
rates than are presently anticipated. However, portfolio turnover for the REIT
Fund, the Currency Hedged International Core Fund, the Global Bond Fund and the
Foreign Fund is not expected to exceed 150%. High portfolio turnover involves
correspondingly greater brokerage commissions and other transaction costs, which
will be borne directly by the relevant Fund, and could involve realization of
capital gains that would be taxable when distributed to shareholders of the
relevant Fund unless such shareholders are themselves exempt. See "Taxes" below.
DIVERSIFIED AND NON-DIVERSIFIED PORTFOLIOS
It is a fundamental policy of each of the Core Fund, the Tobacco-Free
Core Fund, the Core II Secondaries Fund, the Fundamental Value Fund, the
International Core Fund, the International Small Companies Fund, the GMO
International Equity Allocation Fund, the GMO U.S. Equity with International
Allocation Fund, the GMO Global Equity Allocation Fund, and the GMO Global
Balanced Allocation Fund, which may not be changed without shareholder approval,
that at least 75% of the value of each such Funds' total assets are represented
by cash and cash items (including receivables), Government securities,
securities of other investment companies, and other securities for the purposes
of this calculation limited in respect of any one issuer to an amount not
greater in value than 5% of the value of the relevant Fund's total assets and to
not more than 10% of the outstanding voting securities of any single issuer.
Each such Fund is referred to herein as a "diversified" fund.
All other Funds are "non-diversified" funds under the 1940 Act, and as
such are not required to satisfy the "diversified" requirements stated above.
However, the Japan Fund may not own more than 10% of the outstanding voting
securities of any single issuer. As a non-diversified fund, each of these Funds
is permitted to (but is not required to) invest a higher percentage of its
assets in the securities of fewer issuers. Such concentration could increase the
risk of loss to such Funds should there be a decline in the market value of any
one portfolio security. Investment in a non-diversified fund may therefore
entail greater risks than investment in a diversified fund. All Funds, however,
must meet certain diversification standards to qualify as a "regulated
investment company" under the Internal Revenue Code of 1986.
CERTAIN RISKS OF FOREIGN INVESTMENTS
GENERAL. Investment in foreign issuers or securities principally traded
overseas may involve certain special risks due to foreign economic, political
and legal developments, including favorable or unfavorable changes in currency
exchange rates, exchange control regulations (including currency blockage),
expropriation of assets or nationalization, imposition of withholding taxes on
dividend or interest payments, and possible difficulty in obtaining and
enforcing judgments against foreign entities. Furthermore, issuers of foreign
securities are subject to different, often less comprehensive, accounting,
reporting and disclosure requirements than domestic issuers. The securities of
some foreign governments and companies and foreign securities markets are less
liquid and at times more volatile than comparable U.S. securities and securities
markets. Foreign brokerage commissions and other fees are also generally higher
than in the United States. The laws of some foreign countries may limit a Fund's
ability to invest in securities of certain issuers located in these foreign
countries. There are also special tax considerations which apply to securities
of foreign issuers and securities principally traded overseas. Investors should
also be aware that under certain circumstances, markets which are perceived to
have similar characteristics to troubled markets may be adversely affected
whether or not similarities actually exist.
EMERGING MARKETS. The risks described above apply to an even greater
extent to investments in emerging markets. The securities markets of emerging
countries are generally smaller, less developed, less liquid, and more volatile
than the securities markets of the U.S. and developed foreign markets.
Disclosure and regulatory standards in many respects are less stringent than in
the U.S. and developed foreign markets. There also may be a lower level of
monitoring and regulation of securities markets in emerging market countries and
the activities of investors in such markets, and enforcement of existing
regulations has been extremely limited. Many emerging countries have experienced
substantial, and in some periods extremely high, rates of inflation for many
years. Inflation and rapid fluctuations in inflation rates have had and may
continue to have very negative effects on the economies and securities markets
of certain emerging countries. Economies in emerging markets generally are
heavily dependent upon international trade and, accordingly, have been and may
continue to be affected adversely by trade barriers, exchange controls, managed
adjustments in relative currency values, and other protectionist measures
imposed or negotiated by the countries with which they trade. These economies
also have been and may continue to be adversely affected by economic conditions
in the countries in which they trade. The economies of countries with emerging
markets may also be predominantly based on only a few industries or dependent on
revenues from particular commodities. In addition, custodial services and other
costs relating to investment in foreign markets may be more expensive in
emerging markets than in many developed foreign markets, which could reduce a
Fund's income from such securities. Finally, because publicly traded debt
instruments of emerging markets represent a relatively recent innovation in the
world debt markets, there is little historical data or related market experience
concerning the attributes of such instruments under all economic, market and
political conditions.
-47-
In many cases, governments of emerging countries continue to exercise
significant control over their economies, and government actions relative to the
economy, as well as economic developments generally, may affect the capacity of
issuers of emerging country debt instruments to make payments on their debt
obligations, regardless of their financial condition. In addition, there is a
heightened possibility of expropriation or confiscatory taxation, imposition of
withholding taxes on interest payments, or other similar developments that could
affect investments in those countries. There can be no assurance that adverse
political changes will not cause a Fund to suffer a loss of any or all of its
investments or, in the case of fixed-income securities, interest thereon.
SECURITIES LENDING
All of the Funds (except for the Asset Allocation Funds) may make
secured loans of portfolio securities amounting to not more than one-third of
the relevant Fund's total assets, except for the International Core and Currency
Hedged International Core Funds, each of which may make loans of portfolio
securities amounting to not more than 25% of their respective total assets. The
risks in lending portfolio securities, as with other extensions of credit,
consist of possible delay in recovery of the securities or possible loss of
rights in the collateral should the borrower fail financially. However, such
loans will be made only to broker-dealers that are believed by the Manager to be
of relatively high credit standing. Securities loans are made to broker-dealers
pursuant to agreements requiring that loans be continuously secured by
collateral in cash or U.S. Government Securities at least equal at all times to
the market value of the securities lent. The borrower pays to the lending Fund
an amount equal to any dividends or interest the Fund would have received had
the securities not been lent. If the loan is collateralized by U.S. Government
Securities, the Fund will receive a fee from the borrower. In the case of loans
collateralized by cash, the Fund typically invests the cash collateral for its
own account in interest-bearing, short-term securities and pays a fee to the
borrower. Although voting rights or rights to consent with respect to the loaned
securities pass to the borrower, the Fund retains the right to call the loans at
any time on reasonable notice, and it will do so in order that the securities
may be voted by the Fund if the holders of such securities are asked to vote
upon or consent to matters materially affecting the investment. The Fund may
also call such loans in order to sell the securities involved. The Manager has
retained a lending agent on behalf of several of the Funds that is compensated
based on a percentage of a Fund's return on the securities lending activity. The
Fund also pays various fees in connection with such loans including shipping
fees and reasonable custodian fees approved by the Trustees of the Trust or
persons acting pursuant to direction of the Board.
DEPOSITORY RECEIPTS
Many of the Funds may invest in American Depositary Receipts (ADRs),
Global Depository Receipts (GDRs) and European Depository Receipts (EDRs)
(collectively, "Depository Receipts") if issues of such Depository Receipts are
available that are consistent with a Fund's investment objective. Depository
Receipts generally evidence an ownership interest in a corresponding foreign
security on deposit with a financial institution. Transactions in Depository
Receipts usually do not settle in the same currency in which the underlying
securities are denominated or traded. Generally, ADRs, in registered form, are
designed for use in the U.S. securities markets and EDRs, in bearer form, are
designed for use in European securities markets. GDRs may be traded in any
public or private securities markets and may represent securities held by
institutions located anywhere in the world.
CONVERTIBLE SECURITIES
A convertible security is a fixed-income security (a bond or preferred
stock) which may be converted at a stated price within a specified period of
time into a certain quantity of the common stock of the same or a different
issuer. Convertible securities are senior to common stock in a corporation's
capital structure, but are usually subordinated to similar non-convertible
securities. Convertible securities provide, through their conversion feature, an
opportunity to participate in capital appreciation resulting from a market price
advance in a convertible security's underlying common stock. The price of a
convertible security is influenced by the market value of the underlying common
stock and tends to increase as the market value of the underlying stock rises,
whereas it tends to decrease as the market value of the underlying stock
declines. The Manager regards convertible securities as a form of equity
security.
FUTURES AND OPTIONS
As described under "Investment Objectives and Policies" above, many of
the Funds may use futures and options for various purposes. Such transactions
may involve options, futures and related options on futures contracts, and those
instruments may relate to particular equity and fixed income securities, equity
and fixed income indices, and foreign currencies. The Funds may also enter into
a combination of long and short positions (including spreads and straddles) for
a variety of investment strategies, including protecting against changes in
certain yield relationships.
The use of futures contracts and options on futures contracts involves
risk. Thus, while a Fund may benefit from the use of futures and options on
futures, unanticipated changes in interest rates, securities prices, or currency
exchange rates may result in poorer overall performance for the Fund than if it
had not entered into any futures contracts or options transactions. Losses
incurred in transactions in futures and options on futures and the costs of
these transactions will affect a Fund's performance. See Appendix A, "Risks and
Limitations of Options, Futures and Swaps" for a more detailed discussion of the
limits, conditions and risks of the Funds' investments in futures contracts and
related options.
-48-
OPTIONS. As has been noted above, many Funds which may use options (1)
may enter into contracts giving third parties the right to buy the Fund's
portfolio securities for a fixed price at a future date (writing "covered call
options"); (2) may enter into contracts giving third parties the right to sell
securities to the Fund for a fixed price at a future date (writing "covered put
options"); and (3) may buy the right to purchase securities from third parties
("call options") or the right to sell securities to third parties ("put
options") for a fixed price at a future date.
WRITING COVERED OPTIONS. Each Fund (except for the Short-Term Income
Fund and the Asset Allocation Funds) may seek to increase its return by writing
covered call or put options on optionable securities or indices. A call option
written by a Fund on a security gives the holder the right to buy the underlying
security from the Fund at a stated exercise price; a put option gives the holder
the right to sell the underlying security to the Fund at a stated exercise
price. In the case of options on indices, the options are usually cash settled
based on the difference between the strike price and the value of the index.
Each such Fund will receive a premium for writing a put or call option,
which increases the Fund's return in the event the option expires unexercised or
is closed out at a profit. The amount of the premium will reflect, among other
things, the relationship of the market price and volatility of the underlying
security or securities index to the exercise price of the option, the remaining
term of the option, supply and demand and interest rates. By writing a call
option on a security, the Fund limits its opportunity to profit from any
increase in the market value of the underlying security above the exercise price
of the option. By writing a put option on a security, the Fund assumes the risk
that it may be required to purchase the underlying security for an exercise
price higher than its then current market value, resulting in a potential
capital loss unless the security subsequently appreciates in value. In the case
of options on an index, if a Fund writes a call, any profit by the Fund in
respect of portfolio securities expected to correlate with the index will be
limited by an increase in the index above the exercise price of the option. If
the Fund writes a put on an index, the Fund may be required to make a cash
settlement greater than the premium received if the index declines.
A call option on a security is "covered" if a Fund owns the underlying
security or has an absolute and immediate right to acquire that security without
additional cash consideration (or for additional cash consideration held in a
segregated account by its custodian) upon conversion or exchange of other
securities held in its portfolio. A call option is also covered if the Fund
holds on a share-for-share basis a call on the same security as the call written
where the exercise price of the call held is equal to or less than the exercise
price of the call written or greater than the exercise price of the call written
if the difference is maintained by the Fund in cash, U.S. Government Securities
or other high grade debt obligations in a segregated account with its custodian.
A put option is "covered" if the Fund maintains cash, U.S. Government Securities
or other high grade debt obligations with a value equal to the exercise price in
a segregated account with its custodian, or else holds on a share-for-share
basis a put on the same security as the put written where the exercise price of
the put held is equal to or greater than the exercise price of the put written.
If the writer of an option wishes to terminate his obligation, he may
effect a "closing purchase transaction." This is accomplished, in the case of
exchange traded options, by buying an option of the same series as the option
previously written. The effect of the purchase is that the writer's position
will be canceled by the clearing corporation. The writer of an option may not
effect a closing purchase transaction after he has been notified of the exercise
of an option. Likewise, an investor who is the holder of an option may liquidate
his position by effecting a "closing sale transaction." This is accomplished by
selling an option of the same series as the option previously purchased. There
is no guarantee that a Fund will be able to effect a closing purchase or a
closing sale transaction at any particular time. Also, an over-the-counter
option may be closed out only with the other party to the option transaction.
Effecting a closing transaction in the case of a written call option
will permit the Fund to write another call option on the underlying security
with either a different exercise price or expiration date or both, or in the
case of a written put option will permit the Fund to write another put option to
the extent that the exercise price thereof is secured by deposited cash or high
grade debt obligations. Also, effecting a closing transaction will permit the
cash or proceeds from the concurrent sale of any securities subject to the
option to be used for other Fund investments. If the Fund desires to sell a
particular security from its portfolio on which it has written a call option, it
will effect a closing transaction prior to or concurrent with the sale of the
security.
A Fund will realize a profit from a closing transaction if the price of
the transaction is less than the premium received from writing the option or is
more than the premium paid to purchase the option; the Fund will realize a loss
from a closing transaction if the price of the transaction is more than the
premium received from writing the option or is less than the premium paid to
purchase the option. Because increases in the market price of a call option will
generally reflect increases in the market price of the underlying security or
index of securities, any loss resulting from the repurchase of a call option is
likely to be offset in whole or in part by appreciation of the underlying
security or securities owned by the Fund.
A Fund may write options in connection with buy-and- write
transactions; that is, a Fund may purchase a security and then write a call
option against that security. The exercise price of the call the Fund determines
to write will depend upon the expected price movement of the underlying
security. The exercise price of a call option may be below ("in-the-money"),
equal to ("at-the-money") or above ("out-of-the-money") the current value of the
underlying security at the time the option is written. Buy-and-write
transactions using in-the-money call options may be used when it is expected
that the price of the
-49-
underlying security will remain flat or decline moderately during the option
period. Buy-and-write transactions using at-the-money call options may be used
when it is expected that the price of the underlying security will remain fixed
or advance moderately during the option period. Buy-and-write transactions using
out- of-the-money call options may be used when it is expected that the premiums
received from writing the call option plus the appreciation in the market price
of the underlying security up to the exercise price will be greater than the
appreciation in the price of the underlying security alone. If the call options
are exercised in such transactions, the Fund's maximum gain will be the premium
received by it for writing the option, adjusted upward or downward by the
difference between the Fund's purchase price of the security and the exercise
price. If the options are not exercised and the price of the underlying security
declines, the amount of such decline will be offset in part, or entirely, by the
premium received.
The writing of covered put options is similar in terms of risk/return
characteristics to buy-and-write transactions. If the market price of the
underlying security rises or otherwise is above the exercise price, the put
option will expire worthless and the Fund's gain will be limited to the premium
received. If the market price of the underlying security declines or otherwise
is below the exercise price, the Fund may elect to close the position or take
delivery of the security at the exercise price. In that event, the Fund's return
will be the premium received from the put option minus the cost of closing the
position or, if it chooses to take delivery of the security, the premium
received from the put option minus the amount by which the market price of the
security is below the exercise price. Out-of-the-money, at-the- money and
in-the-money put options may be used by the Fund in market environments
analogous to those in which call options are used in buy-and-write transactions.
The extent to which a Fund will be able to write and purchase call and
put options may be restricted by the Fund's intention to qualify as a regulated
investment company under the Internal Revenue Code.
FUTURES. A financial futures contract sale creates an obligation by the
seller to deliver the type of financial instrument called for in the contract in
a specified delivery month for a stated price. A financial futures contract
purchase creates an obligation by the purchaser to pay for and take delivery of
the type of financial instrument called for in the contract in a specified
delivery month, at a stated price. In some cases, the specific instruments
delivered or taken, respectively, at settlement date are not determined until on
or near that date. The determination is made in accordance with the rules of the
exchange on which the futures contract sale or purchase was made. Some futures
contracts are "cash settled" (rather than "physically settled," as described
above) which means that the purchase price is subtracted from the current market
value of the instrument and the net amount if positive is paid to the purchaser,
and if negative is paid by the purchaser. Futures contracts are traded in the
United States only on commodity exchanges or boards of trade -- known as
"contract markets" -- approved for such trading by the Commodity Futures Trading
Commission ("CFTC"), and must be executed through a futures commission merchant
or brokerage firm which is a member of the relevant contract market. Under U.S.
law, futures contracts on individual equity securities are not permitted. See
Appendix A, "Risks and Limitations of Options, Futures and Swaps" for more
information concerning these practices and their accompanying risks.
The purchase or sale of a futures contract differs from the purchase or
sale of a security or option in that no price or premium is paid or received.
Instead, an amount of cash or U.S. Government Securities generally not exceeding
5% of the face amount of the futures contract must be deposited with the broker.
This amount is known as initial margin. Subsequent payments to and from the
broker, known as variation margin, are made on a daily basis as the price of the
underlying futures contract fluctuates making the long and short positions in
the futures contract more or less valuable, a process known as "marking to
market." Prior to the settlement date of the futures contract, the position may
be closed out by taking an opposite position which will operate to terminate the
position in the futures contract. A final determination of variation margin is
then made, additional cash is required to be paid to or released by the broker,
and the purchaser realizes a loss or gain. In addition, a commission is paid on
each completed purchase and sale transaction.
In most cases futures contracts are closed out before the settlement
date without the making or taking of delivery. Closing out a futures contract
sale is effected by purchasing a futures contract for the same aggregate amount
of the specific type of financial instrument or commodity and the same delivery
date. If the price of the initial sale of the futures contract exceeds the price
of the offsetting purchase, the seller is paid the difference and realizes a
gain. Conversely, if the price of the offsetting purchase exceeds the price of
the initial sale, the seller realizes a loss. Similarly, the closing out of a
futures contract purchase is effected by the purchaser entering into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the
purchaser realizes a gain, and if the purchase price exceeds the offsetting sale
price, a loss will be realized.
The ability to establish and close out positions on options on futures
will be subject to the development and maintenance of a liquid secondary market.
It is not certain that this market will develop or be maintained.
INDEX FUTURES. Each of the Funds (except the Short- Term Income Fund)
may purchase futures contracts on various securities indices ("Index Futures").
Each of the Domestic Equity Funds may purchase Index Futures on the S&P 500
("S&P 500 Index Futures") and on such other domestic stock indices as the
Manager may deem appropriate. The Japan Fund may purchase Index Futures on the
Nikkei 225 Stock Average and on the Tokyo Stock Price Index ("TOPIX") (together
with Nikkei 225 futures contracts, "Japanese Index Futures"). The
-50-
International Core Fund, Currency Hedged International Core Fund, the Foreign
Fund, the International Small Companies Fund and the Emerging Markets Fund may
each purchase Index Futures on foreign stock indices, including those which may
trade outside the United States. The Domestic Bond Fund, the International Bond
Fund and the Currency Hedged International Bond Fund, the Global Bond Fund and
the Emerging Country Debt Fund may each purchase Index Futures on domestic and
(except for the Domestic Bond Fund) foreign fixed income securities indices,
including those which may trade outside the United States. A Fund's purchase and
sale of Index Futures is limited to contracts and exchanges which have been
approved by the CFTC.
An Index Future may call for "physical delivery" or be "cash settled."
An Index Future that calls for physical delivery is a contract to buy an
integral number of units of the particular securities index at a specified
future date at a price agreed upon when the contract is made. A unit is the
value from time to time of the relevant index. While a Fund that purchases an
Index Future that calls for physical delivery is obligated to pay the face
amount on the stated date, such an Index Future may be closed out on that date
or any earlier date by selling an Index Future with the same face amount and
contract date. This will terminate the Fund's position and the Fund will realize
a profit or a loss based on the difference between the cost of purchasing the
original Index Future and the price obtained from selling the closing Index
Future. The amount of the profit or loss is determined by the change in the
value of the relevant index while the Index Future was held.
Index Futures that are "cash settled" provide by their terms for
settlement on a net basis reflecting changes in the value of the underlying
index. Thus, the purchaser of such an Index Future is never obligated to pay the
face amount of the contract. The net payment obligation may in fact be very
small in relation to the face amount.
The use of Index Futures involves risk. See Appendix A, "Risks and
Limitations of Options, Futures and Swaps" for a more detailed discussion of the
limits, conditions and risks of the Funds' investment in futures contracts.
INTEREST RATE FUTURES. For the purposes previously described, the Fixed
Income Funds (other than the Short-Term Income Fund) may engage in a variety of
transactions involving the use of futures with respect to U.S. Government
Securities and other fixed income securities. The use of interest rate futures
involves risk. See Appendix A, "Risks and Limitations of Options, Futures and
Swaps" for a more detailed discussion of the limits, conditions and risks of the
Fund's investment in futures contracts.
OPTIONS ON FUTURES CONTRACTS. Options on futures contracts give the
purchaser the right in return for the premium paid to assume a position in a
futures contract at the specified option exercise price at any time during the
period of the option. Funds may use options on futures contracts in lieu of
writing or buying options directly on the underlying securities or purchasing
and selling the underlying futures contracts. For example, to hedge against a
possible decrease in the value of its portfolio securities, a Fund may purchase
put options or write call options on futures contracts rather than selling
futures contracts. Similarly, a Fund may purchase call options or write put
options on futures contracts as a substitute for the purchase of futures
contracts to hedge against a possible increase in the price of securities which
the Fund expects to purchase. Such options generally operate in the same manner
as options purchased or written directly on the underlying investments. See
"Descriptions and Risks of Fund Investment Practices -- Foreign Currency
Transactions" for a description of the Funds' use of options on currency
futures.
USES OF OPTIONS, FUTURES AND OPTIONS ON FUTURES
RISK MANAGEMENT. When futures and options on futures are used for risk
management, a Fund will generally take long positions (e.g., purchase call
options, futures contracts or options thereon) in order to increase the Fund's
exposure to a particular market, market segment or foreign currency. For
example, if a Fixed Income Fund wants to increase its exposure to a particular
fixed income security, the Fund may take long positions in futures contracts on
that security. Likewise, if an Equity Fund holds a portfolio of stocks with an
average volatility (beta) lower than that of the Fund's benchmark securities
index as a whole (deemed to be 1.00), the Fund may purchase Index Futures to
increase its average volatility to 1.00. In the case of futures and options on
futures, a Fund is only required to deposit the initial and variation margin as
required by relevant CFTC regulations and the rules of the contract markets.
Because the Fund will then be obligated to purchase the security or index at a
set price on a future date, the Fund's net asset value will fluctuate with the
value of the security as if it were already included in the Fund's portfolio.
Risk management transactions have the effect of providing a degree of investment
leverage, particularly when the Fund does not segregate assets equal to the face
amount of the contract (i.e., in cash settled futures contracts) since the
futures contract (and related options) will increase or decrease in value at a
rate which is a multiple of the rate of increase or decrease in the value of the
initial and variable margin that the Fund is required to deposit. As a result,
the value of the Fund's portfolio will generally be more volatile than the value
of comparable portfolios which do not engage in risk management transactions. A
Fund will not, however, use futures and options on futures to obtain greater
volatility than it could obtain through direct investment in securities; that
is, a Fund will not normally engage in risk management to increase the average
volatility (beta) of that Fund's portfolio above 1.00, the level of risk (as
measured by volatility) that would be present if the Fund were fully invested in
the securities comprising the relevant index. However, a Fund may invest in
futures and options on futures without regard to this limitation if the face
value of such investments, when aggregated with the Index Futures equity
-51-
swaps and contracts for differences as described below does not exceed 10% of a
Fund's assets.
HEDGING. To the extent indicated elsewhere, a Fund may also enter into
options, futures contracts and buy and sell options thereon for hedging. For
example, if a Fund wants to hedge certain of its fixed income securities against
a decline in value resulting from a general increase in market rates of
interest, it might sell futures contracts with respect to fixed income
securities or indices of fixed income securities. If the hedge is effective,
then should the anticipated change in market rates cause a decline in the value
of the Fund's fixed income security, the value of the futures contract should
increase. Likewise, the Equity Funds may sell equity index futures if a Fund
wants to hedge its equity securities against a general decline in the relevant
equity market(s). The Funds may also use futures contracts in anticipatory hedge
transactions by taking a long position in a futures contract with respect to a
security, index or foreign currency that a Fund intends to purchase (or whose
value is expected to correlate closely with the security or currency to be
purchased) pending receipt of cash from other transactions (including the
proceeds from this offering) to be used for the actual purchase. Then if the
cost of the security or foreign currency to be purchased by the Fund increases
and if the anticipatory hedge is effective, that increased cost should be
offset, at least in part, by the value of the futures contract. Options on
futures contracts may be used for hedging as well. For example, if the value of
a fixed-income security in a Fund's portfolio is expected to decline as a result
of an increase in rates, the Fund might purchase put options or write call
options on futures contracts rather than selling futures contracts. Similarly,
for anticipatory hedging, the Fund may purchase call options or write put
options as a substitute for the purchase of futures contracts. See "Descriptions
and Risks of Fund Investment Practices -- Foreign Currency Transactions" for
more information regarding the currency hedging practices of certain Funds.
INVESTMENT PURPOSES. To the extent indicated elsewhere, a Fund may also
enter into futures contracts and buy and sell options thereon for investment.
For example, a Fund may invest in futures when its Manager believes that there
are not enough attractive securities available to maintain the standards of
diversity and liquidity set for a Fund pending investment in such securities if
or when they do become available. Through this use of futures and related
options, a Fund may diversify risk in its portfolio without incurring the
substantial brokerage costs which may be associated with investment in the
securities of multiple issuers. This use may also permit a Fund to avoid
potential market and liquidity problems (e.g., driving up the price of a
security by purchasing additional shares of a portfolio security or owning so
much of a particular issuer's stock that the sale of such stock depresses that
stock's price) which may result from increases in positions already held by the
Fund.
When any Fund purchases futures contracts for investment, it will
maintain cash, U.S. Government Securities or other high grade debt obligations
in a segregated account with its custodian in an amount which, together with the
initial and variation margin deposited on the futures contracts, is equal to the
face value of the futures contracts at all times while the futures contracts are
held.
Incidental to other transactions in fixed income securities, for
investment purposes a Fund may also combine futures contracts or options on
fixed income securities with cash, cash equivalent investments or other fixed
income securities in order to create "synthetic" bonds which approximate desired
risk and return profiles. This may be done where a "non-synthetic" security
having the desired risk/return profile either is unavailable (e.g., short-term
securities of certain foreign governments) or possesses undesirable
characteristics (e.g., interest payments on the security would be subject to
foreign withholding taxes). A Fund may also purchase forward foreign exchange
contracts in conjunction with U.S. dollar-denominated securities in order to
create a synthetic foreign currency denominated security which approximates
desired risk and return characteristics where the non-synthetic securities
either are not available in foreign markets or possess undesirable
characteristics. For greater detail, see "Foreign Currency Transactions" below.
When a Fund creates a "synthetic" bond with a futures contract, it will maintain
cash, U.S. Government securities or other high grade debt obligations in a
segregated account with its custodian with a value at least equal to the face
amount of the futures contract (less the amount of any initial or variation
margin on deposit).
SYNTHETIC SALES AND PURCHASES. Futures contracts may also be used to
reduce transaction costs associated with short-term restructuring of a Fund's
portfolio. For example, if a Fund's portfolio includes stocks of companies with
medium-sized equity capitalization (e.g., between $300 million and $5.2 billion)
and, in the opinion of the Manager, such stocks are likely to underperform
larger capitalization stocks, the Fund might sell some or all of its
mid-capitalization stocks, buy large capitalization stocks with the proceeds and
then, when the expected trend had played out, sell the large capitalization
stocks and repurchase the mid-capitalization stocks with the proceeds. In the
alternative, the Fund may use futures to achieve a similar result with reduced
transaction costs. In that case, the Fund might simultaneously enter into short
futures positions on an appropriate index (e.g., the S&P Mid Cap 400 Index) (to
synthetically "sell" the stocks in the Fund) and long futures positions on
another index (e.g., the S&P 500) (to synthetically buy the larger
capitalization stocks). When the expected trend has played out, the Fund would
then close out both futures contract positions. A Fund will only enter into
these combined positions if (1) the short position (adjusted for historic
volatility) operates as a hedge of existing portfolio holdings, (2) the face
amount of the long futures position is less than or equal to the value of the
portfolio securities that the Fund would like to dispose of, (3) the contract
settlement date for the short futures position is approximately the same as that
for the long futures position and (4) the Fund segregates an amount of cash,
U.S. Government Securities and other high-quality debt obligations
-52-
whose value, marked-to-market daily, is equal to the Fund's current obligations
in respect of the long futures contract positions. If a Fund uses such combined
short and long positions, in addition to possible declines in the values of its
investment securities, the Fund may also suffer losses associated with a
securities index underlying the long futures position underperforming the
securities index underlying the short futures position. However, the Manager
will enter into these combined positions only if the Manager expects that,
overall, the Fund will perform as if it had sold the securities hedged by the
short position and purchased the securities underlying the long position. A Fund
may also use swaps and options on futures to achieve the same objective. For
more information, see Appendix A, "Risks and Limitations of Options, Futures and
Swaps."
SWAP CONTRACTS AND OTHER TWO-PARTY CONTRACTS
As has been described in the "Investment Objectives and Policies"
section above, many of the Funds may use swap contracts and other two-party
contracts for the same or similar purposes as they may use options, futures and
related options. The use of swap contracts and other two-party contracts
involves risk. See Appendix A, "Risks and Limitations of Options, Futures and
Swaps" for a more detailed discussion of the limits, conditions and risks of the
Funds' investments in swaps and other two-party contracts.
SWAP CONTRACTS. Swap agreements are two-party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to
more than one year. In a standard "swap" transaction, two parties agree to
exchange returns (or differentials in rates of return) calculated with respect
to a "notional amount," e.g., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. A Fund
will usually enter into swaps on a net basis, i.e., the two returns are netted
out, with the Fund receiving or paying, as the case may be, only the net amount
of the two returns.
INTEREST RATE AND CURRENCY SWAP CONTRACTS. Interest rate swaps involve
the exchange of the two parties' respective commitments to pay or receive
interest on a notional principal amount (e.g., an exchange of floating rate
payments for fixed rate payments). Currency swaps involve the exchange of the
two parties' respective commitments to pay or receive fluctuations with respect
to a notional amount of two different currencies (e.g., an exchange of payments
with respect to fluctuations in the value of the U.S. dollar relative to the
Japanese yen).
EQUITY SWAP CONTRACTS AND CONTRACTS FOR DIFFERENCES. As described under
"Investment Objectives and Policies -- Fixed Income Funds -- Global Hedged
Equity Fund," equity swap contracts involve the exchange of one party's
obligation to pay the loss, if any, with respect to a notional amount of a
particular equity index (e.g., the S&P 500 Index) plus interest on such notional
amount at a designated rate (e.g., the London Inter- Bank Offered Rate) in
exchange for the other party's obligation to pay the gain, if any, with respect
to the notional amount of such index.
If a Fund enters into a long equity swap contract, the Fund's net asset
value will fluctuate as a result of changes in the value of the equity index on
which the equity swap is based as if it had purchased the notional amount of
securities comprising the index. The Funds will not use long equity swap
contracts to obtain greater volatility than it could obtain through direct
investment in securities; that is, a Fund will not normally enter an equity swap
contract to increase the volatility (beta) of the Fund's portfolio above 1.00,
the volatility that would be present in the stocks comprising the Fund's
benchheld Index. However, a Fund may invest in long equity swap contracts
without regard to this limitation if the notional amount of such equity swap
contracts, when aggregated with the Index Futures as described above and the
contracts for differences as described below, does not exceed 10% of a Fund's
net assets.
Contracts for differences are swap arrangements in which a Fund may
agree with a counterparty that its return (or loss) will be based on the
relative performance of two different groups or "baskets" of securities. As to
one of the baskets, the Fund's return is based on theoretical long futures
positions in the securities comprising that basket (with an aggregate face value
equal to the notional amount of the contract for differences) and as to the
other basket, the Fund's return is based on theoretical short futures positions
in the securities comprising the basket. The Fund may also use actual long and
short futures positions to achieve the same market exposure(s) as contracts for
differences. The Funds will only enter into contracts for differences where
payment obligations of the two legs of the contract are netted and thus based on
changes in the relative value of the baskets of securities rather than on the
aggregate change in the value of the two legs. The Funds will only enter into
contracts for differences (and analogous futures positions) when the Manager
believes that the basket of securities constituting the long leg will outperform
the basket constituting the short leg. However, it is possible that the short
basket will outperform the long basket - resulting in a loss to the Fund, even
in circumstances where the securities in both the long and short baskets
appreciate in value.
Except for instances in which a Fund elects to obtain leverage up to
the 10% limitation mentioned above, a Fund will maintain cash, U.S. Government
Securities or other high grade debt obligations in a segregated account with its
custodian in an amount equal to the aggregate of net payment obligations on its
swap contracts and contracts for differences, marked to market daily.
A Fund may enter into swaps and contracts for differences for hedging,
investment and risk management. When using swaps for hedging, a Fund may enter
into an interest rate, currency or equity swap, as the case may be, on either an
asset-based or liability-based basis, depending on whether it is hedging its
assets or its liabilities. For risk management or investment purposes a Fund may
also enter into a contract for differences in
-53-
which the notional amount of the theoretical long position is greater than the
notional amount of the theoretical short position. A Fund will not normally
enter into a contract for differences to increase the volatility (beta) of the
Fund's portfolio above 1.00. However, a Fund may invest in contracts for
differences without regard to this limitation if the aggregate amount by which
the theoretical long positions of such contracts exceed the theoretical short
positions of such contacts, when aggregated with the Index Futures and equity
swaps contracts as described above, does not exceed 10% of a Fund's net assets.
INTEREST RATE CAPS, FLOORS AND COLLARS. The Funds may use interest rate
caps, floors and collars for the same purposes or similar purposes as for which
they use interest rate futures contracts and related options. Interest rate
caps, floors and collars are similar to interest rate swap contracts because the
payment obligations are measured by changes in interest rates as applied to a
notional amount and because they are individually negotiated with a specific
counterparty. The purchase of an interest rate cap entitles the purchaser, to
the extent that a specific index exceeds a specified interest rate, to receive
payments of interest on a notional principal amount from the party selling the
interest rate cap. The purchase of an interest rate floor entitles the
purchaser, to the extent that a specified index falls below specified interest
rates, to receive payments of interest on a notional principal amount from the
party selling the interest rate floor. The purchase of an interest rate collar
entitles the purchaser, to the extent that a specified index exceeds or falls
below two specified interest rates, to receive payments of interest on a
notional principal amount from the party selling the interest rate collar.
Except when using such contracts for risk management, each Fund will maintain
cash, U.S. Government Securities or other high grade debt obligations in a
segregated account with its custodian in an amount at least equal to its
obligations, if any, under interest rate cap, floor and collar arrangements. As
with futures contracts, when a Fund uses notional amount contracts for risk
management it is only required to segregate assets equal to its net payment
obligation, not the notional amount of the contract. In those cases, the
notional amount contract will have the effect of providing a degree of
investment leverage similar to the leverage associated with nonsegregated
futures contracts. The Funds' use of interest rate caps, floors and collars for
the same or similar purposes as those for which they use futures contracts and
related options present the same risks and similar opportunities to those
associated with futures and related options. For a description of certain
limitations on the Funds' use of caps, floors and collars, see Appendix A,
"Risks and Limitations of Options, Futures and Swaps -- Additional Regulatory
Limitations on the Use of Futures, Related Options, Interest Rate Floors, Caps
and Collars and Interest Rate and Currency Swap Contracts." Because caps, floors
and collars are recent innovations for which standardized documentation has not
yet been developed they are deemed by the SEC to be relatively illiquid
investments which are subject to a Fund's limitation on investment in illiquid
securities. See "Description and Risks of Fund Investments -- Illiquid
Securities."
FOREIGN CURRENCY TRANSACTIONS
To the extent each of the International Funds and the Fundamental Value
Fund is invested in foreign securities, it may buy or sell foreign currencies or
may deal in forward foreign currency contracts, that is, agree to buy or sell a
specified currency at a specified price and future date. These Funds may use
forward contracts for hedging, investment or currency risk management.
These Funds may enter into forward contracts for hedging under three
circumstances. First, when a Fund enters into a contract for the purchase or
sale of a security denominated in a foreign currency, it may desire to "lock in"
the U.S. dollar price of the security. By entering into a forward contract for
the purchase or sale, for a fixed amount of dollars, of the amount of foreign
currency involved in the underlying security transaction, the Fund will be able
to protect itself against a possible loss resulting from an adverse change in
the relationship between the U.S. dollar and the subject foreign currency during
the period between the date on which the security is purchased or sold and the
date on which payment is made or received.
Second, when the Manager of a Fund believes that the currency of a
particular foreign country may suffer a substantial decline against the U.S.
dollar, it may enter into a forward contract to sell, for a fixed amount of
dollars, the amount of foreign currency approximating the value of some or all
of the Fund's portfolio securities denominated in such foreign currency.
Maintaining a match between the forward contract amounts and the value of the
securities involved will not generally be possible since the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures.
Third, the Funds may engage in currency "cross hedging" when, in the
opinion of the Manager, the historical relationship among foreign currencies
suggests that the Funds may achieve the same protection for a foreign security
at reduced cost through the use of a forward foreign currency contract relating
to a currency other than the U.S. dollar or the foreign currency in which the
security is denominated. By engaging in cross hedging transactions, the Funds
assume the risk of imperfect correlation between the subject currencies. These
practices may present risks different from or in addition to the risks
associated with investments in foreign currencies. See Appendix A, "Risks and
Limitations of Options, Futures and Swaps."
A Fund is not required to enter into hedging transactions with regard
to its foreign currency-denominated securities and will not do so unless deemed
appropriate by the Manager. By entering into the above hedging transactions, the
Funds may be required to forego the benefits of advantageous changes in the
exchange rates.
-54-
Each of the International Funds may also enter foreign currency forward
contracts for investment and currency risk management. When a Fund uses currency
instruments for such purposes, the foreign currency exposure of the Fund may
differ substantially from the currencies in which the Fund's investment
securities are denominated. However, a Fund's aggregate foreign currency
exposure will not normally exceed 100% of the value of the Fund's securities,
except that a Fund may use currency instruments without regard to this
limitation if the amount of such excess, when aggregated with futures contracts,
equity swap contracts and contracts for differences used in similar ways, does
not exceed 10% of a Fund's net assets. The International Bond Fund, the Currency
Hedged International Bond Fund, the Global Bond Fund, the Emerging Country Debt
Fund and the Core Emerging Country Debt Fund may each also enter into foreign
currency forward contracts to give fixed income securities denominated in one
currency (generally the U.S. dollar) the risk characteristics of similar
securities denominated in another currency as described above under "Uses of
Options Futures and Options on Futures--Investment Purposes" or for risk
management in a manner similar to such Funds' use of futures contracts and
related options.
Except to the extent that the Funds may use such contracts for risk
management, whenever a Fund enters into a foreign currency forward contract,
other than a forward contract entered into for hedging, it will maintain cash,
U.S. Government securities or other high grade debt obligations in a segregated
account with its custodian with a value, marked to market daily, equal to the
amount of the currency required to be delivered. A Fund's ability to engage in
forward contracts may be limited by tax considerations.
A Fund may use currency futures contracts and related options and
options on currencies for the same reasons for which they use currency forwards.
Except to the extent that the Funds may use futures contracts and related
options for risk management, a Fund will, so long as it is obligated as the
writer of a call option on currency futures, own on a contract-for- contract
basis an equal long position in currency futures with the same delivery date or
a call option on currency futures with the difference, if any, between the
market value of the call written and the market value of the call or long
currency futures purchased maintained by the Fund in cash, U.S. Government
securities or other high grade debt obligations in a segregated account with its
custodian. If at the close of business on any day the market value of the call
purchased by a Fund falls below 100% of the market value of the call written by
the Fund, the Fund will maintain an amount of cash, U.S. Government securities
or other high grade debt obligations in a segregated account with its custodian
equal in value to the difference. Alternatively, the Fund may cover the call
option by owning securities denominated in the currency with a value equal to
the face amount of the contract(s) or through segregating with the custodian an
amount of the particular foreign currency equal to the amount of foreign
currency per futures contract option times the number of options written by the
Fund.
REPURCHASE AGREEMENTS
A Fund may enter into repurchase agreements with banks and
broker-dealers by which the Fund acquires a security (usually an obligation of
the Government where the transaction is initiated or in whose currency the
agreement is denominated) for a relatively short period (usually not more than a
week) for cash and obtains a simultaneous commitment from the seller to
repurchase the security at an agreed-on price and date. The resale price is in
excess of the acquisition price and reflects an agreed-upon market rate
unrelated to the coupon rate on the purchased security. Such transactions afford
an opportunity for the Fund to earn a return on temporarily available cash at no
market risk, although there is a risk that the seller may default in its
obligation to pay the agreed-upon sum on the redelivery date. Such a default may
subject the relevant Fund to expenses, delays and risks of loss including: (a)
possible declines in the value of the underlying security during the period
while the Fund seeks to enforce its rights thereto, (b) possible reduced levels
of income and lack of access to income during this period and (c) inability to
enforce rights and the expenses involved in attempted enforcement.
DEBT AND OTHER FIXED INCOME SECURITIES GENERALLY
Debt and Other Fixed Income Securities include fixed income securities
of any maturity, although, under normal circumstances, a Fixed Income Fund
(other than the Short-Term Income Fund) will only invest in a security if, at
the time of such investment, at least 65% of its total assets will be comprised
of bonds, as defined in "Investment Objectives and Policies -- Fixed Income
Funds" above. Fixed income securities pay a specified rate of interest or
dividends, or a rate that is adjusted periodically by reference to some
specified index or market rate. Fixed income securities include securities
issued by federal, state, local and foreign governments and related agencies,
and by a wide range of private issuers.
Fixed income securities are subject to market and credit risk. Market
risk relates to changes in a security's value as a result of changes in interest
rates generally. In general, the values of fixed income securities increase when
prevailing interest rates fall and decrease when interest rates rise. Credit
risk relates to the ability of the issuer to make payments of principal and
interest. Obligations of issuers are subject to the provisions of bankruptcy,
insolvency and other laws, such as the Federal Bankruptcy Reform Act of 1978,
affecting the rights and remedies of creditors. Fixed income securities
denominated in foreign currencies are also subject to the risk of a decline in
the value of the denominating currency.
Because interest rates vary, it is impossible to predict the future
income of a Fund investing in such securities. The net asset value of each such
Fund's shares will vary as a result of changes in the value of the securities in
its portfolio and will be affected by the absence and/or success of hedging
strategies.
-55-
TEMPORARY HIGH QUALITY CASH ITEMS
As described under "Investment Objectives and Policies" above, many of
the Funds may temporarily invest a portion of their assets in cash or cash items
pending other investments or in connection with the maintenance of a segregated
account. These cash items must be of high quality and may include a number of
money market instruments such as securities issued by the United States
government and agencies thereof, bankers' acceptances, commercial paper, and
bank certificates of deposit. By investing only in high quality money market
securities a Fund will seek to minimize credit risk with respect to such
investments. The Short-Term Income Fund may make many of the same investments,
although it imposes less strict restrictions concerning the quality of such
investments. See "Investment Objectives and Policies -- Fixed Income Funds --
Short-Term Income Fund" for a general description of various types of money
market instruments.
U.S. GOVERNMENT SECURITIES AND FOREIGN GOVERNMENT SECURITIES
U.S. Government Securities include securities issued or guaranteed by
the U.S. government or its authorities, agencies or instrumentalities. Foreign
Government Securities include securities issued or guaranteed by foreign
governments (including political subdivisions) or their authorities, agencies or
instrumentalities or by supra-national agencies. U.S. Government Securities and
Foreign Government Securities have different kinds of government support. For
example, some U.S. Government Securities, such as U.S. Treasury bonds, are
supported by the full faith and credit of the United States, whereas certain
other U.S. Government Securities issued or guaranteed by federal agencies or
government-sponsored enterprises are not supported by the full faith and credit
of the United States. Similarly, some Foreign Government Securities are
supported by the full faith and credit of a foreign national government or
political subdivision and some are not. In the case of certain countries,
Foreign Government Securities may involve varying degrees of credit risk as a
result of financial or political instability in such countries and the possible
inability of a Fund to enforce its rights against the foreign government issuer.
Supra-national agencies are agencies whose member nations make capital
contributions to support the agencies' activities, and include such entities as
the International Bank for Reconstruction and Development (the World Bank), the
Asian Development Bank, the European Coal and Steel Community and
the Inter-American Development Bank.
Like other fixed income securities, U.S. Government Securities and
Foreign Government Securities are subject to market risk and their market values
fluctuate as interest rates change. Thus, for example, the value of an
investment in a Fund which holds U.S. Government Securities or Foreign
Government Securities may fall during times of rising interest rates. Yields on
U.S. Government Securities and Foreign Government Securities tend to be lower
than those of corporate securities of comparable maturities.
In addition to investing directly in U.S. Government Securities and
Foreign Government Securities, a Fund may purchase certificates of accrual or
similar instruments evidencing undivided ownership interests in interest
payments or principal payments, or both, in U.S. Government Securities and
Foreign Government Securities. These certificates of accrual and similar
instruments may be more volatile than other government securities.
MORTGAGE-BACKED AND OTHER ASSET-BACKED SECURITIES
Mortgage-backed and other asset-backed securities may be issued by the
U.S. government, its agencies or instrumentalities, or by non-governmental
issuers. Interest and principal payments (including prepayments) on the
mortgages underlying mortgage-backed securities are passed through to the
holders of the mortgage-backed security. Prepayments occur when the mortgagor on
an individual mortgage prepays the remaining principal before the mortgage's
scheduled maturity date. As a result of the pass-through of prepayments of
principal on the underlying mortgages, mortgage-backed securities are often
subject to more rapid prepayment of principal than their stated maturity would
indicate. Because the prepayment characteristics of the underlying mortgages
vary, there can be no certainty as to the predicted yield or average life of a
particular issue of pass-through certificates. Prepayments are important because
of their effect on the yield and price of the securities. During periods of
declining interest rates, such prepayments can be expected to accelerate and a
Fund would be required to reinvest the proceeds at the lower interest rates then
available. In addition, prepayments of mortgages which underlie securities
purchased at a premium could result in capital losses because the premium may
not have been fully amortized at the time the obligation was prepaid. As a
result of these principal prepayment features, the values of mortgage-backed
securities generally fall when interest rates rise, but their potential for
capital appreciation in periods of falling interest rates is limited because of
the prepayment feature. The mortgage-backed securities purchased by a Fund may
include Adjustable Rate Securities as such term is defined in "Descriptions and
Risks of Fund Investment Practices -- Adjustable Rate Securities" below.
Other "asset-backed securities" include securities backed by pools of
automobile loans, educational loans and credit card receivables. Mortgage-backed
and asset-backed securities of non-governmental issuers involve prepayment risks
similar to those of U.S. government guaranteed mortgage-backed securities and
also involve risk of loss of principal if the obligors of the underlying
obligations default in payment of the obligations.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"); STRIPS AND RESIDUALS. A
CMO is a security backed by a portfolio of mortgages or mortgage-backed
securities held under an indenture. The issuer's obligation to make interest and
principal payments
-56-
is secured by the underlying portfolio of mortgages or mortgage-backed
securities. CMOs are issued in multiple classes or series which have different
maturities representing interests in some or all of the interest or principal on
the underlying collateral or a combination thereof. CMOs of different classes
are generally retired in sequence as the underlying mortgage loans in the
mortgage pool are repaid. In the event of sufficient early prepayments on such
mortgages, the class or series of CMO first to mature generally will be retired
prior to its stated maturity. Thus, the early retirement of a particular class
or series of CMO held by a Fund would have the same effect as the prepayment of
mortgages underlying a mortgage-backed pass-through security.
CMOs include securities ("Residuals") representing the interest in any
excess cash flow and/or the value of any collateral remaining on mortgages or
mortgage-backed securities from the payment of principal of and interest on all
other CMOs and the administrative expenses of the issuer. Residuals have value
only to the extent income from such underlying mortgages or mortgage-backed
securities exceeds the amounts necessary to satisfy the issuer's debt
obligations represented by all other outstanding CMOs.
CMOs also include certificates representing undivided interests in
payments of interest-only or principal-only ("IO/PO Strips") on the underlying
mortgages. IO/PO Strips and Residuals tend to be more volatile than other types
of securities. IO Strips and Residuals also involve the additional risk of loss
of a substantial portion of or the entire value of the investment if the
underlying securities are prepaid. In addition, if a CMO bears interest at an
adjustable rate, the cash flows on the related Residual will also be extremely
sensitive to the level of the index upon which the rate adjustments are based.
ADJUSTABLE RATE SECURITIES
Adjustable rate securities are securities that have interest rates that
are reset at periodic intervals, usually by reference to some interest rate
index or market interest rate. They may be U.S. Government Securities or
securities of other issuers. Some adjustable rate securities are backed by pools
of mortgage loans. Although the rate adjustment feature may act as a buffer to
reduce sharp changes in the value of adjustable rate securities, these
securities are still subject to changes in value based on changes in market
interest rates or changes in the issuer's creditworthiness. Because the interest
rate is reset only periodically, changes in the interest rates on adjustable
rate securities may lag changes in prevailing market interest rates. Also, some
adjustable rate securities (or, in the case of securities backed by mortgage
loans, the underlying mortgages) are subject to caps or floors that limit the
maximum change in interest rate during a specified period or over the life of
the security. Because of the resetting of interest rates, adjustable rate
securities are less likely than non-adjustable rate securities of comparable
quality and maturity to increase significantly in value when market interest
rates fall.
LOWER RATED SECURITIES
Certain Funds may invest some or all of their assets in securities
rated below investment grade (that is, rated below BBB by Standard & Poor's or
below Baa by Moody's) at the time of purchase, including securities in the
lowest rating categories, and comparable unrated securities ("Lower Rated
Securities"). A Fund will not necessarily dispose of a security when its rating
is reduced below its rating at the time of purchase, although the Manager will
monitor the investment to determine whether continued investment in the security
will assist in meeting the Fund's investment objective.
Lower Rated Securities generally provide higher yields, but are subject
to greater credit and market risk, than higher quality fixed income securities.
Lower Rated Securities are considered predominantly speculative with respect to
the ability of the issuer to meet principal and interest payments. Achievement
of the investment objective of a Fund investing in Lower Rated Securities may be
more dependent on the Manager's own credit analysis than is the case with higher
quality bonds. The market for Lower Rated Securities may be more severely
affected than some other financial markets by economic recession or substantial
interest rate increases, by changing public perceptions of this market or by
legislation that limits the ability of certain categories of financial
institutions to invest in these securities. In addition, the secondary market
may be less liquid for Lower Rated Securities. This reduced liquidity at certain
times may affect the values of these securities and may make the valuation and
sale of these securities more difficult. Securities of below investment grade
quality are commonly referred to as "junk bonds." Securities in the lowest
rating categories may be in poor standing or in default. Securities in the
lowest investment grade category (BBB or Baa) have some speculative
characteristics. See Appendix B for more information concerning commercial paper
and corporate debt ratings.
BRADY BONDS
Brady Bonds are securities created through the exchange of existing
commercial bank loans to public and private entities in certain emerging markets
for new bonds in connection with debt restructurings under a debt restructuring
plan introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady (the
"Brady Plan"). Brady Plan debt restructurings have been imple mented in Mexico,
Uruguay, Venezuela, Costa Rica, Argentina, Nigeria, the Philippines and other
countries.
Brady Bonds have been issued only recently, and for that reason do not
have a long payment history. Brady Bonds may be collateralized or
uncollateralized, are issued in various currencies (but primarily the dollar)
and are actively traded in over-the-counter secondary markets.
Dollar-denominated, collateralized Brady Bonds, which may be fixed-rate bonds or
floating-rate bonds, are generally collateralized in full as to principal by
U.S. Treasury zero coupon bonds having the same maturity as the bonds.
-57-
Brady Bonds are often viewed as having three or four valuation
components: any collateralized repayment of principal at final maturity; any
collateralized interest payments; the uncollateralized interest payments; and
any uncollateralized repayment of principal at maturity (these uncollateralized
amounts constituting the "residual risk"). In light of the residual risk of
Brady bonds and the history of defaults of countries issuing Brady Bonds with
respect to commercial bank loans by public and private entities, investments in
Brady Bonds may be viewed as speculative.
ZERO COUPON SECURITIES
A Fund investing in "zero coupon" fixed income securities is required
to accrue interest income on these securities at a fixed rate based on the
initial purchase price and the length to maturity, but these securities do not
pay interest in cash on a current basis. Each Fund is required to distribute the
income on these securities to its shareholders as the income accrues, even
though that Fund is not receiving the income in cash on a current basis. Thus,
each Fund may have to sell other investments to obtain cash to make income
distributions. The market value of zero coupon securities is often more volatile
than that of non-zero coupon fixed income securities of comparable quality and
maturity. Zero coupon securities include IO and PO strips.
INDEXED SECURITIES
Indexed Securities are securities the redemption values and/or the
coupons of which are indexed to the prices of a specific instrument or
statistic. Indexed securities typically, but not always, are debt securities or
deposits whose value at maturity or coupon rate is determined by reference to
other securities, securities indices, currencies, precious metals or other
commodities, or other financial indicators. Gold-indexed securities, for
example, typically provide for a maturity value that depends on the price of
gold, resulting in a security whose price tends to rise and fall together with
gold prices. Currency- indexed securities typically are short-term to
intermediate-term debt securities whose maturity values or interest rates are
determined by reference to the values of one or more specified foreign
currencies, and may offer higher yields than U.S. dollar-denominated securities
of equivalent issuers. Currency-indexed securities may be positively or
negatively indexed; that is, their maturity value may increase when the
specified currency value increases, resulting in a security that performs
similarly to a foreign-denominated instrument, or their maturity value may
decline when foreign currencies increase, resulting in a security whose price
characteristics are similar to a put on the underlying currency.
Currency-indexed securities may also have prices that depend on the values of a
number of different foreign currencies relative to each other.
The performance of indexed securities depends to a great extent on the
performance of the security, currency, or other instrument to which they are
indexed, and may also be influenced by interest rate changes in the U.S. and
abroad. At the same time, indexed securities are subject to the credit risks
associated with the issuer of the security, and their values may decline
substantially if the issuer's creditworthiness deteriorates. Recent issuers of
indexed securities have included banks, corporations, and certain U.S.
government agencies.
Indexed securities in which each Fund may invest include so-called
"inverse floating obligations" or "residual interest bonds" on which the
interest rates typically decline as short-term market interest rates increase
and increase as short-term market rates decline. Such securities have the effect
of providing a degree of investment leverage, since they will generally increase
or decrease in value in response to changes in market interest rates at a rate
which is a multiple of the rate at which fixed-rate long-term securities
increase or decrease in response to such changes. As a result, the market values
of such securities will generally be more volatile than the market values of
fixed rate securities.
FIRM COMMITMENTS
A firm commitment agreement is an agreement with a bank or
broker-dealer for the purchase of securities at an agreed-upon price on a
specified future date. A Fund may enter into firm commitment agreements with
such banks and broker-dealers with respect to any of the instruments eligible
for purchase by the Fund. A Fund will only enter into firm commitment
arrangements with banks and broker-dealers which the Manager determines present
minimal credit risks. Each such Fund will maintain in a segregated account with
its custodian cash, U.S. Government Securities or other liquid high grade debt
obligations in an amount equal to the Fund's obligations under firm commitment
agreements.
LOANS, LOAN PARTICIPATIONS AND ASSIGNMENTS
Certain Funds may invest in direct debt instruments which are interests
in amounts owed by a corporate, governmental, or other borrower to lenders or
lending syndicates (loans and loan participations), to suppliers of goods or
services (trade claims or other receivables), or to other parties. Direct debt
instruments are subject to a Fund's policies regarding the quality of debt
securities.
Purchasers of loans and other forms of direct indebtedness depend
primarily upon the creditworthiness of the borrower for payment of principal and
interest. Direct debt instruments may not be rated by any nationally recognized
rating and yield could be adversely affected. Loans that are fully secured offer
the Fund more protections than an unsecured loan in the event of non-payment of
scheduled interest of principal. However, there is no assurance that the
liquidation of collateral from a secured loan would satisfy the borrower's
obligation, or that the collateral can be liquidated. Indebtedness of borrowers
whose creditworthiness is poor involves substantially greater risks, and may be
highly speculative. Borrowers that are in bankruptcy or restructuring may never
pay off their indebtedness, or may pay only a small fraction of the amount owed.
Direct indebtedness of emerging countries will
-58-
also involve a risk that the governmental entities responsible for the repayment
of the debt may be unable, or unwilling, to pay interest and repay principal
when due.
When investing in a loan participation, a Fund will typically have the
right to receive payments only from the lender to the extent the lender receives
payments from the borrower, and not from the borrower itself. Likewise, a Fund
typically will be able to enforce its rights only through the lender, and not
directly against the borrower. As a result, a Fund will assume the credit risk
of both the borrower and the lender that is selling the participation.
Investments in loans through direct assignment of a financial
institution's interests with respect to a loan may involve additional risks to
the Fund. For example, if a loan is foreclosed, a Fund could become part owner
of any collateral, and would bear the costs and liabilities associated with
owning and disposing of the collateral. In addition, it is conceivable that
under emerging legal theories of lender liability, a Fund could be held liable
as a co-lender. In the case of a loan participation, direct debt instruments may
also involve a risk of insolvency of the lending bank or other intermediary.
Direct debt instruments that are not in the form of securities may offer less
legal protection to a Fund in the event of fraud or misrepresentation. In the
absence of definitive regulatory guidance, a Fund may rely on the Manager's
research to attempt to avoid situations where fraud or misrepresentation could
adversely affect the fund.
A loan is often administered by a bank or other financial institution
that acts as agent for all holders. The agent administers the terms of the loan,
as specified in the loan agreement. Unless, under the terms of the loan or other
indebtedness, a Fund has direct recourse against the borrower, it may have to
rely on the agent to apply appropriate credit remedies against a borrower.
Direct indebtedness purchased by a Fund may include letters of credit,
revolving credit facilities, or other standby financing commitments obligating
the Fund to pay additional cash on demand. These commitments may have the effect
of requiring the Fund to increase its investment in a borrower at a time when it
would not otherwise have done so. A Fund will set aside appropriate liquid
assets in a segregated custodial account to cover its potential obligations
under standby financing commitments.
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLL AGREEMENTS
Certain Funds may enter into reverse repurchase agreements and dollar
roll agreements with banks and brokers to enhance return. Reverse repurchase
agreements involve sales by a Fund of portfolio assets concurrently with an
agreement by the Fund to repurchase the same assets at a later date at a fixed
price. During the reverse repurchase agreement period, the Fund continues to
receive principal and interest payments on these securities and also has the
opportunity to earn a return on the collateral furnished by the counterparty to
secure its obligation to redeliver the securities.
Dollar rolls are transactions in which a Fund sells securities for
delivery in the current month and simultaneously contracts to repurchase
substantially similar (same type and coupon) securities on a specified future
date. During the roll period, the Fund forgoes principal and interest paid on
the securities. The Fund is compensated by the difference between the current
sales price and the forward price for the future purchase (often referred to as
the "drop") as well as by the interest earned on the cash proceeds of the
initial sale.
A Fund which makes such investments will establish segregated accounts
with its custodian in which the Fund will maintain cash, U.S. Government
Securities or other liquid high grade debt obligations equal in value to its
obligations in respect of reverse repurchase agreements and dollar rolls.
Reverse repurchase agreements and dollar rolls involve the risk that the market
value of the securities retained by a Fund may decline below the price of the
securities the Fund has sold but is obligated to repurchase under the agreement.
In the event the buyer of securities under a reverse repurchase agreement or
dollar roll files for bankruptcy or becomes insolvent, a Fund's use of the
proceeds of the agreement may be restricted pending a determination by the other
party or its trustee or receiver whether to enforce the Fund's obligation to
repurchase the securities. Reverse repurchase agreements and dollar rolls are
not considered borrowings by a Fund for purposes of a Fund's fundamental
investment restriction with respect to borrowings.
ILLIQUID SECURITIES
Each Fund (except for the Asset Allocation Funds) may purchase
"illiquid securities," i.e., securities which may not be sold or disposed of in
the ordinary course of business within seven days at approximately the value at
which the Fund has valued the investment, which include securities whose
disposition is restricted by securities laws, so long as no more than 15% (or,
in the case of the Foreign Fund only, 10%) of net assets would be invested in
such illiquid securities. Each Fund currently intends to invest in accordance
with the SEC staff view that repurchase agreements maturing in more than seven
days are illiquid securities. The SEC staff has stated informally that it is of
the view that over-the-counter options and securities serving as cover for
over-the-counter options are illiquid securities. While the Trust does not agree
with this view, it will operate in accordance with any relevant formal
guidelines adopted by the SEC.
In addition, the SEC staff considers equity swap contracts, caps,
floors and collars to be illiquid securities. Consequently, while the staff
maintains this position, the Fund will not enter into an equity swap contract or
a reverse equity swap contract or purchase a cap, floor or collar if, as a
result of the investment, the total value (i.e., marked-to-market value) of such
investments (without regard to their notional amount) together with that of all
other illiquid securities which the Fund
-59-
owns would exceed 15% (or, in the case of the Foreign Fund only, 10%) of the
Fund's total assets.
SPECIAL ASSET ALLOCATION FUND CONSIDERATIONS
The Manager does not charge an investment management fee for asset
allocation advice provided to the Asset Allocation Funds, but certain other
expenses such as custody, transfer agency and audit fees will be borne by the
Asset Allocation Funds. Investors in Asset Allocation Funds will also indirectly
bear a proportionate share of the Total Operating Expenses (including investment
management, custody, transfer agency, audit and other Fund expenses) of the
underlying Funds in which the Asset Allocation Funds invest, as well as any
purchase premiums or redemption fees charged by such underlying Funds. Since the
Manager will receive fees from the underlying Funds, the Manager has a financial
incentive to invest the assets of the Asset Allocation Funds in underlying Funds
with higher fees, despite the investment interests of the Asset Allocation
Funds. The Manager is legally obligated to disregard that incentive in selecting
shares of the underlying Funds.
MULTIPLE CLASSES
All Funds (except Short-Term Income) offer multiple classes of shares.
Eligibility generally depends on the size of a client's total investment with
GMO, as described more fully in this section. Each Fund (except the Short-Term
Income Fund and Asset Allocation Funds) offers three classes of shares: Class I,
Class II and Class III. Each Asset Allocation Fund offers Class I and Class II
Shares, while the Short-Term Income Fund offers only Class III Shares.
SHAREHOLDER SERVICE FEES
The principal economic difference among the various classes of shares
is the level of Shareholder Service Fee which the classes bear for client and
shareholder service, reporting and other support. The existence of multiple
classes reflects the fact that, as the size of a client relationship increases,
the cost to service that client decreases as a percentage of the assets in that
account. Thus, the Shareholder Service Fee is lower for classes where
eligibility criteria require greater total assets under GMO's management.
The Trust has adopted a Shareholder Servicing Plan with respect to the
multiple classes of shares. Pursuant to the terms of the Shareholder Servicing
Plan, the classes will pay the following Shareholder Service Fees, expressed as
an annual percentage of the average daily net assets attributable to that class
of shares:
Shareholder Service Fee
Fund Class I Class II Class III
- ---- ------- -------- ---------
All Funds (except Asset 0.28% 0.22% 0.15%
Allocation Funds)
Asset Allocation Funds 0.13% 0.07% n/a
CLIENT SERVICE - GMO AND GMO FUNDS
A significant distinction among classes is that clients eligible for
Class I or Class II Shares are serviced by the Manager's GMO FUNDS DIVISION, a
division of GMO established in April of 1996 to deliver institutional quality
service and reporting to clients generally committing between $1 million and $35
million to GMO's management.
Clients eligible to purchase Class III Shares will be serviced directly
by the Manager.
ELIGIBILITY FOR CLASSES
With certain exceptions described below, eligibility for Class I, Class
II, and Class III Shares depends on a client's "TOTAL INVESTMENT" with GMO.
For clients establishing a relationship with GMO on or after June 1,
1996: A client's Total Investment is equal at any time to the aggregate of all
amounts contributed by the client to any GMO Fund, less the "INVESTMENT COST" of
all redemptions by the client from such Funds. Where applicable, the market
value of assets managed by GMO for the client other than in a mutual fund, as of
the prior month end, will be added to the client's Total Investment. For
purposes of class eligibility, market appreciation or depreciation of a client's
mutual fund account is not considered; the Total Investment of a client is
affected only by the amount of purchases and redemptions made by the client.
Further, it is assumed that any redemptions made by a client are satisfied first
by market appreciation so that a redemption does not have Investment Cost except
to the extent that the redemption or withdrawal exceeds the market appreciation
of the client's account in a Fund.
Subject to the exceptions set forth following this table, the minimum
Total Investment for a new client (establishing a GMO Account on or after June
1, 1996) to be eligible for Class I, II or III Shares is set forth below:
Minimum Total Investment
------------------------
Class I $1 Million
Class II $10 Million
Class III $35 Million
-60-
Investments by defined contribution pension plans (such as 401(k)
plans) will be accepted only in Class I Shares regardless of the size of the
investment, and will not be eligible to convert to other classes.
For Clients with Accounts as of May 31, 1996: Any client of GMO whose
Total Investment as of May 31, 1996 was equal to or greater than $7 million will
remain eligible for Class III Shares indefinitely, provided that such client
does not make a withdrawal or redemption that causes the client's Total
Investment to fall below $7 million. Any client whose Total Investment as of May
31, 1996 was less than $7 million, but greater than $0, will convert to Class II
Shares on or shortly after July 31, 1997. For clients with GMO accounts as of
May 31, 1996, their initial Total Investment will equal the market value of all
of their GMO investments as of the close of business on May 31, 1996 and will
subsequently be calculated as described in the preceding section.
There is no minimum for subsequent investments into any class of
shares.
The Manager will make all determinations as to aggregation of client
accounts for purposes of determining eligibility.
CONVERSIONS BETWEEN CLASSES
On July 31 of each year (the "DETERMINATION DATE") the value of each
client's Total Investment with GMO, as defined above, will be determined. Based
on that determination, each client's shares of all Funds will be automatically
converted to that class (Class I, Class II or Class III) with the lowest
Shareholder Service Fee for which the client is eligible based on the amount of
their Total Investment on the Determination Date. The conversion will occur
within 15 business days following the Determination Date. Also, if a client
makes an investment in a GMO Fund or puts additional assets under GMO's
Management so as to cause the client to be eligible for a new class of shares,
such determination will be made as of the close of business on the last day of
the month in which the investment was made, and the conversion will be effected
within 15 business days of that month-end.
The Trust has been advised by counsel that the conversion of a client's
investment from one class of shares to another class of shares in the same Fund
should not result in the recognition of gain or loss in the converted Fund's
shares. The client's tax basis in the new class of shares immediately after the
conversion should equal the client's basis in the converted shares immediately
before conversion, and the holding period of the new class of shares should
include the holding period of the converted shares.
Certain special rules will be applied by the Manager with respect to
clients for whom GMO managed assets prior to the creation of multiple classes on
May 31, 1996. Clients whose Total Investment as of May 31, 1996 is equal to $7
million or more will be eligible to remain invested in Class III Shares
indefinitely (despite the normal $35 million minimum), provided that such client
does not make a withdrawal or redemption that causes the client's Total
Investment to fall below $7 million. Clients whose Total Investment as of May
31, 1996 is less than $7 million will be converted to Class II Shares, (rather
than Class I Shares), and such conversion will not occur until July 31, 1997 or
slightly thereafter. Of course, if such a client makes an additional investment
prior to July 31, 1997 such that their Total Investment on July 31, 1997 is $35
million or more, the client will remain eligible for Class III Shares.
PURCHASE OF SHARES
Shares of each Fund are available only from the Trust and may be
purchased on any day when the New York Stock Exchange is open for business (a
"business day"). Class I and Class II Shares may be purchased by calling (617)
790-5000. Class III Shares may be purchased by calling (617) 330-7500. See
"Purchase Procedures" below.
The purchase price of a share of each Fund is (i) the net asset value
next determined after a purchase order is received in good order plus (ii) a
premium, if any, established from time to time by the Trust for the particular
Fund and class to be purchased. All purchase premiums are paid to and retained
by the Fund and are intended to cover the brokerage and other costs associated
with putting the investment to work in the relevant markets. Each class of
shares of a Fund has the same rate of purchase premium. The purchase premiums
currently in effect for each Fund are as follows:
Fund Purchase Premium
- ---- ----------------
Asset Allocation Funds,
Short-Term Income Fund,
Domestic Bond Fund
and Foreign Fund None
Core Fund, Tobacco-Free
Core Fund, U.S. Sector
Fund, Value Fund and Growth Fund 0.14%
Fundamental Value Fund,
International Bond Fund, Currency
Hedged International Bond Fund and
Global Bond Fund 0.15%
Japan Fund 0.40%
Core II Secondaries Fund,
Emerging Country Debt Fund and
Global Hedged Equity Fund 0.50%
International Core Fund and
Currency Hedged International
Core Fund 0.60%
REIT Fund 0.75%
International Small Companies
Fund 1.00%
Emerging Markets Fund 1.60%
-61-
Purchase premiums apply only to cash transactions. These fees are paid
to and retained by the Fund itself and are designed to allocate transaction
costs caused by shareholder activity to the shareholder generating the activity,
rather than to Fund as a whole. Purchase premiums are not sales loads.
For the Emerging Markets Fund, Emerging Country Debt Fund,
International Bond Fund, Currency Hedged International Bond Fund and Global Bond
Fund only, the Funds will reduce the stated purchase premium by 50% with respect
to any portion of a purchase that is offset by a corresponding redemption
occurring on the same day. For the Fundamental Value Fund and Japan Fund only,
the purchase premium may be waived if, generally due to off-setting
transactions, a purchase resulted in minimal brokerage and/or other transaction
costs. In all of these cases, the Manager will determine whether circumstances
exist to waive a portion of the purchase premium. Absent a clear determination,
the full premium will be charged.
For all other Funds, the stated purchase premium may not be waived in
any circumstance.
Normally, no purchase premium is charged with respect to in-kind
purchases of Fund shares. However, in the case of in-kind purchases involving
transfers of large positions in markets where the costs of re-registration
and/or other transfer expenses are high, the International Core Fund, Currency
Hedged International Core Fund, International Small Companies Fund, Japan Fund
and Global Hedged Equity Fund may each charge a premium of 0.10% and the
Emerging Markets Fund may charge a premium of 0.20%.
Shares may be purchased (i) in cash, (ii) in exchange for securities on
deposit at The Depository Trust Company ("DTC") (or such other depository
acceptable to the Manager), subject to the determination by the Manager that the
securities to be exchanged are acceptable, or (iii) by a combination of such
securities and cash. In all cases, the Manager reserves the right to reject any
particular investment. Securities acceptable to the Manager as consideration for
Fund shares will be valued as set forth under "Determination of Net Asset Value"
(generally the last quoted sale price) as of the time of the next determination
of net asset value after such acceptance. All dividends, subscription or other
rights which are reflected in the market price of accepted securities at the
time of valuation become the property of the relevant Fund and must be delivered
to the Trust upon receipt by the investor from the issuer. A gain or loss for
federal income tax purposes may be realized by investors subject to Federal
income taxation upon the exchange, depending upon the investor's basis in the
securities tendered.
The Manager will not approve securities as acceptable consideration for
Fund shares unless (1) the Manager, in its sole discretion, believes the
securities are appropriate investments for the Fund; (2) the investor represents
and agrees that all securities offered to the Fund are not subject to any
restrictions upon their sale by the Fund under the Securities Act of 1933, or
otherwise; and (3) the securities may be acquired under the investment
restrictions applicable to the relevant Fund. Investors interested in making
in-kind purchases should telephone the Manager at (617) 330-7500.
For purposes of calculating the purchase price of Trust shares, a
purchase order is received by the Trust on the day that it is in "good order"
and is accepted by the Trust. For a purchase order to be in "good order" on a
particular day, the investor's consideration must be received before the
relevant deadline on that day. If the investor makes a cash investment, the
deadline for wiring Federal funds to the Trust is 2:00 p.m.; if the investor
makes an investment in-kind, the investor's securities must be placed on deposit
at DTC (or such other depository as is acceptable to the Manager) and 2:00 p.m.
is the deadline for transferring those securities to the account designated by
the transfer agent, Investors Bank & Trust Company, One Lincoln Plaza, Boston,
Massachusetts 02205. Investors should be aware that approval of the securities
to be used for purchase must be obtained from the Manager prior to this time.
When the consideration is received by the Trust after the relevant deadline, the
purchase order is not considered to be in good order and is required to be
resubmitted on the following business day. With the prior consent of the
Manager, in certain circumstances the Manager may, in its discretion, permit
purchases based on receiving adequate written assurances that Federal Funds or
securities, as the case may be, will be delivered to the Trust by 2:00 p.m. on
or prior to the fourth business day after such assurances are received.
The International Core Fund may be available through a broker or dealer
who may charge a transaction fee for purchases and redemptions of that Fund's
shares. If shares of the International Core Fund are purchased directly from the
Trust without the intervention of a broker or dealer, no such charge will be
imposed.
PURCHASE PROCEDURES:
(a) General: Investors should call the Trust at (617) 790-5000 before
attempting to place an order for Class I or Class II Shares. Investors should
call the Trust at (617) 330-7500 before attempting to place an order for Class
III Shares. The Trust reserves the right to reject any order for Trust shares.
DO NOT SEND CASH, CHECKS OR SECURITIES DIRECTLY TO THE TRUST. Wire transfer and
mailing instructions are contained on the PURCHASE ORDER FORM which can be
obtained from the Trust at the telephone numbers set forth above.
Purchases will be made in full and fractional shares of each Fund
calculated to three decimal places. The Trust will send a written confirmation
(including a statement of shares owned) to shareholders at the time of each
transaction.
(b) Purchase Order Form: Investors must submit an application to the
Trust and it must be accepted by the Trust before it will be considered in "good
order."
-62-
Class I and Class II Shares: A Purchase Order Form for Class I and
Class II Shares may be obtained by calling the Trust at (617) 790-5000. This
Order Form may be submitted to the Trust (i) By Mail to GMO Trust c/o GMO Funds
Division, 40 Rowes Wharf, Boston, MA 02110; or (ii) By Facsimile to (617)
439-4290.
Class III Shares: A Purchase Order Form for Class III Shares may be
obtained by calling the Trust at (617) 330- 7500. This Order Form may be
submitted to the Trust (i) By Mail to GMO Trust c/o Grantham, Mayo, Van Otterloo
& Co., 40 Rowes Wharf, Boston, MA 02110; Attention: Shareholder Services, or
(ii) By Facsimile to (617) 439-4192; Attention: Shareholder Services.
(c) Acceptance of Order: No purchase order is in "good order" until it
has been accepted by the Trust. As noted above, investors should call the Trust
at the telephone numbers indicated before attempting to place an order. If a
Purchase Order Form is faxed to the Trust without first contacting the Trust,
investors should not consider their order acknowledged until they have received
notification from the Trust or have confirmed receipt of the order by contacting
the Trust. A shareholder may confirm acceptance of a mailed or faxed purchase
order by calling the Trust at (617) 330-7500 in the case of Class III Shares, or
at (617) 790-5000 in the case of Class I or II Shares. If a Purchase Order is
mailed to the Trust, it will be acted upon when received.
(d) Payment: All Federal funds must be transmitted to Investors Bank &
Trust Company for the account of the specific Fund of GMO Trust. "Federal funds"
are monies credited to Investors Bank & Trust Company's account with the Federal
Reserve Bank of Boston.
Note: The Trust may attempt to process orders for Trust shares that are
submitted less formally than as described above but, in such cases, the investor
should carefully review confirmations sent by the Trust to verify that the order
was properly executed. The Trust cannot be held responsible for failure to
execute orders or improperly executing orders that are not submitted in
accordance with these procedures.
REDEMPTION OF SHARES
Shares of each Fund may be redeemed on any business day in cash or in
kind. The redemption price is the net asset value per share next determined
after receipt of the redemption request in "good order" less any applicable
redemption fee. All redemption fees are paid to and retained by the Fund and are
intended to cover the brokerage and other Fund costs associated with
redemptions. All classes of a particular Fund bear the same redemption fee rate,
if any.
The redemption fees currently in effect for each Fund are as follows:
Fund Redemption Fee
- ---- --------------
Emerging Country Debt Fund 0.25%1
Emerging Markets Fund 0.40%2
Core II Secondaries Fund 0.50%
International Small Companies Fund 0.60%
Japan Fund 0.61%
REIT Fund 0.75%
Global Hedged Equity Fund 1.40%3
1 Applies only to shares acquired on or after July 1, 1995 (including shares
acquired through the reinvestment of dividends and other distributions after
such date).
2 Applies only to shares acquired on or after June 1, 1995 (including shares
acquired through the reinvestment of dividends and other distributions after
such date).
3 This redemption fee will be 0% unless the size of a redemption forces the
Manager to an early termination of a hedging transaction to meet the redemption
request.
No redemption fees apply to redemptions of shares of any Funds other
than the Funds listed above.
Redemption fees apply only to cash transactions. These fees are paid to
and retained by the Fund itself and are employed to allocate transaction costs
caused by shareholder activity to the shareholder generating the activity,
rather than to the Fund as a whole. Redemption fees are not sales loads or
contingent deferred sales charges.
For the Emerging Markets Fund and Emerging Country Debt Fund only, the
Funds will reduce the stated redemption fee by 50% with respect to any portion
of a redemption that is offset by a corresponding purchase occurring on the same
day. For the Japan Fund only, the redemption fee may be waived if, generally due
to off-setting transactions, a redemption resulted in minimal brokerage and/or
other transaction costs. In each case, the Manager will determine if
circumstances exist to waive a portion of the redemption fee. Absent a clear
determination, the full fee will be charged.
For all other Funds (except the Global Hedged Equity Fund), the
redemption fee may not be waived in any circumstance.
If the Manager determines, in its sole discretion, that it would be
detrimental to the best interests of the remaining shareholders of a Fund to
make payment wholly or partly in cash, the Fund may pay the redemption price in
whole or in part by a distribution in-kind of securities held by the Fund in
lieu of cash.
-63-
Securities used to redeem Fund shares in-kind will be valued in accordance with
the relevant Fund's procedures for valuation described under "Determination of
Net Asset Value." Securities distributed by a Fund in-kind will be selected by
the Manager in light of the Fund's objective and will not generally represent a
pro rata distribution of each security held in the Fund's portfolio. Any in-kind
redemptions will be of readily marketable securities to the extent available.
Investors may incur brokerage charges on the sale of any such securities so
received in payment of redemptions.
Payment on redemption will be made as promptly as possible and in any
event within seven days after the request for redemption is received by the
Trust in "good order". A redemption request is in "good order" if it includes
the exact name in which shares are registered, the investor's account number and
the number of shares or the dollar amount of shares to be redeemed and if it is
signed exactly in accordance with the form of registration. In addition, for a
redemption request to be in "good order" on a particular day, the investor's
request must be received by the Trust by 4:15 p.m. on a business day. When a
redemption request is received after 4:15 p.m., the redemption request will not
be considered to be in "good order" and is required to be resubmitted on the
following business day. Persons acting in a fiduciary capacity, or on behalf of
a corporation, partnership or trust must specify, in full, the capacity in which
they are acting. The redemption request will be considered "received" by the
Trust only after (i) it is mailed to, and received by, the Trust at the
appropriate address set forth above for purchase orders, or (ii) it is faxed to
the Trust at the appropriate facsimile number set forth above for purchase
orders, and the investor has confirmed receipt of the faxed request by calling
the Trust at (617) 330-7500 in the case of Class III Shares, or at (617)
790-5000 in the case of Class I or Class II Shares. In-kind distributions will
be transferred and delivered as directed by the investor. Cash payments will be
made by transfer of Federal funds for payment into the investor's account.
When opening an account with the Trust, shareholders will be required
to designate the account(s) to which funds or securities may be transferred upon
redemption. Designation of additional accounts and any change in the accounts
originally designated must be made in writing.
Each Fund may suspend the right of redemption and may postpone payment
for more than seven days when the New York Stock Exchange is closed for other
than weekends or holidays, or if permitted by the rules of the Securities and
Exchange Commission during periods when trading on the Exchange is restricted or
during an emergency which makes it impracticable for the Fund to dispose of its
securities or to fairly determine the value of the net assets of the Fund, or
during any other period permitted by the Securities and Exchange Commission for
the protection of investors. Because the International Funds each hold portfolio
securities listed on foreign exchanges which may trade on days on which the New
York Stock Exchange is closed, the net asset value of such Funds' shares may be
significantly affected on days when shareholders have no access to such Funds.
DETERMINATION OF NET ASSET VALUE
The net asset value of a share is determined for each Fund once on each
day on which the New York Stock Exchange is open as of 4:15 p.m., New York City
Time, except that a Fund may not determine its net asset value on days during
which no security is tendered for redemption and no order to purchase or sell
such security is received by the relevant Fund. A Fund's net asset value is
determined by dividing the total market value of the Fund's portfolio
investments and other assets, less any liabilities, by the total outstanding
shares of the Fund. Portfolio securities listed on a securities exchange for
which market quotations are available are valued at the last quoted sale price
on each business day, or, if there is no such reported sale, at the most recent
quoted bid price. Price information on listed securities is generally taken from
the closing price on the exchange where the security is primarily traded.
Unlisted securities for which market quotations are readily available are valued
at the most recent quoted bid price, except that debt obligations with sixty
days or less remaining until maturity may be valued at their amortized cost,
unless circumstances dictate otherwise. Circumstances may dictate otherwise,
among other times, when the issuer's creditworthiness has become impaired.
All other fixed income securities (which includes bonds, loans and
structured notes) and options thereon are valued at the closing bid for such
securities as supplied by a primary pricing source chosen by the Manager. While
the Manager evaluates such primary pricing sources on an ongoing basis, and may
change any pricing source at any time, the Manager will not normally evaluate
the prices supplied by the pricing sources on a day-to-day basis. However, the
Manager is kept informed of erratic or unusual movements (including unusual
inactivity) in the prices supplied for a security and has the power to override
any price supplied by a source (by taking a price supplied from another source)
because of such price activity or because the Manager has other reasons to
suspect that a price supplied may not be reliable.
Other assets and securities for which no quotations are readily
available are valued at fair value as determined in good faith by the Trustees
or persons acting at their direction. The values of foreign securities quoted in
foreign currencies are translated into U.S. dollars at current exchange rates or
at such other rates as the Trustees may determine in computing net asset value.
Because of time zone differences, foreign exchanges and securities
markets will usually be closed prior to the time of the closing of the New York
Stock Exchange and values of foreign options and foreign securities will be
determined as of the earlier closing of such exchanges and securities markets.
However, events affecting the values of such foreign securities may occasionally
occur between the earlier closings of such exchanges and securities markets and
the closing of the New York Stock Exchange which will not be reflected in the
computation of the net asset value of the International Funds. If an event
materially affecting the value of such foreign securities occurs during such
period, then such securities will be valued at fair value as
-64-
determined in good faith by the Trustees or persons acting at their direction.
Because foreign securities, options on foreign securities and foreign
futures are quoted in foreign currencies, fluctuations in the value of such
currencies in relation to the U.S. dollar will affect the net asset value of
shares of the International Funds even though there has not been any change in
the values of such securities and options, measured in terms of the foreign
currencies in which they are denominated.
DISTRIBUTIONS
Each Fund intends to pay out as dividends substantially all of its net
investment income (which comes from dividends and interest it receives from its
investments and net short-term capital gains). For these purposes and for
federal income tax purposes, a portion of the premiums from certain expired call
or put options written by a Fund, net gains from certain closing purchase and
sale transactions with respect to such options and a portion of net gains from
other options and futures transactions are treated as short-term capital gain.
Each Fund also intends to distribute substantially all of its net long-term
capital gains, if any, after giving effect to any available capital loss
carryover. The policy of each Domestic Equity Fund, the Short-Term Income Fund
and the Domestic Bond Fund is to declare and pay distributions of its dividends
and interest quarterly. The policy of each International Fund, each Asset
Allocation Fund and the REIT Fund is to declare and pay distributions of its
dividends, interest and foreign currency gains semi-annually. Each Fund also
intends to distribute net short-term capital gains and net long-term gains at
least annually.
All dividends and/or distributions will be paid in shares of the
relevant Fund, at net asset value, unless the shareholder elects to receive
cash. There is no purchase premium on reinvested dividends or distributions.
Shareholders may make this election by marking the appropriate box on the
Purchase Order Form or by writing to the Trust.
TAXES
Each Fund is treated as a separate taxable entity for federal income
tax purposes. Each Fund intends to qualify each year as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended. So
long as a Fund so qualifies, the Fund itself will not pay federal income tax on
the amount distributed.
Fund distributions derived from interest, dividends and certain other
income, including in general short-term capital gains, will be taxable as
ordinary income to shareholders subject to federal income tax whether received
in cash or reinvested shares. Designated distributions of any long-term capital
gains whether received in cash or reinvested shares are taxable as such to
shareholders subject to federal income tax, regardless of how long a shareholder
may have owned shares in the Fund. Any loss realized upon a taxable disposition
of shares held for six months or less will be treated as long-term capital loss
to the extent of any long-term capital gain distributions received by a
shareholder with respect to those shares. A distribution paid to shareholders by
a Fund in January of a year generally is deemed to have been received by
shareholders on December 31 of the preceding year, if the distribution was
declared and payable to shareholders of record on a date in October, November or
December of that preceding year. The Trust will provide federal tax information
annually, including information about dividends and distributions paid during
the preceding year to taxable investors and others requesting such information.
For corporate shareholders, any distributions received by the REIT Fund
from REITs will not qualify for the corporate dividends-received deduction. The
REIT Fund's investments in REIT equity securities may require the REIT Fund to
accrue and distribute income not yet received. In order to generate sufficient
cash to make the requisite distributions, the Fund may be required to sell
securities in its portfolio that it otherwise would have continued to hold. The
REIT Fund's investments in REIT equity securities may at other times result in
the Fund's receipt of cash in excess of the REIT's earnings; if the Fund
distributes such amounts, such distribution would constitute a return of capital
to Fund shareholders for federal income tax purposes.
The back-up withholding rules do not apply to tax exempt entities so
long as each such entity furnishes the Trust with an appropriate certification.
However, other shareholders are subject to back-up withholding at a rate of 31%
on all distributions of net investment income and capital gain, whether received
in cash or reinvested in shares of the relevant Fund, and on the amount of the
proceeds of any redemption of Fund shares paid or credited to any shareholder
account for which an incorrect or no taxpayer identification number has been
provided, where appropriate certification has not been provided for a foreign
shareholder, or where the Trust is notified that the shareholder has
underreported income in the past (or the shareholder fails to certify that he is
not subject to such withholding).
The foregoing is a general summary of the federal income tax
consequences for shareholders who are U.S. citizens, residents or domestic
corporations. Shareholders should consult their own tax advisors about the tax
consequences of an investment in a Fund in light of each shareholder's
particular tax situation. Shareholders should also consult their own tax
advisors about consequences under foreign, state, local or other applicable tax
laws.
WITHHOLDING ON DISTRIBUTIONS TO FOREIGN INVESTORS
Dividend distributions (including distributions derived from short-term
capital gains) are in general subject to a U.S. withholding tax of 31% when paid
to a nonresident alien individual, foreign estate or trust, a foreign
corporation, or a foreign partnership ("foreign shareholder"). Persons who are
resident in a country, such as the U.K., that has an income tax treaty with the
U.S. may be eligible for a reduced withholding rate (upon filing of appropriate
forms), and are urged to consult
-65-
their tax advisors regarding the applicability and effect of such a treaty.
Distributions of net long-term capital gains to a foreign shareholder, and any
gain realized upon the sale of Fund shares by such a shareholder will ordinarily
not be subject to U.S. taxation, unless the recipient or seller is a nonresident
alien individual who is present in the United States for more than 182 days
during the taxable year. However, foreign shareholders with respect to whom
income from a Fund is "effectively connected" with a U.S. trade or business
carried on by such shareholder will in general be subject to U.S. federal income
tax on the income derived from the Fund at the graduated rates applicable to
U.S. citizens, residents or domestic corporations, whether received in cash or
reinvested in shares, and, in the case of a foreign corporation, may also be
subject to a branch profits tax. Again, foreign shareholders who are resident in
a country with an income tax treaty with the United States may obtain different
tax results, and are urged to consult their tax advisors.
FOREIGN TAX CREDITS
If, at the end of the fiscal year, more than 50% of the total assets of
any Fund is represented by stock of foreign corporations, the Fund intends to
make an election with respect to the relevant Fund which allows shareholders
whose income from the Fund is subject to U.S. taxation at the graduated rates
applicable to U.S. citizens, residents or domestic corporations to claim a
foreign tax credit or deduction (but not both) on their U.S. income tax return.
In such case, the amounts of foreign income taxes paid by the Fund would be
treated as additional income to Fund shareholders from non-U.S. sources and as
foreign taxes paid by Fund shareholders. Investors should consult their tax
advisors for further information relating to the foreign tax credit and
deduction, which are subject to certain restrictions and limitations.
Shareholders of any of the International Funds whose income from the Fund is not
subject to U.S. taxation at the graduated rates applicable to U.S. citizens,
residents or domestic corporations may receive substantially different tax
treatment of distributions by the relevant Fund, and may be disadvantaged as a
result of the election described in this paragraph.
LOSS OF REGULATED INVESTMENT COMPANY STATUS
A Fund may experience particular difficulty qualifying as a regulated
investment company in the case of highly unusual market movements, in the case
of high redemption levels and/or during the first year of its operations. If the
Fund does not qualify for taxation as a regulated investment company for any
taxable year, the Fund's income will be taxed at the Fund level at regular
corporate rates, and all distributions from earnings and profits, including
distributions of net long-term capital gains, will be taxable to shareholders as
ordinary income and subject to withholding in the case of non-U.S. shareholders.
In addition, in order to requalify for taxation as a regulated investment
company, the Fund may be required to recognize unrealized gains, pay taxes on
such gains, and make certain distributions.
MANAGEMENT OF THE TRUST
Each Fund is advised and managed by Grantham, Mayo, Van Otterloo & Co.,
40 Rowes Wharf, Boston, Massachusetts 02110 (the "Manager") which provides
investment advisory services to a substantial number of institutional and other
investors, including one other registered investment company. Each of the
following four general partners holds a greater than 5% interest in the Manager:
R. Jeremy Grantham, Richard A. Mayo, Eyk H.A. Van Otterloo and Kingsley Durant.
Under separate Management Contracts with the Trust, the Manager selects
and reviews each Fund's investments and provides executive and other personnel
for the management of the Trust. Pursuant to the Trust's Agreement and
Declaration of Trust, the Board of Trustees supervises the affairs of the Trust
as conducted by the Manager. In the event that the Manager ceases to be the
manager of any Fund, the right of the Trust to use the identifying name "GMO"
may be withdrawn.
The Manager has entered into a Consulting Agreement (the "Consulting
Agreement") with Dancing Elephant, Ltd., 1936 University Avenue, Berkeley,
California 94704 (the "Consultant"), with respect to the management of the
portfolio of the Emerging Markets Fund. The Consultant is wholly-owned by Mr.
Arjun Divecha. Under the Consulting Agreement, the Manager pays the Consultant a
monthly fee at an annual rate equal to the greater of 0.50% of the Fund's
average daily net assets or $500,000. The Consultant may from time to time waive
all or a portion of its fee. Payments made by the Manager to the Consultant will
not affect the amounts payable by the Fund to the Manager or the Fund's expense
ratio.
Each Management Contract provides for payment to the Manager of a
management fee at the stated annual rates set forth under Schedule of Fees and
Expenses. The Management fee is computed and accrued daily, and paid monthly.
While the fee paid to the Manager by each of the Fundamental Value Fund, the
REIT Fund, the International Core Fund, the Currency Hedged International Core
Fund, the Foreign Fund, the International Small Companies Fund, the Japan Fund
and the Emerging Markets Fund is higher than that paid by most funds, each is
comparable to the fees paid by many funds with similar investment objectives. In
addition, with respect to each Fund, the Manager has voluntarily agreed to waive
its fee and to bear certain expenses until further notice in order to limit each
Fund's annual expenses to specified limits (with certain exclusions). These
limits and the terms applicable to them are described under Schedule of Fees and
Expenses.
During the fiscal year ended February 29, 1996, the Manager received,
as compensation for management services rendered in such year (after waiver),
the percentages of each Fund's average daily net assets as set forth on the
following page:
-66-
Fund % of Average Net Assets
- ---- -----------------------
Core Fund 0.45%
Tobacco-Free Core Fund 0.30%
Value Fund 0.56%
Growth Fund 0.43%
U.S. Sector Fund 0.42%
Core II Secondaries Fund 0.37%
Fundamental Value Fund 0.70%
International Core Fund 0.61%
International Small Companies Fund 0.56%
Japan Fund 0.61%
Emerging Markets Fund 0.98%
Global Hedged Equity Fund 0.59%
Domestic Bond Fund 0.19%
Short-Term Income Fund 0.00%
International Bond Fund 0.27%
Currency Hedged International Bond Fund 0.26%
Emerging Country Debt Fund 0.34%
Currency Hedged International Core Fund 0.32%
Global Bond Fund 0.00%
Mr. R. Jeremy Grantham and Christopher Darnell are primarily
responsible for the day-to-day management of the Core Fund, the Tobacco-Free
Core Fund, the Growth Fund, the U.S. Sector Fund, and the Core II Secondaries
Fund. Each has served in this capacity for more than five years. Mr. William L.
Nemerever, Mr. Thomas F. Cooper and Mr. Steven Edelstein are primarily
responsible for the day-to-day management of the Fixed Income Funds other than
the Global Hedged Equity Fund. Each of Messrs. Nemerever and Cooper has served
in this capacity since the inception of all of these Funds except the Short-Term
Income Fund. Messrs. Nemerever and Cooper have served as the managers of the
Short-Term Income Fund since 1993. Mr. Edelstein has served in this capacity
since 1995. Prior to 1993, the Short-Term Income Fund was managed by Mr. Robert
Brokaw. Mr. Richard A. Mayo has been primarily responsible for the day-to-day
management of the Fundamental Value Fund since the Fund's inception. Mr. Mayo
and Mr. Christopher Darnell have been primarily responsible for the day-to-day
management of the Value Fund since the Fund's inception. Mr. Darnell, Mr. Brokaw
and Mr. Richard McQuaid will be primarily responsible for the day-to-day
Management of the REIT Fund. Mr. Grantham, Mr. Darnell, Mr. Forrest Berkley and
Ms. Doris Chu have been primarily responsible for the day-to-day management of
each of the Currency Hedged International Core Fund, the International Small
Companies Fund, the Japan Fund and the Global Hedged Equity Fund since inception
of the Funds and have served as managers of the International Core Fund for the
last six years. Mr. Arjun Bhagwan Divecha has been primarily responsible for the
day-to-day management of the Emerging Markets Fund since the inception of the
Fund. Day-to- day management of the Foreign Fund is the responsibility of a
committee and no person or persons is primarily responsible for making
recommendations to that committee.
Mr. Grantham and Mr. Mayo are both founding partners of the Manager and
have been engaged by the Manager in equity and fixed-income portfolio management
since its inception in 1977. Mr. Grantham serves as President - Domestic
Quantitative and Mr. Mayo serves as President - Domestic Active of the Trust.
Mr. Darnell has been with the Manager since 1979 and has been involved in equity
portfolio management for more than ten years. Mr. Berkley and Ms. Chu have each
been with the Manager for more than eight years and have each been involved in
portfolio management (principally of international equities) for more than six
years. Mr. Nemerever and Mr. Cooper have been employed by the Manager in
fixed-income portfolio management since October, 1993. For the five years prior
to October, 1993, Mr. Nemerever was employed by Boston International Advisors
and Fidelity Management Trust Company in fixed-income portfolio management. For
the five years prior to October, 1993, Mr. Cooper was employed by Boston
International Advisors, Goldman Sachs Asset Management and Western Asset
Management in fixed-income portfolio management. Mr. Edelstein joined the
Manager in June 1995. For the five years prior to that, Mr. Edelstein was Vice
President in the Fixed Income Futures and Options Group at Morgan Stanley &
Company. Mr. Divecha is the sole shareholder and President of the Consultant
which he organized in September 1993. From 1981 until September 1993, Mr.
Divecha was employed by BARRA and during this period he was involved in equity
portfolio management for more than five years.
Pursuant to a Servicing Agreement with the Trust on behalf of each
class of shares of each Fund, Grantham, Mayo, Van Otterloo & Co., in its
capacity as the Trust's shareholder servicer (the "Shareholder Servicer")
provides direct client service, maintenance and reporting to shareholders of
each class of shares. Such servicing and reporting services include, without
limitation, professional and informative reporting, client account information,
personal and electronic access to Fund information, access to analysis and
explanations of Fund reports, and assistance in the correction and maintenance
of client-related information.
ORGANIZATION AND CAPITALIZATION
OF THE TRUST
The Trust was established on June 24, 1985 as a business trust under
Massachusetts law. The Trust has an unlimited authorized number of shares of
beneficial interest which may, without shareholder approval, be divided into an
unlimited number of series of such shares, and which are presently divided into
twenty-seven series of shares: one for each Fund, one for the Pelican Fund, and
one for the Conservative Equity Fund, which is currently inactive. All shares of
all series are entitled to vote at any meetings of shareholders. The Trust does
not generally hold annual meetings of shareholders and will do so only when
required by law. All shares entitle their holders to one vote per share. Matters
submitted to shareholder vote must be approved by each Fund separately except
(i) when required by the 1940 Act shares shall be voted together as a single
class and (ii) when the Trustees have determined that the matter does not affect
a Fund, then only shareholders of the Fund(s) affected shall be entitled to vote
on the matter. Shareholders of a particular class of shares do not have separate
class voting rights except with respect to matters that affect only that class
of shares or as otherwise
-66-
required by law. Shares are freely transferable, are entitled to dividends as
declared by the Trustees, and, in liquidation of the Trust, are entitled to
receive the net assets of their Fund, but not of any other Fund. Shareholders
holding a majority of the outstanding shares of all series may remove Trustees
from office by votes cast in person or by proxy at a meeting of shareholders or
by written consent.
On April 30, 1996, the following shareholders held greater than 25% of
the outstanding shares of the series noted in the following chart:
Fund Shareholders
- ---- ------------
Value Fund Leland Stanford Junior University
Tobacco-Free Core Fund Dewitt Wallace - Reader's Digest Fund,
Inc.; Lila Wallace -
Reader's Digest Fund, Inc.
U.S. Sector Fund John D. MacArthur &
Catherine T. MacArthur Foundation
Fundamental Value Fund Yale University; Leland Stanford Junior
University
Japan Fund International Monetary Fund Staff
Retirement Plan
Domestic Bond Fund Bankers Trust Company as Trustee, GTE
Service Corp. Pension Trust
Short-Term Income Fund Cormorant Fund; MJH Foundation
Currency Hedged Bankers Trust Company as
International Bond Fund Trustee, GTE Service Corp. Pension
Trust
Global Hedged Equity Fund Bankers Trust Company as Trustee, GTE
Service Corp. Pension Trust
Global Bond Fund Essex & Company
Core II Secondaries Fund Bankers Trust Company as Trustee, GTE
Service Corp. Pension Trust
As a result, such shareholders may be deemed to "control" their respective
series as such term is defined in the 1940 Act.
Shareholders could, under certain circumstances, be held personally
liable for the obligations of the Trust. However, the risk of a shareholder
incurring financial loss on account of that liability is considered remote since
it may arise only in very limited circumstances.
-68-
APPENDIX A
RISKS AND LIMITATIONS OF OPTIONS, FUTURES AND SWAPS
Limitations on the Use of Options and Futures Portfolio Strategies. As
noted in "Descriptions and Risks of Fund Investment Practices--Futures and
Options" above, the Funds may use futures contracts and related options for
hedging and, in some circumstances, for risk management or investment but not
for speculation. Thus, except when used for risk management or investment, each
such Fund's long futures contract positions (less its short positions) together
with the Fund's cash (i.e., equity or fixed income) positions will not exceed
the Fund's total net assets.
The Funds' ability to engage in the options and futures strategies
described above will depend on the availability of liquid markets in such
instruments. Markets in options and futures with respect to currencies are
relatively new and still developing. It is impossible to predict the amount of
trading interest that may exist in various types of options or futures.
Therefore no assurance can be given that a Fund will be able to utilize these
instruments effectively for the purposes set forth above. Furthermore, each
Fund's ability to engage in options and futures transactions may be limited by
tax considerations.
Risk Factors in Options Transactions. The option writer has no control
over when the underlying securities or futures contract must be sold, in the
case of a call option, or purchased, in the case of a put option, since the
writer may be assigned an exercise notice at any time prior to the termination
of the obligation. If an option expires unexercised, the writer realizes a gain
in the amount of the premium. Such a gain, of course, may, in the case of a
covered call option, be offset by a decline in the market value of the
underlying security or futures contract during the option period. If a call
option is exercised, the writer realizes a gain or loss from the sale of the
underlying security or futures contract. If a put option is exercised, the
writer must fulfill the obligation to purchase the underlying security or
futures contract at the exercise price, which will usually exceed the then
market value of the underlying security or futures contract.
An exchange-traded option may be closed out only on a national
securities exchange ("Exchange") which generally provides a liquid secondary
market for an option of the same series. An over-the-counter option may be
closed out only with the other party to the option transaction. If a liquid
secondary market for an exchange-traded option does not exist, it might not be
possible to effect a closing transaction with respect to a particular option
with the result that the Fund holding the option would have to exercise the
option in order to realize any profit. For example, in the case of a written
call option, if the Fund is unable to effect a closing purchase transaction in a
secondary market (in the case of a listed option) or with the purchaser of the
option (in the case of an over-the-counter-option), the Fund will not be able to
sell the underlying security (or futures contract) until the option expires or
it delivers the underlying security (or futures contract) upon exercise. Reasons
for the absence of a liquid secondary market on an Exchange include the
following: (i) there may be insufficient trading interest in certain options;
(ii) restrictions may be imposed by an Exchange on opening transactions or
closing transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or series of
options or underlying securities; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an Exchange; (v) the facilities of an Exchange or
the Options Clearing Corporation may not at all times be adequate to handle
current trading volume; or (vi) one or more Exchanges could, for economic or
other reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options), in which event
the secondary market on that Exchange (or in that class or series of options)
would cease to exist, although outstanding options on that Exchange that had
been issued by the Options Clearing Corporation as a result of trades on that
Exchange should continue to be exercisable in accordance with their terms.
The Exchanges have established limitations governing the maximum number
of options which may be written by an investor or group of investors acting in
concert. It is possible that the Funds, the Manager and other clients of the
Manager may be considered to be such a group. These position limits may restrict
a Fund's ability to purchase or sell options on a particular security.
The amount of risk a Fund assumes when it purchases an option is the
premium paid for the option plus related transaction costs. In addition to the
correlation risks discussed below, the purchase of an option also entails the
risk that changes in the value of the underlying security or futures contract
will not be fully reflected in the value of the option purchased.
Risk Factors in Futures Transactions. Investment in futures contracts
involves risk. If the futures are used for hedging, some of that risk may be
caused by an imperfect correlation between movements in the price of the futures
contract and the price of the security or currency being hedged. The correlation
is higher between price movements of futures contracts and the instrument
underlying that futures contract. The correlation is lower when futures are used
to hedge securities other than such underlying instrument, such as when a
futures contract on an index of securities is used to hedge a single security, a
futures contract on one security (e.g., U.S. Treasury bonds) is used to hedge a
different security (e.g., a mortgage-backed security) or when a futures contract
in one currency (e.g., the German Mark) is used to hedge a security denominated
in another currency (e.g., the Spanish Peseta). In the event of an imperfect
correlation between a futures position and a portfolio
-69-
position (or anticipated position) which is intended to be protected, the
desired protection may not be obtained and a Fund may be exposed to risk of
loss. In addition, it is not always possible to hedge fully or perfectly against
currency fluctuations affecting the value of the securities denominated in
foreign currencies because the value of such securities also is likely to
fluctuate as a result of independent factors not related to currency
fluctuations. The risk of imperfect correlation generally tends to diminish as
the maturity date of the futures contract approaches.
A hedge will not be fully effective where there is such imperfect
correlation. To compensate for imperfect correlations, a Fund may purchase or
sell futures contracts in a greater amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, a Fund may purchase or sell fewer
contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contract.
As noted in the Prospectus, a Fund may also purchase futures contracts
(or options thereon) as an anticipatory hedge against a possible increase in the
price of currency in which is denominated the securities the Fund anticipates
purchasing. In such instances, it is possible that the currency may instead
decline. If the Fund does not then invest in such securities because of concern
as to possible further market and/or currency decline or for other reasons, the
Fund may realize a loss on the futures contract that is not offset by a
reduction in the price of the securities purchased.
The liquidity of a secondary market in a futures contract may be
adversely affected by "daily price fluctuation limits" established by commodity
exchanges which limit the amount of fluctuation in a futures contract price
during a single trading day. Once the daily limit has been reached in the
contract, no trades may be entered into at a price beyond the limit, thus
preventing the liquidation of open futures positions. Prices have in the past
exceeded the daily limit on a number of consecutive trading days. Short
positions in index futures may be closed out only by entering into a futures
contract purchase on the futures exchange on which the index futures are traded.
The successful use of transactions in futures and related options for
hedging and risk management also depends on the ability of the Manager to
forecast correctly the direction and extent of exchange rate, interest rate and
stock price movements within a given time frame. For example, to the extent
interest rates remain stable during the period in which a futures contract or
option is held by a Fund investing in fixed income securities (or such rates
move in a direction opposite to that anticipated), the Fund may realize a loss
on the futures transaction which is not fully or partially offset by an increase
in the value of its portfolio securities. As a result, the Fund's total return
for such period may be less than if it had not engaged in the hedging
transaction.
Unlike trading on domestic commodity exchanges, trading on foreign
commodity exchanges is not regulated by the CFTC and may be subject to greater
risks than trading on domestic exchanges. For example, some foreign exchanges
may be principal markets so that no common clearing facility exists and a trader
may look only to the broker for performance of the contract. In addition, unless
a Fund hedges against fluctuations in the exchange rate between the U.S. dollar
and the currencies in which trading is done on foreign exchanges, any profits
that a Fund might realized in trading could be eliminated by adverse changes in
the exchange rate, or the Fund could incur losses as a result of those changes.
Risk Factors in Swap Contracts, OTC Options and other Two-Party
Contracts. A Fund may only close out a swap, contract for differences, cap floor
or collar or OTC option, with the particular counterparty. Also, if the
counterparty defaults, a Fund will have contractual remedies pursuant to the
agreement related to the transaction, but there is no assurance that contract
counterparties will be able to meet their obligations pursuant to such contracts
or that, in the event of default, a Fund will succeed in pursuing contractual
remedies. The Fund thus assumes the risk that it may be delayed or prevented
from obtaining payments owed to it pursuant to swap contracts. The Manager will
closely monitor subject to the oversight of the Trustees, the creditworthiness
of contract counterparties and a Fund will not enter into any swaps, caps,
floors or collars, unless the unsecured senior debt or the claims-paying ability
of the other party thereto is rated at least A by Moody's Investors Service or
Standard and Poor's Corporation at the time of entering into such transaction or
if the counterparty has comparable credit as determined by the Manager. However,
the credit of the counterparty may be adversely affected by larger-than-average
volatility in the markets, even if the counterparty's net market exposure is
small relative to its capital. The management of caps, floors, collars and swaps
may involve certain difficulties because the characteristics of many derivatives
have not been observed under all market conditions or through a full market
cycle.
Additional Regulatory Limitations on the Use of Futures and Related
Options, Interest Rate Floors, Caps and Collars and Interest Rate and Currency
Swap Contracts. In accordance with CFTC regulations, investments by any Fund as
provided in the Prospectus in futures contracts and related options for purposes
other than bona fide hedging are limited such that the aggregate amount that a
Fund may commit to initial margin on such contracts or premiums on such options
may not exceed 5% of that Fund's net assets.
The Manager and the Trust do not believe that the Fund's respective
obligations under equity swap contracts, reverse equity swap contracts or Index
Futures are senior securities and, accordingly, the Fund will not treat them as
being subject to its borrowing restrictions. However, the net amount of the
excess, if any, of the Fund's obligations over its entitlements with respect to
each equity swap contract will be accrued on a daily basis and an amount of
cash, U.S. Government Securities or other high grade debt obligations having an
aggregate market value at least equal to the accrued excess will be maintained
in a segregated account by the Fund's custodian. Likewise, when a Fund takes a
short position with respect to an Index Futures contract the position must be
covered
-70-
or the Fund must maintain at all times while that position is held by the Fund,
cash, U.S. government securities or other high grade debt obligations in a
segregated account with its custodian, in an amount which, together with the
initial margin deposit on the futures contract, is equal to the current delivery
or cash settlement value.
The use of unsegregated futures contracts, related written options,
interest rate floors, caps and collars and interest
rate and currency swap contracts for risk management by a Fund permitted to
engage in any or all of such practices is limited to no more than 10% of a
Fund's total net assets when aggregated with such Fund's traditional borrowings
in accordance with SEC pronouncements. This 10% limitation applies to the face
amount of unsegregated futures contracts and related options and to the amount
of a Fund's net payment obligation that is not segregated against in the case of
interest rate floors, caps and collars and interest rate and currency swap
contracts.
-71-
APPENDIX B
COMMERCIAL PAPER AND CORPORATE DEBT RATINGS
COMMERCIAL PAPER RATINGS
Commercial paper ratings of Standard & Poor's Corporation ("Standard &
Poor's") are current assessments of the likelihood of timely payment of debts
having original maturities of no more than 365 days. Commercial paper rated A-1
by Standard & Poor's indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted A-1+. Commercial paper
rated A-2 by Standard and Poor's indicates that capacity for timely payment on
issues is strong. However, the relative degree of safety is not as high as for
issues designated A-1. Commercial paper rated A-3 indicates capacity for timely
payment. It is, however, somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's Investors Service, Inc. ("Moody's"). Issuers rated Prime-1 (or related
supporting institutions) are considered to have a superior capacity for
repayment of short-term promissory obligations. Issuers rated Prime-2 (or
related supporting institutions) have a strong capacity for repayment of
short-term promissory obligations. This will normally be evidenced by many of
the characteristics of Prime-1 rated issuers, but to a lesser degree. Earnings
trends and coverage ratios, while sound, will be more subject to variations.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternative liquidity is maintained. Issuers rated
Prime-3 have an acceptable capacity for repayment of short-term promissory
obligations. The effect of industry characteristics and market composition may
be more pronounced. Variability in earnings and profitability may result in
changes in the level of debt protection measurements and the requirement of
relatively high financial leverage. Adequate alternate liquidity is maintained.
CORPORATE DEBT RATINGS
Standard & Poor's Corporation. A Standard & Poor's corporate debt
rating is a current assessment of the creditworthiness of an obligor with
respect to a specific obligation. The following is a summary of the ratings used
by Standard & Poor's for corporate debt:
AAA - This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay interest and repay
principal.
AA - Bonds rated AA also qualify as high quality debt obligations. Capacity to
pay interest and repay principal is very strong, and in the majority of
instances they differ from AAA issues only in small degree.
A - Bonds rated A have a strong capacity to pay interest and repay principal,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB - Bonds rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to repay principal and pay interest for
bonds in this category than for bonds in higher rated categories.
BB, B, CCC, CC - Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominately speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and CC the highest degree of speculation. While
such bonds will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
C - The rating C is reserved for income bonds on which no interest is being
paid.
D - Bonds rated D are in default, and payment of interest and/or repayment of
principal is in arrears.
Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Moody's Investors Service, Inc. The following is a summary of the
ratings used by Moody's Investor Services, Inc. for corporate debt:
Aaa - Bonds that are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge." Interest payments are protected by a large, or by an exceptionally
stable, margin, and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa - Bonds that are rated Aa are judged to be high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds.
-72-
They are rated lower than the best bonds because margins of protection may not
be as large as in Aaa securities or fluctuation of protective elements may be of
greater amplitude or there may be other elements present that make the long-term
risks appear somewhat larger than in Aaa securities.1
A - Bonds that are rated A possess many favorable investment attributes and are
to be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present that
suggest a susceptibility to impairment sometime in the future.1
Baa - Bonds that 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.
Should no rating be assigned by Moody's, the reason may be one of the following:
1. An application for rating was not received or
accepted.
2. The issue or issuer belongs to a group of
securities that are not rated as a matter of policy.
3. There is lack of essential data pertaining to the
issue or issuer.
4. The issue was privately placed in which case the
rating is not published in Moody's publications.
Suspension or withdrawal may occur if new and material circumstances arise, the
effects of which preclude satisfactory analysis; if there is no longer available
reasonable up-to-date data to permit a judgment to be formed; if a bond is
called for redemption; or for other reasons.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols 1Aa1,
A1, Baa1, and B1.
-73-
SHAREHOLDER INQUIRIES
Shareholders may direct inquiries regarding CLASS III Shares
to Grantham, Mayo, Van Otterloo & Co.,
40 Rowes Wharf, Boston, MA 02110
(1-617-330-7500)
Shareholders may direct inquiries regarding CLASS I or CLASS II Shares
to GMO Funds Division,
40 Rowes Wharf, Boston, MA 02110
(1-617-790-5000)
