<PAGE> 1
File Nos. 2-98772
811-4347
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
ON NOVEMBER 30, 1998
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933: Not Applicable
Pre-Effective Amendment No. / /
Post-Effective Amendment No. 46 / X /
REGISTRATION STATEMENT UNDER THE INVESTMENT
COMPANY ACT OF 1940
Amendment No. 52 / X /
GMO TRUST
(Exact Name of Registrant as Specified in Charter)
40 Rowes Wharf, Boston, Massachusetts 02110
(Address of principal executive offices)
617-330-7500
(Registrant's telephone number, including area code)
with a copy to:
R. Jeremy Grantham J.B. Kittredge, Esq.
GMO Trust Ropes & Gray
40 Rowes Wharf One International Place
Boston, Massachusetts 02110 Boston, Massachusetts 02110
(Name and address of agents for service)
It is proposed that this filing will become effective:
[ ] Immediately upon filing pursuant to paragraph (b), or
[X] On December 21, 1998 puruant to paragraph (b), or
[ ] 60 days after filing pursuant to paragraph (a)(1), or
[ ] 75 days after filing pursuant to paragraph (a)(2), of Rule 485 under
the Securities Act of 1933.
<PAGE> 2
GMO TRUST
CROSS REFERENCE SHEET
(for GMO Emerging Country Debt Share Fund only)
<TABLE>
<CAPTION>
N-1A Item No. Location
------------- --------
PART A
<S> <C> <C>
Item 1. Cover Page .......................................................... Cover Page
Item 2. Synopsis............................................................. Schedule of Fees and
Expenses
Item 3. Condensed Financial
Information ......................................................... Financial Highlights
Item 4. General Description of
Registrant........................................................... Organization and
Capitalization of the
Trust; Investment
Objectives and
Policies; Description
and Risks of Fund
Investments; Cover
Page
Item 5. Management of the Fund............................................... Management of the
Trust
Item 5A. Management's Discussion
of Fund Performance.................................................. Not Applicable
(to be included in
Trust's Annual Report)
Item 6. Capital Stock and Other
Securities........................................................... Organization and
Capitalization of the
Trust; Back Cover
(Shareholder
Inquiries)
Item 7. Purchase of Securities Being
Offered.............................................................. Purchase of Shares;
Determination of Net
Asset Value
Item 8. Redemption or Repurchase............................................. Redemption of Shares;
Determination of Net
Asset Value
Item 9. Pending Legal Proceedings............................................ None
Part B
Item 10. Cover Page........................................................... Cover Page
Item 11. Table of Contents.................................................... Table of Contents
Item 12. General Information and
History....................................................... Not Applicable
Item 13. Investment Objectives
and Policies.................................................. Investment Objectives
and Policies;
Miscellaneous
Investment Practices
</TABLE>
<PAGE> 3
<TABLE>
<S> <C> <C>
Item 14. Management of the Fund................................................ Management of the
Trust
Item 15. Control Persons and Principal
Holders of Securities.......................................... Description of the
Trust and Ownership of
Shares
Item 16. Investment Advisory and Other
Services....................................................... Investment Advisory
and Other Services
Item 17. Brokerage Allocation and Other
Practices...................................................... Portfolio Transactions
Item 18. Capital Stock and Other
Securities..................................................... Description of the
Trust and Ownership of
Shares
Item 19. Purchase, Redemption and Pricing
of Securities Being Offered.................................... See in Part A Purchase
of Shares; Redemption
of Shares;
Determination of Net
Asset Value
Item 20. Tax Status............................................................ See in Part A
Distributions and
Taxes
Item 21. Underwriters.......................................................... Not Applicable
Item 22. Calculation of Performance
Data........................................................... Performance
Information
Item 23. Financial Statements.................................................. Financial Statements
</TABLE>
Part C
Information to be included in Part C is set forth under the
appropriate item, so numbered, in Part C of this Registration Statement.
This Post-Effective Amendment relates only to the GMO Emerging
Country Debt Share Fund. No information relating to any other series of the
registrant is amended or superseded hereby.
<PAGE> 4
GMO EMERGING COUNTRY DEBT
SHARE FUND
40 Rowes Wharf, Boston, Massachusetts 02110
The GMO EMERGING COUNTRY DEBT SHARE FUND (THE "FUND") is one of
thirty-six separate investment portfolios currently offered by GMO Trust (the
"Trust"), an open-end management investment company. The other portfolios are
offered pursuant to separate prospectuses. The Fund's investment manager is
GRANTHAM, MAYO, VAN OTTERLOO & CO. LLC (the "MANAGER" or "GMO").
The Fund seeks to earn high total return through investment of
substantially all of its assets in Class III Shares of the GMO Emerging Country
Debt Fund, a portfolio of the Trust ("ECDF"). GMO also serves as investment
manager to ECDF. ECDF pursues its objective by investing primarily in sovereign
debt (bonds and loans) of countries in Asia, Latin America, the Middle East and
Africa, as well as countries located in Europe which are not in the European
Community (collectively, "Emerging Countries").
The Fund is a "diversified" portfolio, as defined in the Investment
Company Act of 1940 (the "1940 Act"). See "Description and Risks of Fund
Investments--Diversified and Non-Diversified Portfolios." A TABLE OF CONTENTS
APPEARS ON PAGE i OF THIS PROSPECTUS (THE "PROSPECTUS").
The Fund offers a single class of shares, Class III Shares. Initial
investments in the Fund must be in the amount of at least $1 million, unless
such investment minimum is waived by the Manager. Subsequent investments must be
in the amount of at least $100,000.
INVESTMENT MANAGER
GMO
Grantham, Mayo, Van Otterloo & Co. LLC
- ---------------------------
This Prospectus concisely describes the information which investors
ought to know about the Fund before investing. Please read this Prospectus
carefully and keep it for further reference. A Statement of Additional
Information dated December 21, 1998, as revised from time to time, is available
free of charge by writing to GMO, 40 Rowes Wharf, Boston, Massachusetts 02110,
or by calling (617) 330-7500. The Statement, which contains more detailed
information about the Fund, has been filed with the Securities and Exchange
Commission ("SEC") and is incorporated by reference into this Prospectus.
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 DECEMBER 21, 1998
<PAGE> 5
TABLE OF CONTENTS
SCHEDULE OF FEES AND EXPENSES..................................................1
FINANCIAL HIGHLIGHTS...........................................................3
INVESTMENT OBJECTIVE AND POLICIES..............................................4
DESCRIPTION AND RISKS OF FUND INVESTMENTS......................................5
ADDITIONAL INVESTMENT RESTRICTIONS............................................20
PURCHASE OF SHARES............................................................21
REDEMPTION OF SHARES..........................................................23
DETERMINATION OF NET ASSET VALUE..............................................23
DISTRIBUTIONS.................................................................24
TAXES .....................................................................24
MANAGEMENT OF THE TRUST.......................................................26
ORGANIZATION AND CAPITALIZATION OF THE TRUST..................................26
Appendix A: RISKS AND LIMITATIONS OF OPTIONS, FUTURES AND SWAPS...............28
Appendix B: COMMERCIAL PAPER AND CORPORATE DEBT RATINGS.......................31
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FEES AND EXPENSES
SCHEDULE OF FEES AND EXPENSES
<TABLE>
<CAPTION>
GMO Shareholder
Fund Name Transaction Expenses Annual Operating Expenses** Examples**
---------------------------- ---------------------------------------- -----------------------------------------
Cash Purchase Redemption Inv. Share- Other Total You would pay the You would pay the
Premium (as a Fees (as a Mgmt. holder Ex- Operating following expenses on following expenses
percentage of percentage of Fees after Service penses Expenses a $1,000 investment on the same
amount amount Fee Fee(2) (1) (1) assuming 5% annual investment assuming
invested) redeemed) Waiver(1) return with no redemption:
redemption at the end
of each time period:
1 Yr. 3 Yr. 1 Yr. 3 Yr.
EMERGING COUNTRY ----- ----- ----- -----
DEBT SHARE FUND
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Class III * * 0.30% 0.15% 0.08% 0.53% $13 $25 $10 $22
</TABLE>
Unless otherwise noted, Annual Operating Expenses shown are based on actual
expenses (for ECDF) for the fiscal year ended February 28, 1998.
*Note: No purchase premium or redemption fee is charged directly by the Fund. By
virtue of the Fund's investment in ECDF, an investor in the Fund will, however,
indirectly bear ECDF's purchase premium and redemption fees, which are presently
up to 0.50% and 0.25%, respectively. These fees are paid to and retained by ECDF
itself and are designed to allocate transaction costs caused by shareholder
activity to the shareholder generating the activity (i.e., the Fund), rather
than to ECDF as a whole.
**Note: The Annual Operating Expenses set forth in the table above reflect the
aggregate Annual Operating Expenses of the Fund and ECDF, after giving effect to
the Manager's voluntary undertakings to reduce its management fees and bear
certain expenses, as described in greater detail in the footnotes below. No
investment management fees, shareholder service fees or other operating expenses
are assessed at the Fund level. Thus, the expenses shown in the table above
effectively represent fees and expenses borne by the Fund by virtue of its
investment in ECDF.
The purpose of the foregoing table is to assist investors in understanding the
various costs and expenses of the Fund (and, indirectly, ECDF) 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 THE FUND
AS DESCRIBED IN THE TABLE, 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 ECDF 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").
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<PAGE> 7
NOTES TO SCHEDULE OF FEES AND EXPENSES
1. The Manager has voluntarily undertaken to bear certain expenses with
respect to the Fund until further notice to the extent that the Fund's
total annual operating expenses (excluding expenses indirectly incurred
by investment in other GMO Funds) would otherwise exceed the percentage
of the Fund's daily net assets specified below. Therefore, so long as
the Manager agrees to bear certain expenses, total annual operating
expenses (subject to such exclusions) of the Fund will not exceed the
stated limitation. Absent such an undertaking, management fees for the
Fund and the Fund's annual operating expenses would be as shown below:
Fund level expenses
TOTAL OPERATING
VOLUNTARY MANAGEMENT FEE EXPENSES (ABSENT
EXPENSE LIMIT (ABSENT WAIVER) WAIVER)
0.00% 0.00% 0.05%
In addition, the Manager has voluntarily undertaken to reduce its
management fee and to bear certain expenses with respect to ECDF until
further notice to the extent that ECDF'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, transfer taxes
and custodial fees) would otherwise exceed the percentage of ECDF's
daily net assets specified below. Therefore, so long as the Manager
agrees to reduce its fees and bear certain expenses, total annual
operating expenses (subject to such exclusions) of ECDF will not exceed
the stated limitation. Absent such an undertaking, management fees for
ECDF and the annual operating expenses for Class III Shares of ECDF
would be as shown below:
ECDF expenses
TOTAL OPERATING
VOLUNTARY MANAGEMENT FEE EXPENSES (ABSENT
EXPENSE LIMIT (ABSENT WAIVER) WAIVER)
.35% .50% 0.73%
2. The Shareholder Service Fee ("SSF") is paid to GMO for providing client
services and reporting services. No SSF is charged directly by the
Fund; however, by virtue of the Fund's investment in ECDF, an investor
in the Fund will indirectly bear the SSF set forth in the table above.
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FINANCIAL HIGHLIGHTS
(For a Share outstanding throughout the period)
<TABLE>
<CAPTION>
EMERGING COUNTRY DEBT SHARE FUND CLASS III SHARES
PERIOD FROM JULY 20, 1998
(COMMENCEMENT OF OPERATIONS)
TO AUGUST 31, 1998
----------------------------
<S> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 10.00
----------
Income (loss) from investment operations:
Net investment income (a) --
Net realized and unrealized gain (loss) (4.27)
----------
Total from investment operations (4.27)
----------
NET ASSET VALUE, END OF PERIOD $ 5.73
==========
TOTAL RETURN (b) (42.70)%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000's) $ 34,384
Net expenses to average daily net assets 0.00%*
Net investment income to average daily net assets 0.11%*
Portfolio turnover rate 0%
Fees and expenses voluntarily waived or borne by the
Manager consisted of the following per share amount: (c)
</TABLE>
* Annualized
(a) Recognition of net investment income is affected by the timing of the
declaration of dividends by ECDF.
(b) The total return would have been lower had certain expenses not been
waived during the period shown.
(c) Fees and expenses waived or borne by the Manager were less than $0.01
per Share.
The above information has not been audited. This statement should be read in
conjunction with the other unaudited financial statements and related notes
which are included in the Fund's Semi-Annual Report, which is incorporated by
reference in the Trust's Statement of Additional Information.
Copies of the Fund's Semi-Annual Report are available upon request without
charge.
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<PAGE> 9
INVESTMENT OBJECTIVE AND POLICIES
The Fund's objective is to maximize total return through investment of
substantially all of its assets in Class III Shares of ECDF. Because the Fund
will invest all or substantially all of its assets in Class III Shares of ECDF,
investors in the Fund should carefully consider all risks associated with an
investment in ECDF.
ECDF is a non-diversified fund that 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 ECDF's investments among selected
emerging countries is 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. ECDF 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, Deutschemark, French franc and
Canadian dollar. ECDF will attempt to provide a total return greater than that
generally provided by the international fixed income securities markets as
measured by the J.P. Morgan Emerging Markets Bond Index Plus.
ECDF 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, ECDF may invest in fixed income securities of any
maturity, although ECDF expects that at least 65% of its total assets will be
comprised of "bonds" as such term is described above. Fixed income securities
include securities issued by federal, state, local and foreign governments, and
a wide range of private issuers.
ECDF'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."
ECDF 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. ECDF 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. ECDF may also enter into repurchase agreements, reverse
repurchase agreements and dollar roll agreements. In addition, ECDF 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. ECDF may also invest in
indexed securities the redemption values and/or coupons of which are indexed to
the prices of other securities, securities indexes, currencies, precious metals
or other commodities, or other financial indicators. ECDF 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.
ECDF 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. ECDF's use of
options on particular securities (as opposed to market indexes) is limited such
that the time premiums paid by ECDF on all outstanding options it has purchased
may not exceed 10% of its total assets. ECDF may also write options in
connection with buy-and-write transactions, and use index futures on foreign
indexes for investment, anticipatory hedging and risk management. In addition,
ECDF 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. ECDF 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, ECDF 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
preceding paragraphs and the risks associated with their use, see "Description
and Risks of Fund Investments" in this Prospectus. Additional information
regarding ECDF is contained in the GMO Trust Prospectus, as amended from time to
time, copies of which are available free of charge from the Manager.
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<PAGE> 10
DESCRIPTION AND RISKS OF FUND
INVESTMENTS
The following is a detailed description of the various investment
practices (and the risks associated with their use) to which the Fund may, by
virtue of its investment in ECDF, be exposed. Please refer to "Investment
Objective and Policies" above for additional information regarding the extent to
which ECDF may engage in a particular practice.
PORTFOLIO TURNOVER
Portfolio turnover is not a limiting factor with respect to investment
decisions for the Fund or ECDF. The portfolio turnover rate for ECDF is not
expected to exceed 150%.
In any particular year, market conditions may well result in greater
portfolio turnover rates than are presently anticipated. High portfolio turnover
involves correspondingly greater brokerage commissions and other transaction
costs, which will be borne indirectly by the Fund, and may well involve
realization of capital gains that would be taxable (including short-term capital
gains that are generally taxed at ordinary income tax rates) when distributed to
shareholders of the Fund unless such shareholders are themselves tax-exempt. See
"Taxes" below.
DIVERSIFIED AND NON-DIVERSIFIED PORTFOLIOS
It is a policy of the Fund that at least 75% of the value of the Fund's
total assets are represented by cash and cash items (including receivables),
Government securities, securities of other investment companies (such as ECDF),
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
Fund's total assets and to not more than 10% of the outstanding voting
securities of any single issuer. ECDF, however, is a "non-diversified" fund
under the 1940 Act, and as such is not required to satisfy the "diversified"
requirements set forth in the 1940 Act (described above). As a non-diversified
fund, ECDF is permitted to (but not required to) invest a higher percentage of
its assets in the securities of fewer issuers relative to diversified funds.
Such concentration could increase the risk of loss to ECDF (and thus the Fund)
should there be a decline in the market value of any one portfolio security
relative to diversified funds. Investment in a non-diversified fund may
therefore entail greater risks than an investment in a diversified fund.
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 or nationalization of assets, 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 ECDF'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
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<PAGE> 11
costs relating to investment in foreign markets may be more expensive in
emerging markets than in many developed foreign markets, which could reduce
ECDF's income (and thus the 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.
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 ECDF to suffer a loss of any or all of its
investments or, in the case of fixed-income securities, interest thereon.
Regional financial pressures may cause some countries to place restrictions on
the ability of the Fund to transfer title to the securities of their domestic
corporations. For example, in October of 1998, Malaysia placed significant
time-based restrictions on the ability of foreign investors to transfer title to
the securities of Malaysian corporations and on the repatriation of income
resulting from such transfers.
DIRECT INVESTMENTS IN RUSSIAN SECURITIES. ECDF may invest directly in
securities of Russian issuers. Investment in securities of such issuers presents
many of the same risks as investing in securities of issuers in other emerging
market economies, as described in the immediately preceding section. However,
the political, legal and operational risks of investing in Russian issuers, and
of having assets maintained within Russia, may be particularly acute.
A risk of particular note with respect to direct investment in Russian
securities is the way in which ownership of shares of private companies is
recorded. When ECDF invests in a Russian issuer, it will receive a "share
extract", but that extract is not legally determinative of ownership. The
official record of ownership of a company's share is maintained by the company's
share registrar. Such share registrars are completely under the control of the
issuer, and investors are provided with few legal rights against such
registrars.
INVESTMENTS IN ASIA. In addition to the foregoing risks of foreign
investments and risks specific to emerging markets, ECDF's investments in Asia
involve additional risks specific to investment in the region. ECDF's focus on
Asia makes it more susceptible to investment factors affecting the region than a
more geographically diverse fund. The region encompasses countries at varying
levels of economic development--ranging from emerging markets to more developed
economies. Each country provides unique investment risks, yet the political and
economic prospects of one country or group of countries may impact other
countries in the region. For example, some Asian economies are directly affected
by Japanese capital investment in the region and by Japanese consumer demands.
In addition, a recession, a debt-crisis or a decline in currency valuation in
one country can spread to other countries.
ECDF is susceptible to political and social factors affecting issuers
in Asian countries. Some countries have authoritarian or relatively unstable
governments. Certain governments in the region provide less supervision and
regulation of financial markets then is typical of other emerging markets, and
less financial information is available. Restrictions on direct foreign
investments in securities markets also exist in some countries. For example,
Taiwan permits foreign investment only through authorized qualified foreign
institutional investors. The recent return of Hong Kong to China, and the recent
actions of the Malaysian government (see "Certain Risks of Foreign
Investments--Emerging Markets" above) will continue to affect the region.
Some countries in the region are heavily dependent upon foreign trade.
The economies of some Asian countries are not diversified and are based upon
only a few commodities or industries. Markets in some of these countries are in
the early stages of development, exhibit a high concentration of market
capitalization, have less trading volume, lower liquidity and more volatility
than more developed markets.
In the latter half of 1997 the region began experiencing increased
market volatility and marked declines in foreign currency exchange rates.
Fluctuation in currency exchange rates can affect a country's ability to service
its debt. Currency fluctuation will affect the value of the securities in ECDF's
portfolio because the prices of these securities are generally denominated or
quoted in currencies other than the U.S. dollar.
SECURITIES LENDING
ECDF may make secured loans of portfolio securities amounting to not
more than one-third of ECDF's total assets. The risks in lending portfolio
securities, as with other extensions of credit, consist of possible delay in
recovery of the securities
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<PAGE> 12
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 ECDF an amount equal to any dividends or interest ECDF would
have received had the securities not been lent. If the loan is collateralized by
U.S. Government Securities, ECDF will receive a fee from the borrower. In the
case of loans collateralized by cash, ECDF 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, ECDF 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 ECDF if the holders of such securities are asked to vote upon or
consent to matters materially affecting the investment. ECDF may also call such
loans in order to sell the securities involved. The Manager has retained lending
agents on behalf of ECDF that are compensated based on a percentage of ECDF's
return on the securities lending activity. ECDF 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
ECDF 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 ECDF'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, ECDF 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 indexes, and foreign currencies. ECDF 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 ECDF 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 ECDF 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 ECDF'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 ECDF's investments in futures contracts and
related options.
OPTIONS. As has been noted above, ECDF may use options and (1) may
enter into contracts giving third parties the right to buy ECDF'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 ECDF 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.
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WRITING COVERED OPTIONS. ECDF may seek to increase its return by
writing covered call or put options on optionable securities or indexes. A call
option written by ECDF on a security gives the holder the right to buy the
underlying security from ECDF at a stated exercise price; a put option gives the
holder the right to sell the underlying security to ECDF at a stated exercise
price. In the case of options on indexes, the options are usually cash settled
based on the difference between the strike price and the value of the index.
ECDF will receive a premium for writing a put or call option, which
increases ECDF'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, ECDF 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, ECDF 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 ECDF writes a call, any profit by ECDF 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 ECDF writes a put on an index, ECDF
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 ECDF 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 ECDF 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 ECDF 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 ECDF 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 its obligation, it 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 it has been notified of the exercise
of an option. Likewise, an investor who is the holder of an option may liquidate
its 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 ECDF 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 ECDF 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 ECDF 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 ECDF 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.
ECDF 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; ECDF 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 ECDF.
ECDF may write options in connection with buy-and-write transactions;
that is, ECDF may purchase a security and then write a call option against that
security. The exercise price of the call ECDF 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 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
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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, ECDF's maximum gain will be the premium received by it for writing
the option, adjusted upward or downward by the difference between ECDF'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 ECDF'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, ECDF may elect to close the position or take
delivery of the security at the exercise price. In that event, ECDF'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 ECDF in market environments analogous to
those in which call options are used in buy-and-write transactions.
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. ECDF may purchase futures contracts on various
securities indexes ("Index Futures"). ECDF'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. Even though ECDF is obligated to
pay the face amount on the stated date on the purchase of an Index Future that
calls for physical delivery, such an Index Future may
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<PAGE> 15
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 ECDF's position and
ECDF 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.
ECDF may close open positions on the futures exchange on which Index
Futures are then traded at any time up to and including the expiration day. All
positions which remain open at the close of the last business day of the
contract's life are required to settle on the next business day (based upon the
value of the relevant index on the expiration day). Because the specific
procedures for trading foreign stock Index Futures on futures exchanges are
still under development, additional or different margin requirements as well as
settlement procedures may be applicable to foreign stock Index Futures at the
time ECDF purchases foreign stock Index Futures.
The price of Index Futures may not correlate perfectly with movement in
the relevant index due to certain market distortions. First, all participants in
the futures market are subject to margin deposit and maintenance requirements.
Rather than meeting additional margin deposit requirements, investors may close
futures contracts through offsetting transactions which could distort the normal
relationship between the Index and futures markets. Secondly, the deposit
requirements in the futures market are less onerous than margin requirements in
the securities market, and as a result the futures market may attract more
speculators than does the securities market. Increased participation by
speculators in the futures market may also cause temporary price distortions. In
addition, trading hours for foreign stock Index Futures may not correspond
perfectly to hours of trading on the foreign exchange to which a particular
foreign stock Index Future relates. This may result in a disparity between the
price of Index Futures and the value of the relevant index due to the lack of
continuous arbitrage between the Index Futures price and the value of the
underlying index.
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 ECDF's investment in futures contracts.
INTEREST RATE FUTURES. For the purposes previously described, ECDF 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 ECDF'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. ECDF 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, ECDF may purchase
put options or write call options on futures contracts rather than selling
futures contracts. Similarly, ECDF 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
ECDF expects to purchase. Such options generally operate in the same manner as
options purchased or written directly on the underlying investments. See
"Description and Risks of Fund Investment Practices -- Foreign Currency
Transactions" for a description of ECDF's 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, ECDF will generally take long positions (e.g., purchase call
options, futures contracts or options thereon) in order to increase ECDF's
exposure to a particular market, market segment or foreign currency. In the case
of futures and options on futures, ECDF is only required to deposit the initial
and variation margin as required by relevant CFTC regulations and the rules of
the contract markets. Because ECDF will then be obligated to purchase the
security or index at a set price on a future date, ECDF's net asset value will
fluctuate with the value of the security as if it were already included in
ECDF's portfolio. Risk management transactions have the effect of providing a
degree of investment leverage, particularly when ECDF 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 variation margin that ECDF is required
to deposit. As a result, the value of ECDF's portfolio will generally be more
volatile than the value of comparable portfolios which do not engage in risk
management transactions. ECDF will not, however, use futures and options on
futures
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to obtain greater volatility than it could obtain through direct investment in
securities; that is, ECDF will not normally engage in risk management to
increase the average volatility (beta) of ECDF's portfolio above 1.00, the level
of risk (as measured by volatility) that would be present if ECDF were fully
invested in the securities comprising the relevant index. However, ECDF 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 swaps and contracts for differences as described below does not exceed
10% of ECDF's assets.
HEDGING. To the extent indicated elsewhere, ECDF may also enter into
options, futures contracts and buy and sell options thereon for hedging. For
example, if ECDF 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
indexes of fixed income securities. If the hedge is effective, then should the
anticipated change in market rates cause a decline in the value of ECDF's fixed
income security, the value of the futures contract should increase. ECDF 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 ECDF 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 ECDF 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 ECDF's portfolio is expected
to decline as a result of an increase in rates, ECDF might purchase put options
or write call options on futures contracts rather than selling futures
contracts. Similarly, for anticipatory hedging, ECDF may purchase call options
or write put options as a substitute for the purchase of futures contracts. See
"Description and Risks of Fund Investment Practices -- Foreign Currency
Transactions" for more information regarding the currency hedging practices of
ECDF.
INVESTMENT PURPOSES. To the extent indicated elsewhere, ECDF may also
enter into futures contracts and buy and sell options thereon for investment.
For example, ECDF 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 ECDF pending investment in such securities if or
when they do become available. Through this use of futures and related options,
ECDF 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 ECDF 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 ECDF.
When ECDF 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 ECDF 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). ECDF 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 ECDF 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 ECDF's
portfolio. For example, if ECDF'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, ECDF 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, ECDF may use futures to achieve a similar result with reduced
transaction costs. In that case, ECDF 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 ECDF) 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, ECDF would then close
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out both futures contract positions. ECDF 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 ECDF 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) ECDF segregates an amount of cash, U.S. Government Securities
and other high-quality debt obligations whose value, marked-to-market daily, is
equal to ECDF's current obligations in respect of the long futures contract
positions. If ECDF uses such combined short and long positions, in addition to
possible declines in the values of its investment securities, ECDF 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, ECDF will perform as if it had sold the
securities hedged by the short position and purchased the securities underlying
the long position. ECDF 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, ECDF 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 ECDF's 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. ECDF
will usually enter into swaps on a net basis, i.e., the two returns are netted
out, with ECDF 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. 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 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 ECDF enters into a long equity swap contract, ECDF'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. ECDF will not use long equity swap contracts to
obtain greater volatility than it could obtain through direct investment in
securities; that is, ECDF will not normally enter an equity swap contract to
increase the volatility (beta) of ECDF's portfolio above 1.00, the volatility
that would be present in the stocks comprising ECDF's benchmark index. However,
ECDF 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 ECDF's net assets.
Contracts for differences are swap arrangements in which ECDF 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, ECDF'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,
ECDF's return is based on theoretical short futures positions in the securities
comprising the basket. ECDF may also use actual long and short futures positions
to achieve the same market exposure(s) as contracts for differences. ECDF 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. ECDF 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 ECDF, even in circumstances where the securities in both
the long and short baskets appreciate in value.
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Except for instances in which ECDF elects to obtain leverage up to the
10% limitation mentioned above, ECDF 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.
ECDF may enter into swaps and contracts for differences for hedging,
investment and risk management. When using swaps for hedging, ECDF 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 ECDF may
also enter into a contract for differences in which the notional amount of the
theoretical long position is greater than the notional amount of the theoretical
short position. ECDF will not normally enter into a contract for differences to
increase the volatility (beta) of ECDF's portfolio above 1.00. However, ECDF 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 ECDF's net assets.
INTEREST RATE CAPS, FLOORS AND COLLARS. ECDF 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, ECDF 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 ECDF 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 non-segregated futures contracts. ECDF's 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 ECDF's 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 ECDF's limitation on
investment in illiquid securities. See "Description and Risks of Fund
Investments -- Illiquid Securities."
FOREIGN CURRENCY TRANSACTIONS
Foreign currency exchange rates may fluctuate significantly over short
periods of time. They generally are determined by the forces of supply and
demand in the foreign exchange markets and the relative merits of investments in
different countries, actual or perceived changes in interest rates and other
complex factors. Currency exchange rates also can be affected unpredictably by
intervention (or the failure to intervene) by U.S. or foreign governments or
central banks, or by currency controls or political developments in the U.S. or
abroad. For example, significant uncertainty surrounds the proposed introduction
of the "euro" (a common currency unit for the European Union) in January 1999.
These and other currencies in which ECDF's assets are denominated may be
devalued against the U.S. dollar, resulting in a loss to ECDF, and thus the
Fund.
ECDF is permitted to invest in securities denominated in foreign
currencies and may buy or sell foreign currencies, deal in forward foreign
currency contracts, currency futures contracts and related options and options
on currencies. ECDF may use such currency instruments for hedging, investment or
currency risk management. Currency risk management may include taking active
currency positions relative to both the securities portfolio of ECDF and its
performance benchmark.
Forward foreign currency contracts are contracts between two parties to
purchase and sell a specific quantity of a particular currency at a specified
price, with delivery and settlement to take place on a specified future date.
Currency futures contracts are contracts to buy or sell a standard quantity of a
particular currency at a specified future date and price. Options on currency
futures contracts give their owner the right, but not the obligation, to buy (in
the case of a call option) or sell (in the case of a put option) a specified
currency futures contract at a fixed price during a specified period. Options on
currencies give
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their owner the right, but not the obligation, to buy (in the case of a call
option) or sell (in the case of a put option) a specified quantity of a
particular currency at a fixed price during a specified period.
ECDF may enter into forward contracts for hedging under three
circumstances. First, when ECDF 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, ECDF 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 ECDF 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 ECDF'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, ECDF may engage in currency "cross hedging" when, in the opinion
of the Manager, the historical relationship among foreign currencies suggests
that ECDF 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, ECDF assumes 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."
ECDF 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,
ECDF may be required to forgo the benefits of advantageous changes in the
exchange rates.
ECDF may also enter foreign currency forward contracts for investment
and currency risk management. When ECDF uses currency instruments for such
purposes, the foreign currency exposure of ECDF may differ substantially from
the currencies in which ECDF's investment securities are denominated. However,
ECDF's aggregate foreign currency exposure will not normally exceed 100% of the
value of ECDF's securities, except that ECDF 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 ECDF's net assets.
Except to the extent that ECDF may use such contracts for risk
management, whenever ECDF 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.
ECDF 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 ECDF may use futures contracts and related options for risk
management, ECDF 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 ECDF 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 ECDF falls below
100% of the market value of the call written by ECDF, ECDF 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, ECDF 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 ECDF.
REPURCHASE AGREEMENTS
ECDF may enter into repurchase agreements with banks and broker-dealers
by which ECDF 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
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<PAGE> 20
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 ECDF 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 ECDF to expenses, delays and risks of loss including: (a) possible
declines in the value of the underlying security during the period while ECDF
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. 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 ECDF investing in such securities. The net asset value of ECDF'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.
TEMPORARY HIGH QUALITY CASH ITEMS
As described under "Investment Objectives and Policies" above, ECDF may
temporarily invest a portion of its 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 ECDF will
seek to minimize credit risk with respect to such investments.
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 ECDF 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 ECDF 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.
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<PAGE> 21
In addition to investing directly in U.S. Government Securities and
Foreign Government Securities, ECDF 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.
LOWER RATED SECURITIES
ECDF may invest some or all of its 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"). ECDF
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
ECDF'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 ECDF 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.
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 indexes, 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 ECDF 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.
ECDF's investment in indexed securities may also create taxable income
in excess of the cash such investments generate. See "Taxes - Tax Implications
of Certain Investments" in the GMO Trust Prospectus.
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<PAGE> 22
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. ECDF may enter into firm commitment agreements with such
banks and broker-dealers with respect to any of the instruments eligible for
purchase by ECDF. ECDF will only enter into firm commitment arrangements with
banks and broker-dealers which the Manager determines present minimal credit
risks. ECDF 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 ECDF's obligations under firm commitment agreements.
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLL AGREEMENTS
ECDF may enter into reverse repurchase agreements and dollar roll
agreements with banks and brokers to enhance return. Reverse repurchase
agreements involve sales by ECDF of portfolio assets concurrently with an
agreement by ECDF to repurchase the same assets at a later date at a fixed
price. During the reverse repurchase agreement period, ECDF 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 ECDF 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, ECDF forgoes principal and interest paid on the
securities. ECDF 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.
ECDF which makes such investments will establish segregated accounts
with its custodian in which ECDF 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 ECDF may decline below the price of the securities ECDF
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, ECDF'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 ECDF's obligation to repurchase the securities.
Reverse repurchase agreements and dollar rolls are not considered borrowings by
ECDF for purposes of ECDF's fundamental investment restriction with respect to
borrowings.
ILLIQUID SECURITIES
ECDF 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 ECDF has valued the investment, which include
securities whose disposition is restricted by securities laws, so long as no
more than 15% of net assets would be invested in such illiquid securities. ECDF
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, ECDF 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 ECDF owns would exceed 15% of ECDF's total
assets.
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-
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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 ECDF 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 ECDF may include Adjustable Rate
Securities as such term is defined in "Description 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 pre-payment
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 is secured by 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 ECDF 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 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 rates
securities are less likely than non-adjustable rate securities of comparable
quality and maturity to increase significantly when market interest rates fall.
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 implemented 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
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<PAGE> 24
bonds, are generally collateralized in full as to principal by U.S. Treasury
zero coupon bonds having the same maturity as the bonds.
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. ECDF is required to distribute the
income on these securities to its shareholders as the income accrues, even
though ECDF is not receiving the income in cash on a current basis. Thus, ECDF
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.
LOANS, LOAN PARTICIPATIONS AND ASSIGNMENTS
ECDF 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 ECDF'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 agency and yield could be adversely affected. Loans that are fully
secured offer ECDF more protections than an unsecured loan in the event of
non-payment of scheduled interest or 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 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, ECDF 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, ECDF
typically will be able to enforce its rights only through the lender, and not
directly against the borrower. As a result, ECDF 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
ECDF. For example, if a loan is foreclosed, ECDF 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, ECDF 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 ECDF in the event of fraud or misrepresentation. In the absence of
definitive regulatory guidance, ECDF may rely on the Manager's research to
attempt to avoid situations where fraud or misrepresentation could adversely
affect ECDF.
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, ECDF has direct recourse against the borrower, it may have to rely
on the agent to apply appropriate credit remedies against the borrower.
Direct indebtedness purchased by ECDF may include letters of credit,
revolving credit facilities, or other standby financing commitments obligating
ECDF to pay additional cash on demand. These commitments may have the effect of
requiring ECDF to increase its investment in a borrower at a time when it would
not otherwise have done so. ECDF will set aside appropriate liquid assets in a
segregated custodial account to cover its potential obligations under standby
financing commitments.
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<PAGE> 25
SPECIAL YEAR 2000 RISK CONSIDERATIONS
Many of the services provided to the Fund and ECDF depend on the proper
functioning of computer systems. Many systems in use today cannot distinguish
between the year 1900 and the year 2000. Should any of the Fund's or ECDF's
service systems fail to process information properly, that could have an adverse
impact on the Fund's operations and services provided to shareholders. GMO, as
well as the Fund's and ECDF's administrator, transfer agent, custodian and other
service providers, have reported that each is working toward mitigating the
risks associated with the so-called "Year 2000 problem." However, there can be
no assurance that the problems will be corrected in all respects and that the
Fund's operations and services provided to shareholders will not be adversely
affected.
ADDITIONAL INVESTMENT RESTRICTIONS
Fundamental Restrictions:
Without a vote of the majority of the outstanding voting securities of
the Fund, the Trust will not take any of the following actions with respect to
the Fund as indicated:
(1) Borrow money except under the following circumstances: (i) The Fund
may borrow money from banks so long as after such a transaction, the total
assets (including the amount borrowed) less liabilities other than debt
obligations, represent at least 300% of outstanding debt obligations; (ii) The
Fund may also borrow amounts equal to an additional 5% of its total assets
without regard to the foregoing limitation for temporary purposes, such as for
the clearance and settlement of portfolio transactions and to meet shareholder
redemption requests; (iii) The Fund may enter into transactions that are
technically borrowings under the 1940 Act because they involve the sale of a
security coupled with an agreement to repurchase that security (e.g., reverse
repurchase agreements, dollar rolls and other similar investment techniques)
without regard to the asset coverage restriction described in (i) above, so long
as and to the extent that the Fund establishes a segregated account with its
custodian in which it maintains cash and/or high grade debt securities equal in
value to its obligations in respect of these transactions. Under current
pronouncements of the SEC staff, such transactions are not treated as senior
securities so long as and to the extent that the Fund establishes a segregated
account with its custodian in which it maintains liquid assets, such as cash,
U.S. Government securities or other appropriate high grade debt securities equal
in value to its obligations in respect of these transactions.
(2) Purchase securities on margin, except such short-term credits as
may be necessary for the clearance of purchases and sales of securities. (For
this purpose, the deposit or payment of initial or variation margin in
connection with futures contracts or related options transactions is not
considered the purchase of a security on margin.)
(3) Make short sales of securities or maintain a short position for the
Fund's account unless at all times when a short position is open the Fund owns
an equal amount of such securities or owns securities which, without payment of
any further consideration, are convertible into or exchangeable for securities
of the same issue as, and equal in amount to, the securities sold short.
(4) Underwrite securities issued by other persons except to the extent
that, in connection with the disposition of its portfolio investments, it may be
deemed to be an underwriter under federal securities laws.
(5) Purchase or sell real estate, although it may purchase securities
of issuers which deal in real estate, including securities of real estate
investment trusts, and may purchase securities which are secured by interests in
real estate.
(6) Make loans, except by purchase of debt obligations or by entering
into repurchase agreements or through the lending of the Fund's portfolio
securities. Loans of portfolio securities may be made with respect to up to 100%
of the Fund's total assets.
(7) Concentrate more than 25% of the value of its total assets in any
one industry (except that, as described herein, the Fund may invest all of its
assets in shares of ECDF, an open-end investment company).
(8) Purchase or sell commodities or commodity contracts, except that
the Fund may purchase and sell financial futures contracts and options thereon.
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<PAGE> 26
(9) Issue senior securities, as defined in the 1940 Act and as
amplified by rules, regulations and pronouncements of the SEC. The SEC has
concluded that even though reverse repurchase agreements, firm commitment
agreements and standby commitment agreements fall within the functional meaning
of the term "evidence of indebtedness", the issue of compliance with Section 18
of the 1940 Act will not be raised with the SEC by the Division of Investment
Management if the Fund covers such securities by maintaining certain "segregated
accounts." Similarly, so long as such segregated accounts are maintained, the
issue of compliance with Section 18 will not be raised with respect to any of
the following: any swap contract or contract for differences; any pledge or
encumbrance of assets permitted by non-fundamental policy (5) below; any
borrowing permitted by restriction 1 above; any collateral arrangements with
respect to initial and variational margin permitted by non-fundamental policy
(5) below; and the purchase or sale of options, forward contracts, futures
contracts or options on futures contracts.
Non-Fundamental Restrictions:
It is contrary to the present policy of the Fund which may be changed
by the Trustees without shareholder approval, to:
(1) Invest in warrants or rights excluding options (other than warrants
or rights acquired by the Fund as a part of a unit or attached to securities at
the time of purchase), except that the Fund may invest in such warrants or
rights so long as the aggregate value thereof (taken at the lower of cost or
market) does not exceed 5% of the value of the fund's total net assets; provided
that within this 5%, not more than 2% of its net assets may be invested in
warrants that are not listed on the New York or American Stock Exchange or a
recognized foreign exchange.
(2) Buy or sell oil, gas or other mineral leases, rights or royalty
contracts.
(3) Make investments for the purpose of gaining control of a company's
management.
(4) Invest more than 15% of net assets in illiquid securities. The
securities currently thought to be included as "illiquid securities" are
restricted securities under the Federal securities laws (including illiquid
securities traded under Rule 144A), repurchase agreements and securities that
are not readily marketable. To the extent the Trustees determine that restricted
securities traded under Section 4(2) or Rule 144A under the Securities Act of
1933 are in fact liquid, they will not be included in the 15% limit on
investment in illiquid securities.
(5) Pledge, hypothecate, mortgage or otherwise encumber its assets in
excess of 33 1/3% of the Fund's total assets (taken at cost). (For the purposes
of this restriction, collateral arrangements with respect to swap agreements,
the writing of options, stock index, interest rate, currency or other futures,
options on futures contracts and collateral arrangements with respect to initial
and variation margin are not deemed to be a pledge or other encumbrance of
assets. The deposit of securities or cash or cash equivalents in escrow in
connection with the writing of covered call or put options, respectively is not
deemed to be a pledge or encumbrance.)
Except as indicated above in Fundamental Restriction No. 1, all
percentage limitations on investments set forth herein and in the Prospectus
will apply at the time of the making of an investment and shall not be
considered violated unless an excess or deficiency occurs or exists immediately
after and as a result of such investment.
The phrase "shareholder approval," as used in the Prospectus, and the
phrase "vote of a majority of the outstanding voting securities," as used herein
with respect to the Fund, means the affirmative vote of the lesser of (1) more
than 50% of the outstanding shares of the Fund, or (2) 67% or more of the shares
of the Fund present at a meeting if more than 50% of the outstanding shares are
represented at the meeting in person or by proxy.
PURCHASE OF SHARES
Shares of the 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"). Shares may be purchased by calling (617) 330-7500. See
"Purchase Procedures" below.
The purchase price of a share of the Fund is the net asset value next
determined after a Purchase Order is received in good order. No purchase premium
is charged by the Fund, although investors in the Fund will indirectly bear
ECDF's purchase premium, which is currently 0.50%. This purchase premium is paid
to and retained by ECDF and is intended to cover the brokerage and other costs
associated with putting the investment to work in the relevant markets.
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<PAGE> 27
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 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 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, 200 Clarendon Street,
Boston, Massachusetts 02116. 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.
PURCHASE PROCEDURES:
(a) General: Investors should call the Trust at (617) 330-7500 before
attempting to place an order for 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 in 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 the 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."
A Purchase Order Form for Shares may be obtained by calling the Trust
at (617) 330-7500. The Purchase Order Form may be submitted to the Trust (i) By
Mail to GMO Trust c/o Grantham, Mayo, Van Otterloo & Co. LLC, 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 number 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 Form by calling the Trust at (617) 330-7500. If a Purchase Order Form 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 Fund. "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.
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<PAGE> 28
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 the 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". The Fund does not
charge any redemption fees. Investors in the Fund will, however, indirectly bear
ECDF's redemption fee, which is currently 0.25%. These fees are paid to and
retained by ECDF and are employed to allocate transaction costs caused by
shareholder activity to the shareholder generating the activity, rather than to
ECDF as a whole. Redemption fees are not sales loads or contingent deferred
sales charges.
If the Manager determines, in its sole discretion, that it would be
detrimental to the best interests of the remaining shareholders of the 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. Securities used to redeem Fund shares in-kind will be valued in
accordance with the Fund's procedures for valuation described under
"Determination of Net Asset Value." Securities distributed by the 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 address
set forth above for purchase orders, or (ii) it is faxed to the Trust at the
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-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.
The 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 Fund holds 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 the Fund's shares may be
significantly affected on days when shareholders have no access to the Fund.
DETERMINATION OF NET ASSET VALUE
The net asset value of a share is determined for the 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 the 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. The 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
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<PAGE> 29
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 Fund. 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 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 Fund 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
The Fund intends to pay out as dividends, at least annually,
substantially all of its net investment income (which is derived from dividends
and interest it receives from its portfolio investments and net short-term
capital gains). The Fund also intends to distribute substantially all of its net
long-term capital gains, if any, after giving effect to any available capital
loss carryovers. It is the policy of the Fund to make distributions, at least
annually, sufficient to avoid the imposition of a non-deductible 4% excise tax
on certain undistributed amounts of taxable investment income and capital gains.
The policy of the Fund is to declare and pay distributions of its dividends,
interest and foreign currency gains semi-annually. The Fund also intends to
distribute net short-term capital gains and net long-term capital gains at least
annually. Investors should be aware that by purchasing shares shortly before
the record date of a dividend or capital gains distribution, they will pay the
full price of the shares and shortly thereafter will receive some portion of
the price paid back as a taxable dividend or taxable capital gains
distribution.
All dividends and/or distributions will be paid in shares of the 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 Application or by writing to
the Trust.
TAXES
The Fund is treated as a separate taxable entity for federal income tax
purposes. The Fund intends to qualify each year as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended, and
to meet all other requirements necessary for it to be relieved of federal taxes
on income and gains it distributes to shareholders. So long as the Fund so
qualifies, the Fund itself will not pay federal income taxes on the amounts
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. Distributions of net capital gains (that is, the
excess of net gains from capital assets held for more than one year ("long-term
capital assets") over net losses from capital assets held for not more than one
year ("short-term capital assets"))
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<PAGE> 30
will be taxable to shareholders as such (generally at a 20% rate for
noncorporate shareholders), regardless of how long a shareholder has held the
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. The recognition of certain losses upon the sale of
shares of the Fund may be limited to the extent shareholders dispose of shares
of one Fund and invest in shares of the same or another Fund. A distribution
paid to shareholders by the 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.
Dividends and distributions on the Fund's shares are generally subject
to federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects unrealized
losses.
Depending on the Fund's percentage ownership in ECDF both before and
after a redemption, the Fund's redemption of shares of ECDF may cause the Fund
to be treated as not receiving capital gain income on the amount by which the
distribution exceeds the Fund's tax basis in the shares of ECDF, but instead to
be treated as receiving a dividend taxable as ordinary income on the full
amount of the distribution. This could cause shareholders of the Fund to
recognize higher amounts of ordinary income than if the shareholders had held
the shares of ECDF directly. In addition, although the Fund may itself be
entitled to a deduction for foreign taxes paid by ECDF, the Fund will not be
able to "pass-through" to its shareholders any foreign tax deduction or
credit received from ECDF.
For additional information regarding the tax consequences to ECDF of
its investments, please see "Taxes" in the GMO Trust Prospectus.
The Fund's investment in foreign securities through ECDF may be subject
to withholding taxes at the source on dividends or interest payments. In that
case, the Fund's yield on those securities would be decreased. The Fund does not
expect to be eligible to elect to permit shareholders to claim a credit or
deduction on their income tax return for their pro rata share of such taxes.
The U.S. 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 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 Internal Revenue Service recently revised its regulations affecting
the application to foreign investors of the back-up withholding and withholding
tax rules described above. The new regulations will generally be effective for
payments made after December 31, 1999 (although transition rules will apply). In
some circumstances, the new rules will increase the certification and filing
requirements imposed on foreign investors in order to qualify for exemption from
the 31% back-up withholding tax and for reduced withholding tax rates under
income tax treaties. Foreign investors in the Fund should consult their tax
advisors with respect to the potential application of these new regulations.
The foregoing is a general summary of the principal federal income tax
consequences of investing in the Fund for shareholders who are U.S. citizens,
residents or domestic corporations. Shareholders should consult their own tax
advisors about the precise tax consequences of an investment in the 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 (including possible liability for federal alternative
minimum tax).
LOSS OF REGULATED INVESTMENT COMPANY STATUS
If the Fund does not qualify for taxation as a regulated investment
company for any taxable year (or if ECDF fails to qualify as a regulated
investment company), 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 that is accorded special tax treatment, the Fund
may be required to recognize unrealized gains, pay substantial taxes and
interest on such gains, and make certain substantial distributions.
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<PAGE> 31
MANAGEMENT OF THE TRUST
The Fund is advised and managed by Grantham, Mayo, Van Otterloo & Co.
LLC, 40 Rowes Wharf, Boston, Massachusetts 02110 (the "Manager" or "GMO") which
provides investment advisory services to a substantial number of institutional
and other investors, including one other registered investment company.
Grantham, Mayo, Van Otterloo & Co. LLC converted from a general partnership to a
limited liability company on December 16, 1996. Each of the following four
members holds a greater than 5% interest in the Manager: R. Jeremy Grantham,
Richard A. Mayo, Eyk H.A. Van Otterloo and Kingsley Durant.
Under a Management Contract with ECDF, the Manager selects and reviews
ECDF'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 the Fund or
ECDF, the right of the Trust to use the identifying name "GMO" may be withdrawn.
The 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. In
addition, with respect to the Fund, the Manager has voluntarily agreed to waive
its fee and to bear certain expenses until further notice in order to limit the
Fund's and ECDF's annual expenses to specified limits (with certain exclusions).
These limits and the terms applicable to them are described under the Schedule
of Fees and Expenses.
Mr. William L. Nemerever, Mr. Thomas F. Cooper and Mr. Steven Edelstein
are primarily responsible for the day-to- day management of ECDF.
Pursuant to an Administrative Services Agreement with GMO, Investors
Bank & Trust Company provides administrative services to the Fund and ECDF. GMO
pays Investors Bank & Trust Company an annual fee for its services to the Fund
and ECDF.
Pursuant to a Servicing Agreement with the Trust on behalf of each
class of shares of each fund of the Trust (including the Fund and ECDF),
Grantham, Mayo, Van Otterloo & Co. LLC, 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 and classes of such shares. The Trusts's shares are
presently divided into thirty-seven series of shares, one for the Emerging
Country Debt Share Fund, one for ECDF, and one for each of the Asia Fund,
International Core Plus Allocation Fund, Fundamental Value Fund, Pelican Fund,
U.S. Core Fund, Tobacco-Free Core Fund, Tax-Managed U.S. Equities Fund,
Tax-Managed International Equities Fund, Value Fund, Growth Fund, U.S. Sector
Fund, Small Cap Value Fund, Small Cap Growth Fund, REIT Fund, International Core
Fund, Currency Hedged International Core Fund, Foreign Fund, International Small
Companies Fund, Japan Fund, Emerging Markets Fund, Evolving Countries Fund,
Global Properties Fund, Domestic Bond Fund, U.S. Bond/Global Alpha A Fund, U.S.
Bond/Global Alpha B Fund, International Bond Fund, Currency Hedged International
Bond Fund, Global Bond Fund, Short-Term Income Fund, Global Hedged Equity Fund,
Inflation Indexed Bond Fund, International Equity Allocation Fund, World Equity
Allocation Fund, Global (U.S.+) Equity Allocation Fund, and Global Balanced
Allocation Fund, and up to eight classes of shares. All shares of all series are
entitled to vote at any meetings of share holders. 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 the 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 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
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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 October 15, 1998, the following Shareholders held greater than 25%
of the outstanding Shares of the Fund: Sprint Corporate Master Trust.
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.
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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, ECDF 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, ECDF's
long futures contract positions (less its short positions) together with ECDF's
cash (i.e., equity or fixed income) positions will not exceed ECDF's total net
assets.
ECDF's 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 ECDF will be able to utilize these
instruments effectively for the purposes set forth above.
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 ECDF 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 ECDF 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), ECDF 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 ECDF, the Manager and other clients of the Manager
may be considered to be such a group. These position limits may restrict ECDF's
ability to purchase or sell options on a particular security.
The amount of risk ECDF 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
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<PAGE> 34
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
position (or anticipated position) which is intended to be protected, the
desired protection may not be obtained and ECDF 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, ECDF 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, ECDF 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, ECDF 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 ECDF anticipates
purchasing. In such instances, it is possible that the currency may instead
decline. If ECDF does not then invest in such securities because of concern as
to possible further market and/or currency decline or for other reasons, ECDF
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 ECDF investing in fixed income securities (or such rates move
in a direction opposite to that anticipated), ECDF 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, ECDF'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
ECDF 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 ECDF might realized in trading could be eliminated by adverse changes in
the exchange rate, or ECDF could incur losses as a result of those changes.
Risk Factors in Swap Contracts, OTC Options and other Two-Party
Contracts. ECDF 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, ECDF 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, ECDF will succeed in pursuing contractual
remedies. ECDF 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 ECDF 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 ECDF 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
ECDF may commit to initial margin on such contracts or time premiums on such
options may not exceed 5% of that Fund's net assets.
The Manager and the Trust do not believe that ECDF's respective
obligations under equity swap contracts, reverse equity swap contracts or Index
Futures are senior securities and, accordingly, ECDF will not treat them as
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<PAGE> 35
being subject to its borrowing restrictions. However, the net amount of the
excess, if any, of ECDF'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 ECDF's custodian. Likewise, when ECDF takes a short
position with respect to an Index Futures contract the position must be covered
or ECDF must maintain at all times while that position is held by ECDF, 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 ECDF permitted to engage in any or all of such
practices is limited to no more than 10% of ECDF'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 ECDF'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.
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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
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comprise what are generally known as high grade bonds. They are rated lower than
the best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater amplitude or
there may be other elements present 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.
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<PAGE> 38
SHAREHOLDER INQUIRIES
Shareholders may direct inquiries regarding Shares
to Grantham, Mayo, Van Otterloo & Co. LLC,
40 Rowes Wharf, Boston, MA 02110
(1-617-330-7500)
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<PAGE> 39
GMO EMERGING COUNTRY DEBT SHARE FUND
STATEMENT OF ADDITIONAL INFORMATION
December 21, 1998
This Statement of Additional Information is not a prospectus. This Statement of
Additional Information relates to the GMO Emerging Country Debt Share Fund
Prospectus dated December 21, 1998, as amended from time to time, and should be
read in conjunction therewith. A copy of the Prospectus may be obtained from GMO
Trust, 40 Rowes Wharf, Boston, Massachusetts 02110.
<PAGE> 40
Table of Contents
Caption Page
INVESTMENT OBJECTIVES AND POLICIES...........................................1
MISCELLANEOUS INVESTMENT PRACTICES...........................................1
MANAGEMENT OF THE TRUST......................................................1
INVESTMENT ADVISORY AND OTHER SERVICES.......................................3
PORTFOLIO TRANSACTIONS.......................................................5
DESCRIPTION OF THE TRUST AND OWNERSHIP OF SHARES.............................6
FINANCIAL STATEMENTS.........................................................9
PERFORMANCE INFORMATION.....................................................10
SPECIMEN PRICE MAKE-UP SHEET................................................11
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<PAGE> 41
INVESTMENT OBJECTIVES AND POLICIES
The investment objective and policies of the GMO Emerging Country Debt
Share Fund (the "Emerging Country Debt Share Fund" or the "Fund") are described
in the Fund's Prospectus. Unless otherwise indicated in the Prospectus or this
Statement of Additional Information, the investment objective and policies of
the Fund may be changed without shareholder approval.
MISCELLANEOUS INVESTMENT PRACTICES
Index Futures. As described in the Prospectus, the Fund expects to
invest substantially all of its assets in shares of the GMO Emerging Country
Debt Fund ("ECDF"), a series of GMO Trust. As stated in the Prospectus under the
heading "Description and Risks of Fund Investments -- Futures and Options," ECDF
may purchase futures contracts on various securities indexes ("Index Futures").
An Index Future is a contract to buy or sell an integral number of units of the
particular stock 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. Entering into a contract to buy units is commonly referred to as buying
or purchasing a contract or holding a long position in the relevant index.
For example, if the value of a unit of a particular index were $1,000,
a contract to purchase 500 units would be worth $500,000 (500 units x $1,000).
The Index Futures contract specifies that no delivery of the actual stocks
making up the index will take place. Instead, settlement in cash must occur upon
the termination of the contract, with the settlement being the difference
between the contract price and the actual level of the relevant index at the
expiration of the contract. For example, if ECDF enters into one futures
contract to buy 500 units of an index at a specified future date at a contract
price of $1,000 per unit and the index is at $1,010 on that future date, ECDF
will gain $5,000 (500 units x gain of $10).
MANAGEMENT OF THE TRUST
The names and ages of the Trustees and officers of the Trust and their
principal occupations during the past five years are as follows:
R. Jeremy Grantham* (60). President-Quantitative and Chairman of the
Trustees of the Trust. Member, Grantham, Mayo, Van Otterloo & Co. LLC
Harvey R. Margolis (55). Trustee of the Trust. Mathematics Professor,
Boston College.
Jay O. Light (56). Trustee of the Trust. Professor of Business
Administration, Harvard University; Senior Associate Dean, Harvard
University (1988-1992).
<PAGE> 42
Eyk del Mol Van Otterloo (61). President-International of the Trust.
Member, Grantham, Mayo, Van Otterloo & Co. LLC
Richard Mayo (56). President-Domestic Active of the Trust. Member,
Grantham, Mayo, Van Otterloo & Co. LLC
Kingsley Durant (66). Vice President and Secretary of the Trust.
Member, Grantham, Mayo, Van Otterloo & Co. LLC
Susan Randall Harbert (41). Secretary and Treasurer of the Trust.
Member, Grantham, Mayo, Van Otterloo & Co. LLC
William R. Royer, Esq. (33). Vice President and Assistant Treasurer of
the Trust. General Counsel, Grantham, Mayo, Van Otterloo & Co. LLC
(January 1995 - Present). Associate, Ropes & Gray, Boston,
Massachusetts (September 1992 - January 1995).
Jui Lai (49). Secretary of the Trust. Member, Grantham, Mayo, Van
Otterloo & Co. LLC
Ann Spruill (44). Secretary of the Trust. Member, Grantham, Mayo, Van
Otterloo & Co. LLC
Alison E. Baur, Esq. (34). Vice President and Clerk of the Trust.
Associate General Counsel, Grantham, Mayo, Van Otterloo & Co. LLC
(February 1997 - Present). Attorney, Securities and Exchange Commission
(April 1991 - January 1997).
Robert V. Brokaw, Jr. (54). Secretary of the Trust. Member, Grantham,
Mayo, Van Otterloo & Co. LLC
Forrest Berkley (44). Vice President of the Trust. Member, Grantham,
Mayo, Van Otterloo & Co. LLC
Scott Eston (42). Vice President of the Trust. Chief Financial Officer,
Grantham, Mayo, Van Otterloo & Co. LLC (September 1997 - Present).
Senior Partner, Coopers & Lybrand (1987 - 1997).
Brent Arvidson (29). Assistant Treasurer. Senior Fund Administrator,
Grantham, Mayo, Van Otterloo & Co. LLC (September 1997 - Present).
Senior Financial Reporting Analyst, John Hancock Funds (August 1996 -
September 1997). Account Supervisor/Senior Account Specialist,
Investors Bank and Trust Company (June 1993 - August 1996).
*Trustee is deemed to be an "interested person" of the Trust and the Manager, as
defined by the 1940 Act.
The mailing address of each of the officers and Trustees is c/o GMO
Trust, 40 Rowes Wharf, Boston, Massachusetts 02110. As of November 1, 1998, the
Trustees and officers of the Trust as a group owned less than 1% of the Class
III Shares of the Fund.
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<PAGE> 43
Except as stated above, the principal occupations of the officers and
Trustees for the last five years have been with the employers as shown above,
although in some cases they have held different positions with such employers.
Other than as set forth in the following table, no Trustee or officer
of the Trust receives any direct compensation from the Trust or any series
thereof:
NAME OF PERSON, TOTAL ANNUAL COMPENSATION FROM
POSITION THE TRUST
Harvey R. Margolis, Trustee $70,000
Jay O. Light, Trustee $70,000
Messrs. Grantham, Mayo, Van Otterloo, Durant, Lai and Brokaw, and Mses.
Harbert and Spruill, as members of the Manager, will benefit from the management
fees paid by each Fund of the Trust.
INVESTMENT ADVISORY AND OTHER SERVICES
Management Contract
As disclosed in the Prospectus under the heading "Management of the
Fund," the Fund does not charge an investment advisory fee. However, an
investment advisory fee is charged under a separate Management Contract (the
"Management Contract") between the Trust, on behalf of ECDF, and Grantham, Mayo,
Van Otterloo & Co. LLC (the "Manager"). Subject to such policies as the Trustees
of the Trust may determine, the Manager will furnish continuously an investment
program for ECDF, will make investment decisions on behalf of ECDF and place all
orders for the purchase and sale of portfolio securities. Subject to the control
of the Trustees, the Manager also manages, supervises and conducts the other
affairs and business of the Trust, furnishes office space and equipment,
provides bookkeeping and certain clerical services and pays all salaries, fees
and expenses of officers and Trustees of the Trust who are affiliated with the
Manager. As indicated under "Portfolio Transactions --Brokerage and Research
Services," the Trust's portfolio transactions may be placed with broker-dealers
which furnish the Manager, at no cost, certain research, statistical and
quotation services of value to the Manager in advising the Trust or its other
clients.
As disclosed in the Prospectus, the Manager has voluntarily agreed to
bear all Fund expenses (including the management fee but 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, transfer taxes
and expenses indirectly incurred by investment in ECDF) until further notice. In
addition, the Manager's compensation from ECDF will be reduced to the extent
that
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<PAGE> 44
the annual expenses incurred in the operation of ECDF (including the management
fee but 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, transfer taxes and all custodial fees) would exceed the percentage
of ECDF's average daily net assets described in the Prospectus. Because the
Manager's compensation is fixed at an annual rate equal to this expense
limitation, it is expected that the Manager will pay such expenses (with the
exceptions noted) as they arise. In addition, the Manager's compensation under
the Management Contract is subject to reduction to the extent that in any year
the expenses of ECDF exceed the limits on investment company expenses imposed by
any statute or regulatory authority of any jurisdiction in which shares of ECDF
are qualified for offer and sale. The term "expenses" is defined in the statutes
or regulations of such jurisdictions, and, generally speaking, excludes
brokerage commissions, taxes, interest and extraordinary expenses. Neither the
Fund nor ECDF are currently subject to any state imposed limit on expenses.
The Management Contract provides that the Manager shall not be subject
to any liability in connection with the performance of its services thereunder
in the absence of willful misfeasance, bad faith, gross negligence or reckless
disregard of its obligations and duties.
The Management Contract was approved by the Trustees of the Trust
(including a majority of the Trustees who are not "interested persons" of the
Manager) and by ECDF's initial sole shareholder in connection with the
organization of the Trust and the establishment of ECDF. The Management Contract
will continue in effect for a period more than two years from the date of its
execution only so long as its continuance is approved at least annually by (i)
vote, cast in person at a meeting called for that purpose, of a majority of
those Trustees who are not "interested persons" of the Manager or the Trust, and
by (ii) the majority vote of either the full Board of Trustees or the vote of a
majority of the outstanding shares of ECDF. The Management Contract
automatically terminates on assignment, and is terminable on not more than 60
days' notice by the Trust to the Manager. In addition, the Management Contract
may be terminated on not more than 60 days' written notice by the Manager to the
Trust.
Custodial Arrangements. Investors Bank & Trust Company ("IBT"), 200
Clarendon Street, Boston, Massachusetts 02116 serves as the Trust's custodian on
behalf of the Fund and ECDF. As such, IBT holds in safekeeping certificated
securities and cash belonging to the Fund and, in such capacity, is the
registered owner of securities in book-entry form belonging to the Fund. Upon
instruction, IBT receives and delivers cash and securities of the Fund in
connection with the Fund's transactions and collects all dividends and other
distributions made with respect to the Fund's portfolio securities. IBT also
maintains certain accounts and records of the Trust and calculates the total net
asset value, total net income and net asset value per share of the Fund on a
daily basis.
Shareholder Service Arrangements. As disclosed in the Prospectus,
pursuant to the terms of a single Servicing Agreement with each Fund of the
Trust, Grantham, Mayo, Van
-4-
<PAGE> 45
Otterloo & Co. LLC ("GMO") provides direct client service, maintenance and
reporting to shareholders of the Fund and ECDF. The Servicing Agreement was
approved by the Trustees of the Trust (including a majority of the Trustees who
are not "interested persons" of the Manager or the Trust). The Servicing
Agreement will continue in effect for a period more than one year from the date
of its execution only so long as its continuance is approved at least annually
by (i) vote, cast in person at a meeting called for the purpose, of a majority
of those Trustees who are not "interested persons" of the Manager or the Trust,
and by (ii) the majority vote of the full Board of Trustees. The Servicing
Agreement automatically terminates on assignment (except as specifically
provided in the Servicing Agreement) and is terminable by either party upon not
more than 60 days written notice to the other party.
The Trust initially entered into the Servicing Agreement with GMO on
May 30, 1996.
Independent Accountants. The Trust's independent accountants are
PricewaterhouseCoopers LLP, 160 Federal Street, Boston, Massachusetts 02110.
PricewaterhouseCoopers will conduct annual audits of the Trust's financial
statements, assist in the preparation of the Fund's federal and state income
tax returns, consult with the Trust as to matters of accounting and federal and
state income taxation and provide assistance in connection with the preparation
of various Securities and Exchange Commission filings.
PORTFOLIO TRANSACTIONS
The purchase and sale of portfolio securities for ECDF and for the
other investment advisory clients of the Manager are made by the Manager with a
view to achieving their respective investment objectives. For example, a
particular security may be bought or sold for certain clients of the Manager
even though it could have been bought or sold for other clients at the same
time. Likewise, a particular security may be bought for one or more clients when
one or more other clients are selling the security. In some instances,
therefore, one client may sell indirectly a particular security to another
client. It also happens that two or more clients may simultaneously buy or sell
the same security, in which event purchases or sales are effected on a pro rata,
rotating or other equitable basis so as to avoid any one account's being
preferred over any other account.
Transactions involving the issuance of Fund shares for securities or
assets other than cash will be limited to a bona fide reorganization or
statutory merger and to other acquisitions of portfolio securities that meet all
of the following conditions: (a) such securities meet the investment objectives
and policies of the Fund; (b) such securities are acquired for investment and
not for resale; (c) such securities are liquid securities which are not
restricted as to transfer either by law or liquidity of market; and (d) such
securities have a value which is readily ascertainable as evidenced by a listing
on the American Stock Exchange, the New York Stock Exchange, NASDAQ or a
recognized foreign exchange.
-5-
<PAGE> 46
Brokerage and Research Services. In placing orders for the portfolio
transactions of ECDF, the Manager will seek the best price and execution
available, except to the extent it may be permitted to pay higher brokerage
commissions for brokerage and research services as described below. The
determination of what may constitute best price and execution by a broker-dealer
in effecting a securities transaction involves a number of considerations,
including, without limitation, the overall net economic result to ECDF
(involving price paid or received and any commissions and other costs paid), the
efficiency with which the transaction is effected, the ability to effect the
transaction at all where a large block is involved, availability of the broker
to stand ready to execute possibly difficult transactions in the future and the
financial strength and stability of the broker. Because of such factors, a
broker-dealer effecting a transaction may be paid a commission higher than that
charged by another broker-dealer. Most of the foregoing are judgmental
considerations.
Over-the-counter transactions often involve dealers acting for their
own account.
Although the Manager does not consider the receipt of research services
as a factor in selecting brokers to effect portfolio transactions for ECDF, the
Manager will receive such services from brokers who are expected to handle a
substantial amount of ECDF's portfolio transactions. Research services may
include a wide variety of analyses, reviews and reports on such matters as
economic and political developments, industries, companies, securities and
portfolio strategy. The Manager uses such research in servicing other clients
(including other Funds of the Trust) as well as ECDF.
As permitted by Section 28(e) of the Securities Exchange Act of 1934
and subject to such policies as the Trustees of the Trust may determine, the
Manager may pay an unaffiliated broker or dealer that provides "brokerage and
research services" (as defined in the Act) to the Manager an amount of
commission for effecting a portfolio investment transaction in excess of the
amount of commission another broker or dealer would have charged for effecting
that transaction.
DESCRIPTION OF THE TRUST AND OWNERSHIP OF SHARES
The Trust is organized as a Massachusetts business trust under the laws
of Massachusetts by an Agreement and Declaration of Trust ("Declaration of
Trust") dated June 24, 1985. A copy of the Declaration of Trust is on file with
the Secretary of The Commonwealth of Massachusetts. The fiscal year for the Fund
ends on February 28.
Pursuant to the Declaration of Trust, the Trustees have currently
authorized the issuance of an unlimited number of full and fractional shares of
thirty-seven series: one for the Emerging Country Debt Share Fund, and one for
each of the GMO Asia Fund, GMO International Core Plus Allocation Fund, GMO
Fundamental Value Fund, Pelican Fund, GMO U.S. Core Fund, GMO Tobacco-Free Core
Fund, GMO Value Fund, GMO Growth Fund,
-6-
<PAGE> 47
GMO U.S. Sector Fund, GMO Small Cap Value Fund, GMO Small Cap Growth Fund, GMO
REIT Fund, GMO International Core Fund, GMO Currency Hedged International Core
Fund, GMO Foreign Fund, GMO International Small Companies Fund, GMO Japan Fund,
GMO Emerging Markets Fund, GMO Evolving Countries Fund, GMO Global Properties
Fund, GMO Domestic Bond Fund, GMO U.S. Bond/Global Alpha A Fund, GMO U.S.
Bond/Global Alpha B Fund, GMO International Bond Fund, GMO Currency Hedged
International Bond Fund, GMO Global Bond Fund, GMO Emerging Country Debt Fund,
GMO Short-Term Income Fund, GMO Global Hedged Equity Fund, GMO Inflation Indexed
Bond Fund, GMO International Equity Allocation Fund, GMO World Equity Allocation
Fund, GMO Global (U.S.+) Equity Allocation Fund, GMO Global Balanced Allocation
Fund, GMO Tax-Managed U.S. Equities Fund, and GMO Tax-Managed International
Equities Fund. Interests in each portfolio (Fund) are represented by shares of
the corresponding series. Each share of each series represents an equal
proportionate interest, together with each other share, in the corresponding
Fund. The shares of such series do not have any preemptive rights. Upon
liquidation of a Fund, shareholders of the corresponding series are entitled to
share pro rata in the net assets of the Fund available for distribution to
shareholders. The Declaration of Trust also permits the Trustees to charge
shareholders directly for custodial and transfer agency expenses, but there is
no present intention to make such charges.
The Declaration of Trust also permits the Trustees, without shareholder
approval, to subdivide any series of shares into various sub-series or classes
of shares with such dividend preferences and other rights as the Trustees may
designate. This power is intended to allow the Trustees to provide for an
equitable allocation of the impact of any future regulatory requirements which
might affect various classes of shareholders differently. The Trustees have
currently authorized the establishment and designation of up to eight classes of
shares for each series of the Trust (except for the Pelican Fund): Class I
Shares, Class II Shares, Class III Shares, Class IV Shares, Class V Shares,
Class VI Shares, Class VII Shares and Class VIII Shares.
The Trustees may also, without shareholder approval, establish one or
more additional separate portfolios for investments in the Trust or merge two or
more existing portfolios (i.e., a new fund). Shareholders' investments in such a
portfolio would be evidenced by a separate series of shares.
The Declaration of Trust provides for the perpetual existence of the
Trust. The Trust, however, may be terminated at any time by vote of at least
two-thirds of the outstanding shares of the Trust. While the Declaration of
Trust further provides that the Trustees may also terminate the Trust upon
written notice to the shareholders, the Investment Company Act of 1940 (the
"1940 Act") requires that the Trust receive the authorization of a majority of
its outstanding shares in order to change the nature of its business so as to
cease to be an investment company.
-7-
<PAGE> 48
Voting Rights
As summarized in the Prospectus, shareholders are entitled to one vote
for each full share held (with fractional votes for fractional shares held) and
will vote (to the extent provided herein) in the election of Trustees and the
termination of the Trust and on other matters submitted to the vote of
shareholders. Shareholders vote by individual Fund on all matters except (i)
when required by the 1940 Act, shares shall be voted in the aggregate and not by
individual Fund, and (ii) when the Trustees have determined that the matter
affects only the interests of one or more Funds, then only shareholders of such
affected Funds shall be entitled to vote thereon. Shareholders of one Fund shall
not be entitled to vote on matters exclusively affecting another Fund, such
matters including, without limitation, the adoption of or change in the
investment objectives, policies or restrictions of the other Fund and the
approval of the investment advisory contracts of the other Fund. 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 and as otherwise
required by law.
There will normally be no meetings of shareholders for the purpose of
electing Trustees except that in accordance with the 1940 Act (i) the Trust will
hold a shareholders' meeting for the election of Trustees at such time as less
than a majority of the Trustees holding office have been elected by
shareholders, and (ii) if, as a result of a vacancy in the Board of Trustees,
less than two-thirds of the Trustees holding office have been elected by the
shareholders, that vacancy may only be filled by a vote of the shareholders. In
addition, Trustees may be removed from office by a written consent signed by the
holders of two-thirds of the outstanding shares and filed with the Trust's
custodian or by a vote of the holders of two-thirds of the outstanding shares at
a meeting duly called for the purpose, which meeting shall be held upon the
written request of the holders of not less than 10% of the outstanding shares.
Upon written request by the holders of at least 1% of the outstanding shares
stating that such shareholders wish to communicate with the other shareholders
for the purpose of obtaining the signatures necessary to demand a meeting to
consider removal of a Trustee, the Trust has undertaken to provide a list of
shareholders or to disseminate appropriate materials (at the expense of the
requesting shareholders). Except as set forth above, the Trustees shall continue
to hold office and may appoint successor Trustees. Voting rights are not
cumulative.
No amendment may be made to the Declaration of Trust without the
affirmative vote of a majority of the outstanding shares of the Trust except (i)
to change the Trust's name or to cure technical problems in the Declaration of
Trust and (ii) to establish, designate or modify new and existing series or
sub-series of Trust shares or other provisions relating to Trust shares in
response to applicable laws or regulations.
Shareholder and Trustee Liability
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the Trust.
However, the Declaration of Trust disclaims
-8-
<PAGE> 49
shareholder liability for acts or obligations of the Trust and requires that
notice of such disclaimer be given in each agreement, obligation, or instrument
entered into or executed by the Trust or the Trustees. The Declaration of Trust
provides for indemnification out of all the property of the relevant Fund for
all loss and expense of any shareholder of that Fund held personally liable for
the obligations of the Trust. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is considered remote since it
is limited to circumstances in which the disclaimer is inoperative and the Fund
of which he is or was a shareholder would be unable to meet its obligations.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law. However, nothing in
the Declaration of Trust protects a Trustee against any liability to which the
Trustee would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence, or reckless disregard of the duties involved in the conduct of
his office. The By-laws of the Trust provide for indemnification by the Trust of
the Trustees and the officers of the Trust except with respect to any matter as
to which any such person did not act in good faith in the reasonable belief that
his action was in or not opposed to the best interests of the Trust. Such person
may not be indemnified against any liability to the Trust or the Trust
shareholders to which he would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his office.
Beneficial Owners of 5% or More of the Fund's Shares
The following chart sets forth the names, addresses and percentage
ownership of those shareholders owning beneficially 5% or more of the
outstanding Class III Shares of the Fund as of November 1, 1998:
Name Address %Ownership
Sprint Corporate Master Attn: William N. Searcy, Jr. 100%
Trust 2320 Shawnee Mission Parkway
Westwood, KS 66205
FINANCIAL STATEMENTS
The Fund's unaudited financial statements for the period from July 20,
1998 to August 31, 1998 included in the Fund's Semi-Annual Report filed with the
Securities and Exchange Commission on November 6, 1998 pursuant to Section 30(d)
of the Investment Company Act of 1940, as amended, and the rules promulgated
thereunder, are hereby incorporated in this Statement of Additional Information
by reference.
-9-
<PAGE> 50
PERFORMANCE INFORMATION
The Fund may from time to time include its total return in
advertisements or in information furnished to present or prospective
shareholders.
Quotations of average annual total return for the Fund will be expressed
in terms of the average annual compounded rate of return of a hypothetical
investment in the Fund or class over periods of one, three, five, and ten years
(or for such shorter or longer periods as shares of the Fund have been offered),
calculated pursuant to the following formula: P (1 + T)(n) = ERV (where P = a
hypothetical initial payment of $1,000, T = the average annual total return, n =
the number of years, and ERV = the ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the period). Except as noted below, all
total return figures reflect the deduction of a proportional share of Fund
expenses on an annual basis, and assume that (i) the maximum purchase premium is
deducted from the initial $1,000 payment, (ii) all dividends and distributions
are reinvested when paid and (iii) the maximum redemption fee is charged at the
end of the relevant period. Quotations of total return may also be shown for
other periods. The Fund may also, with respect to certain periods of less than
one year, provide total return information for that period that is unannualized.
Any such information would be accompanied by standardized total return
information.
The Fund may also from time to time advertise net return and gross
return data for each month and calendar quarter since the Fund's inception.
Monthly and quarterly return data is calculated by linking daily performance for
the Fund (current net asset value divided by prior net asset value), and assumes
reinvestment of all dividends and gains. Monthly and quarterly performance data
does not reflect payment of any applicable purchase premiums or redemptions
fees. All quotations of monthly and quarterly returns would be accompanied by
standardized total return information.
Quotations of the Fund's gross return do not reflect any reduction for
any Fund fees or expenses unless otherwise noted; if the gross return data
reflected the estimated fees and expenses of the Fund, the returns would be
lower than those shown. Quotations of gross return for the Fund for a particular
month or quarter will be calculated in accordance with the following formula:
Gross Return =
Net Return + (Total Annual Operating Expense Ratio) (# of days in relevant
period/365)
Information relating to the Fund's return for a particular month or
calendar quarter is provided to permit evaluation of the Fund's performance and
volatility in different market conditions, and should not be considered in
isolation.
-10-
<PAGE> 51
From time to time, in advertisements, in sales literature, or in
reports to shareholders, the Fund may compare its performance to that of other
mutual funds with similar investment objectives and to fixed income or other
relevant indices. For example, the Fund may compare its total return to rankings
prepared by Lipper Analytical Services, Inc., a widely recognized independent
service which monitors mutual fund performance.
Performance rankings, listings and ratings reported in national
financial publications, such as Money Magazine, Barron's, Morningstar and
Changing Times, may also be cited (if the Fund is listed in any such
publication) or used for comparison, as well as performance listings and
rankings from various other sources including No Load Fund X, CDA Investment
Technologies, Inc., Weisenberger Investment Companies Service, and Donoghue's
Mutual Fund Almanac.
-11-
<PAGE> 52
GMO TRUST - EMERGING COUNTRY DEBT SHARE FUND
SPECIMEN PRICE MAKE-UP SHEET
Following are computations of the total offering price per share for the
Fund as of August 31, 1998, based upon the Fund's net asset value and shares of
beneficial interest outstanding at the close of business on August 31, 1998.
Emerging Country Debt Share Fund - Class III
<TABLE>
<S> <C>
Net Assets at Value (Equivalent to $5.73 per share based on $34,384,276
6,000,000 shares of beneficial interest outstanding)
Offering Price $5.73 $5.73
</TABLE>
-12-
<PAGE> 53
GMO TRUST
PART C. OTHER INFORMATION
Note: This Part C relates solely to the GMO Emerging Country Debt Share Fund
(the "New Fund"). No information relating to any other series of GMO Trust is
amended or superseded hereby.
Item 24. Financial Statements and Exhibits
(a) Financial Statements: See "Financial Highlights" in the Prospectus and
"Financial Statements" in the Statement of Additional Information. The
Financial Statements required pursuant to Item 23 of Form N-1A are
hereby incorporated by reference to the Semi-Annual Reports to
shareholders previously filed with the Commission by means of EDGAR
pursuant to the requirements of Section 30(d) of the 1940 Act and the
rules promulgated thereunder.
(b) Exhibits
1. Amended and Restated Agreement and Declaration of Trust(1).
2. Amended and Restated By-laws of the Trust(1).
3. None.
4. Not Applicable.
5. Form of Management Contract between the Trust, on behalf of the
New Fund, and Grantham, Mayo, Van Otterloo & Co. LLC ("GMO")(1).
6. None.
7. None.
<PAGE> 54
8. (a) Custodian Agreement (the "IBT Custodian Agreement")
among the Trust, on behalf of its GMO U.S. Core Fund
(formerly "GMO Core Fund"), GMO Currency Hedged
International Bond Fund (formerly "GMO SAF Core Fund"), GMO
Value Fund (formerly "GMO Value Allocation Fund"), GMO
Growth Fund (formerly "GMO Growth Allocation Fund"), and GMO
Short-Term Income Fund, GMO and Investors Bank & Trust
Company ("IBT")(1); and
(c) Form of Letter Agreement with respect to the IBT Custodian
Agreement among the Trust, on behalf of the New Fund, GMO
and IBT(1).
9. (a) Transfer Agency Agreement among the Trust, on behalf of
its GMO U.S. Core Fund (formerly "GMO Core Fund"), GMO
Currency Hedged International Bond Fund, GMO Growth Fund
(formerly "GMO Growth Allocation Fund"), GMO Value Fund
(formerly "GMO Growth Allocation Fund"), GMO Short-Term
Income Fund, GMO International Core Fund and
GMO Japan Fund, GMO and IBT(1);
(b) Form of Letter Agreement to the Transfer Agency Agreement
among the Trust, on behalf of the New Fund, GMO and IBT(1);
(c) Form of Notification of Fee Waiver and Expense Limitation by
GMO to the Trust relating to all Funds of the Trust(1); and
(d) Form of Amended and Restated Servicing Agreement between the
Trust, on behalf of the Funds, and GMO(1).
10. Opinion and Consent of Ropes & Gray -- See Item 10 of
Pre-Effective Amendment No. 1 which is hereby incorporated by
reference.
11. Not Applicable.
12. None.
13. None.
14. Prototype Retirement Plans(1).
15. None.
16. Not Applicable.
17. Financial Data Schedule -- Exhibit 17.
-2-
<PAGE> 55
18. Form of Rule 18f-3 Multiclass Plan(1).
Item 25. Persons Controlled by or Under Common Control with Registrant
None.
Item 26. Number of Holders of Securities
The following table sets forth the number of record holders of
each class of the Fund's securities as of November 1, 1998:
Title of Class Number of Record Holders
-------------- ------------------------
Class III Shares 1
Item 27. Indemnification
See Item 27 of Pre-Effective Amendment No. 1 which is hereby
incorporated by reference.
Item 28. Business and Other Connections of Investment Adviser
See Item 28 of Pre-Effective Amendment No. 1 which is hereby
incorporated by reference.
Item 29. Principal Underwriters
Not Applicable.
Item 30. Location of Accounts and Records
See Item 30 of Pre-Effective Amendment No. 1 which is hereby
incorporated by reference.
Item 31. Management Services
Not Applicable.
Item 32. Undertakings
(a) Not Applicable.
(b) Registrant hereby undertakes to furnish each person to whom a
prospectus is delivered with a copy of the Registrant's latest
annual report to shareholders
-3-
<PAGE> 56
containing the information required by Item 5A of Form N-1A
omitted from the Prospectus, upon request and without charge.
- ----------------
1 = Previously filed with the Securities and Exchange Commission and
incorporated herein by reference.
-4-
<PAGE> 57
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 (the
"Securities Act") and the Investment Company Act of 1940 (the "1940 Act"), the
Registrant represents that this Post-Effective Amendment is being filed solely
for one or more of the purposes specified in paragraph (b)(1) of Rule 485 under
the Securities Act, and that no material event requiring disclosure in the
Prospectus other than those specified in such paragraph (b)(1) has occurred
since the effective date of this Registration Statement, and has duly caused
this Post-Effective Amendment No. 46 to the Trust's Registration Statement under
the Securities Act and Post-Effective Amendment No. 52 to the Trust's
Registration Statement under the 1940 Act, to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Boston and The
Commonwealth of Massachusetts, on the 25th day of November, 1998.
GMO Trust
By: R. JEREMY GRANTHAM*
R. Jeremy Grantham
President - Quantitative;
Principal Executive Officer;
Title: Trustee
Pursuant to the Securities Act, this Post-Effective Amendment
No. 46 to the Trust's Registration Statement under the Securities Act has been
signed below by the following persons in the capacities and on the dates
indicated.
<TABLE>
<CAPTION>
Signatures Title Date
- ---------- ----- ----
<S> <C> <C>
R. JEREMY GRANTHAM* President - Quantitative; Principal November 25, 1998
R. Jeremy Grantham Executive Officer; Trustee
SUSAN RANDALL HARBERT* Treasurer; Principal Financial and November 25, 1998
Susan Randall Harbert Accounting Officer
HARVEY R. MARGOLIS* Trustee November 25, 1998
Harvey R. Margolis
JAY O. LIGHT* Trustee November 25, 1998
Jay O. Light
</TABLE>
<PAGE> 58
* By: /s/ WILLIAM R. ROYER
-------------------------
William R. Royer
Attorney-in-Fact
<PAGE> 59
POWER OF ATTORNEY
We, the undersigned officers and trustees of GMO Trust, a Massachusetts
business trust, hereby severally constitute and appoint William R. Royer our
true and lawful attorney, with full power to him to sign for us, and in our
names and in the capacities indicated below, any and all amendments to the
Registration Statement filed with the Securities and Exchange Commission for the
purpose of registering shares of beneficial interest of GMO Trust, hereby
ratifying and confirming our signatures as they may be signed by our said
attorneys on said Registration Statement.
Witness our hands and common seal on the date set forth below.
(Seal)
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
President-Domestic;
Principal Executive
/S/ R. Jeremy Grantham Officer; Trustee March 12, 1996
- --------------------------
R. Jeremy Grantham
/S/ Eyk H.A. Van Otterloo President-International March 12, 1996
- --------------------------
Eyk H.A. Van Otterloo
</TABLE>
<PAGE> 60
<TABLE>
<S> <C> <C>
/S/ Harvey Margolis Trustee March 12, 1996
- -----------------------------
Harvey Margolis
Treasurer; Principal
Financial and
/S/ Kingsley Durant Accounting Officer March 12, 1996
- -----------------------------
Kingsley Durant
</TABLE>
<PAGE> 61
POWER OF ATTORNEY
I, the undersigned trustee of GMO Trust, a Massachusetts business trust,
hereby constitute and appoint William R. Royer my true and lawful attorney, with
full power to him to sign for me, and in my names and in the capacity indicated
below, any and all amendments to the Registration Statement filed with the
Securities and Exchange Commission for the purpose of registering shares of
beneficial interest of GMO Trust, hereby ratifying and confirming my signature
as it may be signed by my said attorney on said Registration Statement.
Witness my hand and common seal on the date set forth below.
(Seal)
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/S/ JAY O. LIGHT Trustee May 23, 1996
- --------------------
Jay O. Light
</TABLE>
<PAGE> 62
POWER OF ATTORNEY
I, the duly elected Treasurer of GMO Trust, a Massachusetts business
trust, hereby constitute and appoint each of William R. Royer, Alison E. Baur
and Brent Arvidson as my true and lawful attorneys, with full power to each of
them severally to sign for me, and in my name and in the capacities indicated
below, any and all amendments to the Registration Statement filed with the
Securities and Exchange Commission for the purpose of registering shares of
beneficial interest of GMO Trust, hereby ratifying and confirming my signature
as it may be signed by any of my said attorneys on said Registration Statement.
Witness my hand on the date set forth below.
Signature Title Date
- --------- ----- ----
/S/ SUSAN RANDALL HARBERT Treasurer; Principal November 24, 1998
- ------------------------- Financial and
Susan Randall Harbert Accounting Officer
<PAGE> 63
EXHIBIT INDEX
GMO TRUST
Exhibit No. Title of Exhibit
- ----------- ----------------
17 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 6
<LEGEND>
This schedule contains summary financial information extracted from GMO Trust
form N-SAR for the period ended August 31, 1998 and is qualified in its entirety
by reference to such financial statements.
</LEGEND>
<SERIES>
<NUMBER> 383
<NAME> EMERGING COUNTRY DEBT SHARE FUND, CLASS III
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> FEB-28-1999
<PERIOD-END> AUG-31-1998
<INVESTMENTS-AT-COST> 60,007,141
<INVESTMENTS-AT-VALUE> 34,385,285
<RECEIVABLES> 3,132
<ASSETS-OTHER> 0
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 34,388,417
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 4,141
<TOTAL-LIABILITIES> 4,141
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 60,000,000
<SHARES-COMMON-STOCK> 6,000,000
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 6,132
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
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<APPREC-INCREASE-CURRENT> (25,621,856)
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</TABLE>
