<PAGE> 1
File Nos. 2-98772
811-4347
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
ON OCTOBER 7, 1998
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933:
Pre-Effective Amendment No. ___ [ ]
Post-Effective Amendment No. 45 [X]
REGISTRATION STATEMENT UNDER THE INVESTMENT
COMPANY ACT OF 1940
Amendment No. 51 [X]
GMO TRUST
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(Exact Name of Registrant as Specified in Charter)
40 Rowes Wharf, Boston, Massachusetts 02110
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(Address of principal executive offices)
617-330-7500
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(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
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(Name and address of agents for service)
It is proposed that this filing will become effective:
[ ] Immediately upon filing pursuant to paragraph (b), or
[ ] 60 days after filing pursuant to paragraph (a)(1), or
[X] 75 days after filing pursuant to paragraph (a)(2), of Rule 485 under the
Securities Act of 1933.
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GMO TRUST
CROSS REFERENCE SHEET
(for GMO Emerging Country Debt Share Fund only)
N-1A Item No. Location
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PART A
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 (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
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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
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
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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
<TABLE>
<CAPTION>
<S> <C>
SCHEDULE OF FEES AND EXPENSES .............................................. 1
FINANCIAL HIGHLIGHTS ....................................................... 3
INVESTMENT OBJECTIVE AND POLICIES .......................................... 4
DESCRIPTION AND RISKS OF FUND INVESTMENTS .................................. 5
ADDITIONAL INVESTMENT RESTRICTIONS ......................................... 21
PURCHASE OF SHARES ......................................................... 23
REDEMPTION OF SHARES ....................................................... 24
DETERMINATION OF NET ASSET VALUE ........................................... 25
DISTRIBUTIONS .............................................................. 26
TAXES ...................................................................... 26
MANAGEMENT OF THE TRUST .................................................... 27
ORGANIZATION AND CAPITALIZATION OF THE TRUST ............................... 28
Appendix A: RISKS AND LIMITATIONS OF OPTIONS, FUTURES AND SWAPS ........... 29
Appendix B: COMMERCIAL PAPER AND CORPORATE DEBT RATINGS ................... 32
</TABLE>
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FEES AND EXPENSES
SCHEDULE OF FEES AND EXPENSES
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
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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 following expenses
percentage of percentage Fees Service penses(1) Expenses(1) on a $1,000 on the same
amount of amount after Fee Fee(2) investment assuming investment assuming
invested) redeemed) Waiver(1) 5% annual return no redemption:
with redemption at
the end of each
time period:
____________________________________________________________________________________________________________________________________
EMERGING COUNTRY 1 YR. 3 YR. 1 YR. 3 YR.
DEBT SHARE FUND
____________________________________________________________________________________________________________________________________
Class III * * 0.30% 0.15% 0.08% 0.53% $13 $25 $10 $22
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</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").
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
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MANAGEMENT FEE TOTAL OPERATING EXPENSES
VOLUNTARY EXPENSE LIMIT (ABSENT WAIVER) (ABSENT WAIVER)
___________________________________________________________________________
0.00% 0.00% 0.05%
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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:
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ECDF EXPENSES
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MANAGEMENT FEE TOTAL OPERATING EXPENSES
VOLUNTARY EXPENSE LIMIT (ABSENT WAIVER) (ABSENT WAIVER)
___________________________________________________________________________
.35% .50% 0.73%
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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
(unaudited)
<S> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $
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Income (loss) from investment operations:
Net investment income
Net realized and unrealized gain
Total from investment operations ___________
NET ASSET VALUE, END OF PERIOD $
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TOTAL RETURN (a)
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000's) $
Net expenses to average daily net assets
Net investment income to average daily net assets
Portfolio turnover rate
Average broker commission rate per equity share (c) $
Fees and expenses voluntarily waived or borne by the
Manager consisted of the following per share amount: $
</TABLE>
* Annualized
(a) Calculation excludes subscription and redemption fees. The total return
would have been lower had certain expenses not been waived during the
period shown.
(b) Computed using average shares outstanding throughout the period.
(c) The average broker commission rate will vary depending on the markets in
which trades are executed.
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.
A comparison of the Fund's performance over the life of the Fund with that
of a benchmark securities index selected by the Manager is included in the
Fund's Semi-Annual Report for the period from July 20, 1998 to August 31, 1998.
Copies of the Semi-Annual Report are available upon request without charge.
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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 agreement 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.
DESCRIPTION AND RISKS OF FUND
INVESTMENTS
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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 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 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
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<PAGE> 11
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.
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 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 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 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
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<PAGE> 12
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.
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.
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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 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.
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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 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.
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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 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
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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 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.
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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.
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
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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 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.
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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 forego 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 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
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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.
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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.
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.
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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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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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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> 26
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> 27
(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 % 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 premiums 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> 28
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> 29
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> 30
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.
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<PAGE> 31
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.
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. Pursuant to the Taxpayer Relief Act of 1997 (the
"1997 Act"), two different tax rates apply to 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")). One rate (generally 28%) applies to net
gains on capital assets held for more than one year but not more than 18 months
("28% gains") and a second, preferred rate (generally 20%) applies to the
balance of such net capital gains ("20% gains"). Distributions of net capital
gains will be treated in the hands of shareholders as 28% gains to the extent
designated by the Fund as deriving from net gains from assets held for more than
one year but not more than 18 months, and the balance will be treated as 20%
gains. Distributions of 28% gains and 20% gains will be taxable to shareholders
as such, 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.
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 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
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<PAGE> 32
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 (for example, 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.
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
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<PAGE> 33
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 shareholders. The Trust does not generally
hold annual meetings of shareholders and will do so only when required by law.
All shares entitle their holders to one vote per share. Matters submitted to
shareholder vote must be approved by each Fund separately except (i) when
required by the 1940 Act shares shall be voted together as a single class and
(ii) when the Trustees have determined that the matter does not affect 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 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: [_________________________________________].
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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<PAGE> 34
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> 35
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> 36
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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<PAGE> 37
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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<PAGE> 38
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> 39
==============================================================================
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> 40
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> 41
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Caption Page
------- ----
<S> <C>
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 ................................................... 9
SPECIMEN PRICE MAKE-UP SHEET .............................................. 11
</TABLE>
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<PAGE> 42
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* (59). 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> 43
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. (32). 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 ANDERSON (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 October 15, 1998, the
Trustees and officers of the Trust as a group owned [___]% of the Class III
Shares of the Fund.
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:
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<PAGE> 44
---------------------------------------------------------------
NAME OF PERSON, TOTAL ANNUAL COMPENSATION
POSITION FROM THE TRUST
---------------------------------------------------------------
Harvey R. Margolis, Trustee $70,000
---------------------------------------------------------------
Jay O. Light, Trustee $70,000
---------------------------------------------------------------
Messrs. Grantham, Mayo, Van Otterloo, Durant, Lai, Berkley 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 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
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<PAGE> 45
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 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
-4-
<PAGE> 46
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 conducts annual audits of the Trust's financial
statements, assists in the preparation of the Fund's federal and state income
tax returns, consults with the Trust as to matters of accounting and federal
and state income taxation and provides 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.
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
-5-
<PAGE> 47
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, 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
-6-
<PAGE> 48
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.
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
-7-
<PAGE> 49
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 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
-8-
<PAGE> 50
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 October 15, 1998:
NAME ADDRESS %OWNERSHIP
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 [OCTOBER ___, 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.
PERFORMANCE INFORMATION
The Fund may from time to time include its total return in advertisements
or in information furnished to present or prospective shareholders.
-9-
<PAGE> 51
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.
From time to time, in advertisements, in sales literature, or in reports
to shareholders, the Fund may compare its respective performance to that of
other mutual funds with similar investment objectives and to stock 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; the Standard and
Poor's 500 Stock Index ("S&P 500"), an index of unmanaged groups of common
stock; or the Dow Jones Industrial Average, a recognized unmanaged index of
common stocks of 30 industrial companies listed on the New York Stock Exchange.
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.
-10-
<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
Net Assets at Value (Equivalent to $___ per share based on _____ $_____
shares of beneficial interest outstanding)
Offering Price (________)* $_____
* Represents maximum offering price charged on certain cash purchases. See
"Purchase of Shares" in the Prospectus.
-11-
<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: Not Applicable
(b) Exhibits
1. Amended and Restated Agreement and Declaration of Trust1.
2. Amended and Restated By-laws of the Trust1.
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 -- [To be provided.]
-2-
<PAGE> 55
18. Form of Rule 18f-3 Multiclass Plan1.
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 October 15, 1998:
Title of Class Number of Record Holders
-------------- ------------------------
Class III Shares [ ]
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
has duly caused this Post-Effective Amendment No. 45 to the Trust's Registration
Statement under the Securities Act and Post-Effective Amendment No. 51 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 5th day of October, 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. 45 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 October 5, 1998
- ---------------------- Executive Officer; Trustee
R. Jeremy Grantham
/s/ Brent Arvidson
- ---------------------- Assistant Treasurer; Acting Principal October 5, 1998
Brent Arvidson Financial and Accounting Officer
HARVEY R. MARGOLIS* Trustee October 5, 1998
- ----------------------
Harvey R. Margolis
JAY O. LIGHT* Trustee October 5, 1998
- ----------------------
Jay O. Light
</TABLE>
* By: /s/William R. Royer
-------------------
William R. Royer
Attorney-in-Fact
<PAGE> 58
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)
Signatures Title Date
- ---------- ----- ----
/s/ R. Jeremy Grantham President-Domestic; March 12, 1996
- ------------------------- Principal Executive
R. Jeremy Grantham Officer; Trustee
/s/ Eyk H.a. Van Otterloo President-International March 12, 1996
- -------------------------
Eyk H.A. Van Otterloo
/s/ Harvey Margolis Trustee March 12, 1996
- -------------------------
Harvey Margolis
Treasurer; Principal
/s/ Kingsley Durant Financial an March 12, 1996
- -------------------------- Accounting Officer
Kingsley Durant
<PAGE> 59
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)
Signatures Title Date
- ---------- ----- ----
/s/ JAY O. LIGHT Trustee May 23, 1996
- --------------------
Jay O. Light
