<PAGE> 1
GMO ASIA FUND
40 Rowes Wharf, Boston, Massachusetts 02110
The GMO ASIA FUND (THE "ASIA FUND" OR 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 Manager has entered
into a Consulting Agreement with Dancing Elephant, Ltd. (the "Consultant") with
respect to the management of the Fund.
The Asia Fund seeks long-term capital appreciation through investment
primarily in equity securities and equity-related securities of issuers in
countries in Asia. The Fund is a "non-diversified" portfolio, as defined in the
Investment Company Act of 1940 (the "1940 Act"). See "Description and Risks of
Fund Investments--Non-Diversified Portfolios." A TABLE OF CONTENTS APPEARS ON
PAGE i OF THIS PROSPECTUS.
The Fund has four classes of shares: Class I, Class II, Class III and Class
IV. The Fund is currently offering Class III Shares only. Eligibility for the
classes is generally based on the total amount of assets that a client has
invested with GMO (with Class I requiring the least total assets and Class IV
the most), as described more fully herein. See "Multiple Classes--Eligibility
for Classes."
The classes differ solely with regard to the level of SHAREHOLDER SERVICE
FEE borne by the class. This difference is described briefly below and in more
detail elsewhere in this Prospectus. ALL CLASSES OF THE FUND HAVE AN INTEREST IN
THE SAME UNDERLYING ASSETS, ARE MANAGED BY GMO, AND PAY THE SAME INVESTMENT
MANAGEMENT FEE.
INVESTMENT MANAGER
GMO
Grantham, Mayo, Van Otterloo & Co. LLC
CLIENT SERVICE PROVIDER SHAREHOLDER SERVICE FEE
GMO The level of Shareholder Fee for each class is set
Tel: (617) 330-7500 forth on the following page and described more fully
Fax: (617) 439-4132 under "Multiple Classes--Shareholder Service Fees."
- ---------------------------
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 the Trust, 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> 2
CLASSES AND FEES
<TABLE>
<CAPTION>
ELIGIBILITY
REQUIREMENT* SHAREHOLDER SERVICE FEE**
<S> <C> <C>
ASIA FUND
Class I N/A 0.28%
Class II N/A 0.22%
Class III $1,000,000 0.15%
Class IV N/A 0.105%
</TABLE>
* More detailed explanation of eligibility criteria is provided below and
under "Multiple Classes -- Eligibility for Classes."
** As noted above, all classes of shares of the Fund pay the same investment
management fee.
CLASS ELIGIBILITY
For full details of the class eligibility criteria summarized below and an
explanation of how conversions between classes will occur, see "Multiple Classes
- - Eligibility for Classes" and "Multiple Classes - Conversions Between Classes."
Class I Shares. Class I Shares are not currently being offered by the Trust, but
may be offered by the Trust in the future. Class I Shares bear a Shareholder
Service Fee of 0.28%.
Class II Shares. Class II Shares are not currently being offered by the Trust,
but may be offered by the Trust in the future. Class II Shares bear a
Shareholder Service Fee of 0.22%.
Class III Shares. Class III Shares are available to any investor who commits
assets to GMO management to establish a "Total Investment" (as defined) with GMO
of at least $1,000,000. Class III Shares bear a Shareholder Service Fee of 0.15%
of average net assets.
Class IV Shares. Class IV Shares are not currently being offered by the Trust,
but may be offered by the Trust in the future. Class IV Shares bear a
Shareholder Service Fee of 0.105%. See "Multiple Classes--Eligibility for
Classes" and "Multiple Classes--Conversions Between Classes" for full details of
the eligibility criteria for the Class IV Shares (which work differently than
that for Class I, II and III Shares) and an explanation of how conversions
between classes will occur.
Purchasers of all classes of shares should follow purchase instructions
described under "Purchase of Shares" and direct questions to the Trust at (617)
330-7500.
<PAGE> 3
TABLE OF CONTENTS
SCHEDULE OF FEES AND EXPENSES..................................................2
FINANCIAL HIGHLIGHTS...........................................................4
INVESTMENT OBJECTIVE AND POLICIES..............................................5
DESCRIPTION AND RISKS OF FUND INVESTMENTS......................................6
ADDITIONAL INVESTMENT RESTRICTIONS............................................20
MULTIPLE CLASSES..............................................................22
PURCHASE OF SHARES............................................................24
REDEMPTION OF SHARES..........................................................26
DETERMINATION OF NET ASSET VALUE..............................................27
DISTRIBUTIONS.................................................................27
TAXES.........................................................................28
MANAGEMENT OF THE TRUST.......................................................30
ORGANIZATION AND CAPITALIZATION OF THE TRUST..................................31
Appendix A: RISKS AND LIMITATIONS OF OPTIONS, FUTURES AND SWAPS..............33
Appendix B: COMMERCIAL PAPER AND CORPORATE DEBT RATINGS......................36
1
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SCHEDULE OF FEES AND EXPENSES
<TABLE>
<CAPTION>
GMO Shareholder
Fund Name Transaction Expenses Annual Operating Expenses Examples
Cash Purchase Redemption Inv. Share- Other Total You would pay the You would pay the
Premium (as a Fees (as a Mgmt. holder Ex- Operating following expenses following expenses
percentage of percentage Fees after Service penses(3),(4) Expenses(3) on a $1,000 invest- on the same
amount of amount Fee Fee(2) ment assuming 5% investment
invested)(1) redeemed)(1) Waiver(3) annual return with assuming no
redemption at the end redemption:
of each time period:
ASIA FUND 1 Yr. 3 Yr. 1 Yr. 3 Yr.
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Class I 1.20%(5) .40%(5) .74% .28% .31% 1.33% $29 $58 $25 $54
Class II 1.20%(5) .40%(5) .74% .22% .31% 1.27% $29 $56 $25 $52
Class III 1.20%(5) .40%(5) .74% .15% .31% 1.20% $28 $54 $24 $50
Class IV 1.20%(5) .40%(5) .74% .105% .31% 1.155% $28 $53 $24 $48
</TABLE>
The footnotes set forth below are important to understanding this table.
The purpose of the foregoing table is to assist investors in understanding the
various costs and expenses of the Fund that are borne by holders of Fund shares.
THE FIVE PERCENT ANNUAL RETURN AND EXPENSE NUMBERS USED ARE NOT REPRESENTATIONS
OF FUTURE PERFORMANCE OR EXPENSES. SUBJECT TO THE MANAGER'S UNDERTAKING TO WAIVE
ITS FEE AND/OR BEAR CERTAIN EXPENSES FOR 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 the Fund
in certain instances, the foregoing examples assume the payment of such purchase
premium and/or redemption fee even though such purchase premium and/or
redemption fee is not applicable in all cases. (See "Purchase of Shares" and
"Redemption of Shares").
NOTES TO SCHEDULE OF FEES AND EXPENSES
1. Purchase premiums and redemption fees apply only to cash transactions as
set forth under "Purchase of Shares" and "Redemption of Shares"
respectively. These fees are paid to and retained by the Fund itself and
are designed to allocate transaction costs caused by shareholder activity
to the shareholder generating the activity, rather than to the Fund as a
whole. As described in greater detail in the footnotes below, the Manager
may reduce purchase premiums and/or redemption fees if the Manager
determines there are minimal brokerage and/or other transaction costs
caused by a particular purchase or redemption. However, the instances in
which such fees may be properly waived are extremely limited.
Normally no purchase premium is charged with respect to in-kind purchases
of Fund shares. However, in the case of in-kind purchases involving
transfers of large positions in markets where the cost of re-registration
and/or transfer expenses are high, the Fund may charge a premium of up to
0.20% on in-kind purchases.
2. Shareholder Service Fee ("SSF") paid to GMO for providing client services
and reporting services.
The level of SSF is the sole economic distinction between the various
classes of Fund shares. A lower SSF for larger investments reflects that
the cost of servicing client accounts is lower for larger accounts when
expressed as a percentage of the account. See "Multiple Classes -
Shareholder Service Fees" for more information.
3. The Manager has voluntarily undertaken to reduce its management fees and to
bear certain expenses with respect to the Fund until further notice to the
extent that the Fund's total annual operating expenses (excluding
Shareholder Service Fees, brokerage commissions and other
investment-related costs, hedging transaction fees, extraordinary,
non-recurring and certain other unusual expenses (including taxes),
securities lending fees and expenses, transfer taxes and custodial fees)
would otherwise exceed the percentage of the Fund's daily net assets
specified below. Therefore, so long as the Manager agrees to reduce its
fees and bear
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certain expenses, total annual operating expenses (subject to such
exclusions) of the Fund will not exceed these stated limitations. Absent
such undertakings, management fees for each Fund and the annual operating
expenses for each class would be as shown below.
<TABLE>
<CAPTION>
MANAGEMENT
VOLUNTARY FEE
FUND EXPENSE (ABSENT TOTAL CLASS
LIMIT WAIVER) OPERATING EXPENSES (ABSENT WAIVER)
Class I Class II Class III Class IV
<S> <C> <C> <C> <C> <C> <C>
Asia Fund .81% 1.00% 1.59% 1.53% 1.46% 1.415%
</TABLE>
4. Based on estimated amounts for the Fund's first fiscal year.
5. The stated purchase premium and/or redemption fee for the Fund will always
be charged in full except that the relevant purchase premium or redemption
fee will be reduced by 50% with respect to any portion of a purchase or
redemption that is offset by a corresponding redemption or purchase,
respectively, occurring on the same day. The Manager examines each purchase
and redemption of shares eligible for such treatment to determine if
circumstances warrant waiving a portion of the purchase premium or
redemption fee. Absent a clear determination that transaction costs will be
reduced or absent for the purchase or redemption, the full premium or fee
will be charged.
3
<PAGE> 6
FINANCIAL HIGHLIGHTS
(For a Share outstanding throughout each period)
<TABLE>
<CAPTION>
ASIA FUND Class III Shares
SIX MONTHS ENDED PERIOD FROM FEBRUARY 18,
AUGUST 31, 1998 1998 (COMMENCEMENT OF
(UNAUDITED) OPERATIONS) TO
FEBRUARY 28, 1998
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 10.44 $ 10.00
---------- ----------
Income (loss) from investment operations:
Net investment income 0.05(b) 0.01(b)
Net realized and unrealized gain (loss) (5.17) 0.43
---------- ----------
Total from investment operations (5.12) 0.44
---------- ----------
Less distributions to shareholders:
From net investment income (0.01) --
---------- ----------
NET ASSET VALUE, END OF PERIOD $ 5.31 $ 10.44
========== ==========
TOTAL RETURN (A) (49.00%) 4.40%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000's) $ 52,919 $ 40,161
Net expenses to average daily net assets 1.29%* 2.52%*
Net investment income to average daily net assets 1.25%* 2.86%*
Portfolio turnover rate 16% 1%
Fees and expenses voluntarily waived or borne by the
Manager consisted of the following per share
amount: $ 0.01 $ 0.01
</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.
Except as otherwise noted, the above information has been audited by
PricewaterhouseCoopers LLP, independent accountants. This statement should be
read in conjunction with the other audited financial statements and related
notes which are included in the Fund's Annual Report, and with the other
unaudited financial statements and related notes which are included in the
Fund's Semi-Annual Report, each of which is incorporated by reference in the
Trust's Statement of Additional Information. Information is presented for each
class of shares of the Fund which had investment operations during the reporting
periods and is currently being offered.
Copies of the Fund's Annual Report and Semi-Annual Report for the six month
period ended August 31, 1998 are available upon request without charge.
4
<PAGE> 7
INVESTMENT OBJECTIVE AND POLICIES
The Asia Fund seeks long-term capital appreciation through investment in
and exposure to equity and equity-related securities of issuers in countries in
Asia. The Fund was established to take advantage of increased market volatility
and declines in foreign currency rates in the Asian region that began in the
latter half of 1997. Consequently, the Fund's investment program involves
substantial risks associated with the instability in this region, and is
designed for investors who are willing to accept such risks. Prospective
investors should carefully read this Prospectus, particularly "Description and
Risks of Fund Investments -- Certain Risks of Foreign Investments -- Investments
in Asia" below.
The Manager has appointed Dancing Elephant, Ltd. to serve as Consultant to
the Fund. The Consultant's efforts focus on asset allocation and stock selection
among the selected Asian markets. (See "Description and Risks of Fund
Investments -- Certain Risks of Foreign Investments.") In addition to
considerations relating to a particular market's investment restrictions and tax
barriers, asset allocation and stock selection are based on certain other
relevant factors including the outlook for economic growth, currency exchange
rates, commodity prices, interest rates, political factors and the stage of the
local market cycle in such Asian market. The Consultant expects to allocate the
Fund's investments over geographic as well as economic sectors.
Asian markets in which the Fund intends to invest may include the following
markets:
Bangladesh, China, Hong Kong, India, Indonesia, Republic of Korea,
Malaysia, Mauritius, Myanmar, Mongolia, Pakistan, Philippines,
Singapore, Sri Lanka, Republic of China (Taiwan), Thailand, Vietnam
The Asia Fund has a fundamental policy that, under normal conditions, at
least 65% of its total assets will be invested in or exposed to equity and
equity-related securities of issuers that are organized under the laws of an
Asian country, that have their principal office in an Asian country, or whose
securities are predominantly traded on Asian market exchanges ("Asian
Securities"). The Fund invests in individual stocks listed on Asian stock
exchanges or in depository receipts of such stocks listed on markets in
industrialized countries or traded in the international equity market. The Fund
may also invest in shares of companies which are not presently listed but are in
the process of being privatized by the government and, subject to a maximum
aggregate investment equal to 25% of the total assets of the Fund, shares of
companies that are traded in unregulated over-the-counter markets or other types
of unlisted securities markets. The Fund may also invest through investment
funds, pooled accounts or other investment vehicles designed to permit
investments in a portfolio of stocks listed in a particular Asian country,
subject to obtaining any necessary local regulatory approvals, particularly in
the case of countries in which such an investment vehicle is the exclusive or
main vehicle for foreign portfolio investment. Such investments may result in
additional costs, as the Fund may be required to bear a pro rata share of the
expenses of each such fund in which it invests. The Fund may also invest in
companies listed on major markets outside of the Asian markets that, based on
information obtained by the Consultant, derive at least half of their revenues
from trade with or production in Asian countries. Such investments will not be
deemed to count towards the Fund's fundamental policy of investing at least 65%
of its total assets in equity and equity-related securities predominantly traded
on Asian market exchanges. In addition, the Fund's assets may be invested on a
temporary basis in debt securities issued by companies or governments in Asian
countries or money market securities of high-grade issuers in industrialized
countries denominated in various currencies.
The Fund may also invest in bonds and money market instruments in Canada,
the United States and other markets of industrialized nations, as well as all
Asian securities markets, and, for temporary defensive purposes, may invest
without limit in cash and high quality money market instruments such as
securities issued by the U.S. government and agencies thereof, bankers'
acceptances, commercial paper, and bank certificates of deposit. The Fund
expects that, not including the margin deposits or the segregated accounts
created in connection with index futures and other derivatives, less than 5% of
its total assets will be exposed to such high quality cash items. The Fund may
also invest in indexed securities, the redemption value and/or coupons of which
are indexed to the prices of other securities, securities indexes, currencies,
precious metal, or other commodities, as well as other technical indicators.
The Fund may also invest up to 10% of its total assets through debt-equity
conversion funds established to exchange foreign bank debt of countries whose
principal repayments are in arrears into a portfolio of listed and
5
<PAGE> 8
unlisted equities, subject to certain repatriation restrictions. The Fund may
also invest in convertible securities, enter into repurchase agreements and lend
portfolio securities valued at up to one-third of total assets. The Fund may
invest up to 15% of its net assets in illiquid securities.
The Fund may also buy put and call options, sell (write) covered options
and enter into futures contracts and options on futures contracts for hedging
and risk management. The Fund's use of options on particular securities (as
opposed to market indexes) is limited such that the time premiums paid by the
Fund on all outstanding options it has purchased may not exceed 5% of its total
assets. The Fund may also write options in connection with buy-and-write
transactions, and use index futures (on foreign stock indexes), options on
futures, equity swap contracts and contracts for differences for investment,
anticipatory hedging and risk management and to effect synthetic sales and
purchases.
The Fund may use forward foreign currency contracts, currency futures
contracts, currency swap contracts, options on currencies and buy and sell
foreign currencies for hedging, investment, and for currency risk management.
The put and call options on currency futures written by the Fund will always be
covered.
For a detailed description of the investment practices described in the
preceding paragraphs and the risks associated with them, see "Description and
Risks of Fund Investments."
DESCRIPTION AND RISKS OF FUND
INVESTMENTS
The following is a detailed description of the various investment practices
in which the Fund may engage and the risks associated with their use. Please
refer to "Investment Objectives and Policies" above for additional information
regarding the extent to which the Fund may engage in a particular practice.
PORTFOLIO TURNOVER
Portfolio turnover is not a limiting factor with respect to investment
decisions for the Fund. The portfolio turnover rate for the Asia Fund is not
expected to exceed 150%.
In any particular year, market conditions may well result in greater rates
than are presently anticipated. High portfolio turnover involves correspondingly
greater brokerage commissions and other transaction costs, which will be borne
directly by the Fund, and may well involve realization of capital gains that
would be taxable when distributed to shareholders of the Fund unless such
shareholders are themselves tax exempt. See "Taxes" below.
NON-DIVERSIFIED PORTFOLIOS
The Fund 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. As
a non-diversified fund, the Fund 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 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 the
Fund's ability to invest in securities of certain issuers located in these
foreign countries. There are also special tax considerations which apply to
securities of foreign issuers and securities principally
6
<PAGE> 9
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 the Fund's 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 the
Fund's income from such securities. Finally, because publicly traded debt
instruments of emerging markets represent a relatively recent innovation in the
world debt markets, there is little historical data or related market experience
concerning the attributes of such instruments under all economic, market and
political conditions.
In many cases, governments of emerging countries continue to exercise
significant control over their economies, and government actions relative to the
economy, as well as economic developments generally, may affect the capacity of
issuers of emerging country debt instruments to make payments on their debt
obligations, regardless of their financial condition. In addition, there is a
heightened possibility of expropriation or confiscatory taxation, imposition of
withholding taxes on interest payments, or other similar developments that could
affect investments in those countries. There can be no assurance that adverse
political changes will not cause the Fund to suffer a loss of any or all of its
investments or, in the case of fixed-income securities, interest thereon.
Regional financial pressures may cause some countries to place restrictions on
the ability of the Fund to transfer title to the securities of their domestic
corporations. For example, in October of 1998, Malaysia placed significant
time-based restrictions on the ability of foreign investors to transfer title to
the securities of Malaysian corporations and on the repatriation of income
resulting from such transfers.
INVESTMENTS IN ASIA. In addition to the foregoing risks of foreign
investments and risks specific to emerging markets, the Fund's investments in
Asia involve additional risks specific to investment in the region. The Fund'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 market 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.
The Fund 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 than is typical of other emerging markets, and
less financial information is available. Restrictions on direct foreign
investments in securities markets also exist in some countries. For example,
Taiwan permits foreign investment only through authorized qualified foreign
institutional investors. The recent return of Hong Kong to China and the recent
actions of the Malaysian government (see "Certain Risks of Foreign
Investments--Emerging Markets" above) will continue to affect the region.
Some countries in the region are heavily dependent upon foreign trade. The
economies of some Asian countries are not diversified and are based upon only a
few commodities or industries. Markets in some of these countries are in the
early stages of development, exhibit a high concentration of market
capitalization, have less trading volume, lower liquidity and more volatility
than more developed markets.
7
<PAGE> 10
In the latter half of 1997, the region began experiencing increased market
volatility and marked declines in foreign currency exchange rates. Fluctuation
in currency exchange rates can affect a country's ability to service its debt.
Currency fluctuation will affect the value of the securities in the Fund's
portfolio because the prices of these securities are generally denominated or
quoted in currencies other than the U.S. dollar.
SECURITIES LENDING
The Fund may make secured loans of portfolio securities amounting to not
more than one-third of the Fund'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 the lending Fund an amount equal to any
dividends or interest the Fund would have received had the securities not been
lent. If the loan is collateralized by U.S. Government Securities, the Fund will
receive a fee from the borrower. In the case of loans collateralized by cash,
the Fund typically invests the cash collateral for its own account in
interest-bearing, short-term securities and pays a fee to the borrower. Although
voting rights or rights to consent with respect to the loaned securities pass to
the borrower, the Fund retains the right to call the loans at any time on
reasonable notice, and it will do so in order that the securities may be voted
by the Fund if the holders of such securities are asked to vote upon or consent
to matters materially affecting the investment. The Fund may also call such
loans in order to sell the securities involved. The Manager has retained lending
agents on behalf of the Fund that are compensated based on a percentage of the
Fund's return on the securities lending activity. The Fund also pays various
fees in connection with such loans including shipping fees and reasonable
custodian fees approved by the Trustees of the Trust or persons acting pursuant
to direction of the Board.
DEPOSITORY RECEIPTS
The Fund 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 the Fund's investment objective. Depository
Receipts generally evidence an ownership interest in a corresponding foreign
security on deposit with a financial institution. Transactions in Depository
Receipts usually do not settle in the same currency in which the underlying
securities are denominated or traded. Generally, ADRs, in registered form, are
designed for use in the U.S. securities markets and EDRs, in bearer form, are
designed for use in European securities markets. GDRs may be traded in any
public or private securities markets and may represent securities held by
institutions located anywhere in the world.
CONVERTIBLE SECURITIES
A convertible security is a fixed-income security (a bond or preferred
stock) which may be converted at a stated price within a specified period of
time into a certain quantity of the common stock of the same or a different
issuer. Convertible securities are senior to common stock in a corporation's
capital structure, but are usually subordinated to similar non-convertible
securities. Convertible securities provide, through their conversion feature, an
opportunity to participate in capital appreciation resulting from a market price
advance in a convertible security's underlying common stock. The price of a
convertible security is influenced by the market value of the underlying common
stock and tends to increase as the market value of the underlying stock rises,
whereas it tends to decrease as the market value of the underlying stock
declines. The Manager regards convertible securities as a form of equity
security.
FUTURES AND OPTIONS
As described under "Investment Objectives and Policies" above, the Fund 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. The Fund 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.
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<PAGE> 11
The use of futures contracts and options on futures contracts involves
risk. Thus, while the Fund may benefit from the use of futures and options on
futures, unanticipated changes in interest rates, securities prices, or currency
exchange rates may result in poorer overall performance for the Fund than if it
had not entered into any futures contracts or options transactions. Losses
incurred in transactions in futures and options on futures and the costs of
these transactions will affect the Fund's performance. See Appendix A, "Risks
and Limitations of Options, Futures and Swaps" for a more detailed discussion of
the limits, conditions and risks of the Fund's investments in futures contracts
and related options.
OPTIONS. As has been noted above, the Fund may use options and (1) may
enter into contracts giving third parties the right to buy the Fund's portfolio
securities for a fixed price at a future date (writing "covered call options");
(2) may enter into contracts giving third parties the right to sell securities
to the Fund for a fixed price at a future date (writing "covered put options");
and (3) may buy the right to purchase securities from third parties ("call
options") or the right to sell securities to third parties ("put options") for a
fixed price at a future date.
WRITING COVERED OPTIONS. The Fund may seek to increase its return by
writing covered call or put options on optionable securities or indexes. A call
option written by the Fund on a security gives the holder the right to buy the
underlying security from the Fund at a stated exercise price; a put option gives
the holder the right to sell the underlying security to the Fund at a stated
exercise price. In the case of options on indexes, the options are usually cash
settled based on the difference between the strike price and the value of the
index.
The Fund will receive a premium for writing a put or call option, which
increases the Fund's return in the event the option expires unexercised or is
closed out at a profit. The amount of the premium will reflect, among other
things, the relationship of the market price and volatility of the underlying
security or securities index to the exercise price of the option, the remaining
term of the option, supply and demand and interest rates. By writing a call
option on a security, the Fund limits its opportunity to profit from any
increase in the market value of the underlying security above the exercise price
of the option. By writing a put option on a security, the Fund assumes the risk
that it may be required to purchase the underlying security for an exercise
price higher than its then current market value, resulting in a potential
capital loss unless the security subsequently appreciates in value. In the case
of options on an index, if the Fund writes a call, any profit by the Fund in
respect of portfolio securities expected to correlate with the index will be
limited by an increase in the index above the exercise price of the option. If
the Fund writes a put on an index, the Fund may be required to make a cash
settlement greater than the premium received if the index declines.
A call option on a security is "covered" if the Fund owns the underlying
security or has an absolute and immediate right to acquire that security without
additional cash consideration (or for additional cash consideration held in a
segregated account by its custodian) upon conversion or exchange of other
securities held in its portfolio. A call option is also covered if the Fund
holds on a share-for-share basis a call on the same security as the call written
where the exercise price of the call held is equal to or less than the exercise
price of the call written or greater than the exercise price of the call written
if the difference is maintained by the Fund in cash, U.S. Government Securities
or other high grade debt obligations in a segregated account with its custodian.
A put option is "covered" if the Fund maintains cash, U.S. Government Securities
or other high grade debt obligations with a value equal to the exercise price in
a segregated account with its custodian, or else holds on a share-for-share
basis a put on the same security as the put written where the exercise price of
the put held is equal to or greater than the exercise price of the put written.
If the writer of an option wishes to terminate 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 the Fund will be able to effect a closing purchase or a
closing sale transaction at any particular time. Also, an over-the-counter
option may be closed out only with the other party to the option transaction.
Effecting a closing transaction in the case of a written call option will
permit the Fund to write another call option on the underlying security with
either a different exercise price or expiration date or both, or in the case of
a written put option will permit the Fund to write another put option to the
extent that the exercise price thereof is secured by deposited cash or high
grade debt obligations. Also, effecting a closing transaction will
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permit the cash or proceeds from the concurrent sale of any securities subject
to the option to be used for other investments. If the Fund desires to sell a
particular security from its portfolio on which it has written a call option, it
will effect a closing transaction prior to or concurrent with the sale of the
security.
The Fund will realize a profit from a closing transaction if the price of
the transaction is less than the premium received from writing the option or is
more than the premium paid to purchase the option; the Fund will realize a loss
from a closing transaction if the price of the transaction is more than the
premium received from writing the option or is less than the premium paid to
purchase the option. Because increases in the market price of a call option will
generally reflect increases in the market price of the underlying security or
index of securities, any loss resulting from the repurchase of a call option is
likely to be offset in whole or in part by appreciation of the underlying
security or securities owned by the Fund.
The Fund may write options in connection with buy-and-write transactions;
that is, the Fund may purchase a security and then write a call option against
that security. The exercise price of the call the Fund determines to write will
depend upon the expected price movement of the underlying security. The exercise
price of a call option may be below ("in-the-money"), equal to ("at-the-money")
or above ("out-of-the-money") the current value of the underlying security at
the time the option is written. Buy-and-write transactions using in-the-money
call options may be used when it is expected that the price of the underlying
security will remain flat or decline moderately during the option period.
Buy-and-write transactions using at-the-money call options may be used when it
is expected that the price of the underlying security will remain fixed or
advance moderately during the option period. Buy-and-write transactions using
out-of-the-money call options may be used when it is expected that the premiums
received from writing the call option plus the appreciation in the market price
of the underlying security up to the exercise price will be greater than the
appreciation in the price of the underlying security alone. If the call options
are exercised in such transactions, the Fund's maximum gain will be the premium
received by it for writing the option, adjusted upward or downward by the
difference between the Fund's purchase price of the security and the exercise
price. If the options are not exercised and the price of the underlying security
declines, the amount of such decline will be offset in part, or entirely, by the
premium received.
The writing of covered put options is similar in terms of risk/return
characteristics to buy-and-write transactions. If the market price of the
underlying security rises or otherwise is above the exercise price, the put
option will expire worthless and the Fund's gain will be limited to the premium
received. If the market price of the underlying security declines or otherwise
is below the exercise price, the Fund may elect to close the position or take
delivery of the security at the exercise price. In that event, the Fund's return
will be the premium received from the put option minus the cost of closing the
position or, if it chooses to take delivery of the security, the premium
received from the put option minus the amount by which the market price of the
security is below the exercise price. Out-of-the-money, at-the-money and
in-the-money put options may be used by the Fund in market environments
analogous to those in which call options are used in buy-and-write transactions.
The extent to which the Fund will be able to write and purchase call and
put options may be restricted by the Fund's intention to qualify as a regulated
investment company under the Internal Revenue Code.
FUTURES. A financial futures contract sale creates an obligation by the
seller to deliver the type of financial instrument called for in the contract in
a specified delivery month for a stated price. A financial futures contract
purchase creates an obligation by the purchaser to pay for and take delivery of
the type of financial instrument called for in the contract in a specified
delivery month, at a stated price. In some cases, the specific instruments
delivered or taken, respectively, at settlement date are not determined until on
or near that date. The determination is made in accordance with the rules of the
exchange on which the futures contract sale or purchase was made. Some futures
contracts are "cash settled" (rather than "physically settled," as described
above) which means that the purchase price is subtracted from the current market
value of the instrument and the net amount if positive is paid to the purchaser,
and if negative is paid by the purchaser. Futures contracts are traded in the
United States only on commodity exchanges or boards of trade -- known as
"contract markets" --approved for such trading by the Commodity Futures Trading
Commission ("CFTC"), and must be executed through a futures commission merchant
or brokerage firm which is a member of the relevant contract market. Under U.S.
law, futures contracts on individual equity securities are not permitted. See
Appendix A, "Risks and Limitations of Options, Futures and Swaps" for more
information concerning these practices and their accompanying risks.
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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. The Fund may purchase futures contracts on various
securities indexes ("Index Futures"). The Fund's purchase and sale of Index
Futures is limited to contracts and exchanges which have been approved by the
CFTC.
An Index Future may call for "physical delivery" or be "cash settled." An
Index Future that calls for physical delivery is a contract to buy an integral
number of units of the particular securities index at a specified future date at
a price agreed upon when the contract is made. A unit is the value from time to
time of the relevant index. While the Fund that purchases an Index Future that
calls for physical delivery is obligated to pay the face amount on the stated
date, such an Index Future may be closed out on that date or any earlier date by
selling an Index Future with the same face amount and contract date. This will
terminate the Fund's position and the Fund will realize a profit or a loss based
on the difference between the cost of purchasing the original Index Future and
the price obtained from selling the closing Index Future. The amount of the
profit or loss is determined by the change in the value of the relevant index
while the Index Future was held.
Index Futures that are "cash settled" provide by their terms for settlement
on a net basis reflecting changes in the value of the underlying index. Thus,
the purchaser of such an Index Future is never obligated to pay the face amount
of the contract. The net payment obligation may in fact be very small in
relation to the face amount.
The Fund 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 the Fund 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 S&P 500 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
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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 the Fund's investment in futures contracts.
INTEREST RATE FUTURES. For the purposes previously described, the Fund may
engage in a variety of transactions involving the use of futures with respect to
U.S. Government Securities and other fixed income securities. The use of
interest rate futures involves risk. See Appendix A, "Risks and Limitations of
Options, Futures and Swaps" for a more detailed discussion of the limits,
conditions and risks of the Fund's investment in futures contracts.
OPTIONS ON FUTURES CONTRACTS. Options on futures contracts give the
purchaser the right in return for the premium paid to assume a position in a
futures contract at the specified option exercise price at any time during the
period of the option. The Fund 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, the Fund may
purchase put options or write call options on futures contracts rather than
selling futures contracts. Similarly, the Fund may purchase call options or
write put options on futures contracts as a substitute for the purchase of
futures contracts to hedge against a possible increase in the price of
securities which the Fund expects to purchase. Such options generally operate in
the same manner as options purchased or written directly on the underlying
investments. See "Description and Risks of Fund Investment Practices -- Foreign
Currency Transactions" for a description of the Fund's use of options on
currency futures contracts.
USES OF OPTIONS, FUTURES AND OPTIONS ON FUTURES
RISK MANAGEMENT. When futures and options on futures are used for risk
management, the Fund will generally take long positions (e.g., purchase call
options, futures contracts or options thereon) in order to increase the Fund's
exposure to a particular market, market segment or foreign currency. In the case
of futures and options on futures, the Fund is only required to deposit the
initial and variation margin as required by relevant CFTC regulations and the
rules of the contract markets. Because the Fund will then be obligated to
purchase the security or index at a set price on a future date, the Fund's net
asset value will fluctuate with the value of the security as if it were already
included in the Fund's portfolio. Risk management transactions have the effect
of providing a degree of investment leverage, particularly when the Fund does
not segregate assets equal to the face amount of the contract (i.e., in cash
settled futures contracts) since the futures contract (and related options) will
increase or decrease in value at a rate which is a multiple of the rate of
increase or decrease in the value of the initial and variable margin that the
Fund is required to deposit. As a result, the value of the Fund's portfolio will
generally be more volatile than the value of comparable portfolios which do not
engage in risk management transactions. The Fund will not, however, use futures
and options on futures to obtain greater volatility than it could obtain through
direct investment in securities; that is, the Fund will not normally engage in
risk management to increase the average volatility (beta) of that Fund's
portfolio above 1.00, the level of risk (as measured by volatility) that would
be present if the Fund were fully invested in the securities comprising the
relevant index. However, the Fund may invest in futures and options on futures
without regard to this limitation if the face value of such investments, when
aggregated with the Index Futures equity swaps and contracts for differences as
described below does not exceed 10% of the Fund's assets.
HEDGING. To the extent indicated elsewhere, the Fund may also enter into
options, futures contracts and buy and sell options thereon for hedging. For
example, if the Fund wants to hedge certain of its fixed income securities
against a decline in value resulting from a general increase in market rates of
interest, it might sell futures contracts with respect to fixed income
securities or 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 the Fund's fixed income security, the value of the futures contract should
increase. The Fund 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 the Fund intends to purchase (or whose
value is expected to correlate closely with the security or currency to be
purchased) pending receipt of cash from other transactions (including the
proceeds from this offering) to be used for the actual purchase. Then if the
cost of the security or foreign currency to be purchased by the Fund increases
and if the anticipatory hedge is effective, that increased cost should be
offset, at least in part, by the value of the futures contract. Options on
futures contracts may be used for hedging as well.
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For example, if the value of a fixed-income security in the Fund's portfolio is
expected to decline as a result of an increase in rates, the Fund might purchase
put options or write call options on futures contracts rather than selling
futures contracts. Similarly, for anticipatory hedging, the Fund may purchase
call options or write put options as a substitute for the purchase of futures
contracts. See "Description and Risks of Fund Investment Practices --Foreign
Currency Transactions" for more information regarding the currency hedging
practices of the Fund.
INVESTMENT PURPOSES. To the extent indicated elsewhere, the Fund may also
enter into futures contracts and buy and sell options thereon for investment.
For example, the Fund may invest in futures when its Manager believes that there
are not enough attractive securities available to maintain the standards of
diversity and liquidity set for the Fund pending investment in such securities
if or when they do become available. Through this use of futures and related
options, the Fund may diversify risk in its portfolio without incurring the
substantial brokerage costs which may be associated with investment in the
securities of multiple issuers. This use may also permit the Fund to avoid
potential market and liquidity problems (e.g., driving up the price of a
security by purchasing additional shares of a portfolio security or owning so
much of a particular issuer's stock that the sale of such stock depresses that
stock's price) which may result from increases in positions already held by the
Fund.
When the Fund purchases futures contracts for investment, it will maintain
cash, U.S. Government Securities or other high grade debt obligations in a
segregated account with its custodian in an amount which, together with the
initial and variation margin deposited on the futures contracts, is equal to the
face value of the futures contracts at all times while the futures contracts are
held.
Incidental to other transactions in fixed income securities, for investment
purposes the Fund may also combine futures contracts or options on fixed income
securities with cash, cash equivalent investments or other fixed income
securities in order to create "synthetic" bonds which approximate desired risk
and return profiles. This may be done where a "non-synthetic" security having
the desired risk/return profile either is unavailable (e.g., short-term
securities of certain foreign governments) or possesses undesirable
characteristics (e.g., interest payments on the security would be subject to
foreign withholding taxes). The Fund may also purchase forward foreign exchange
contracts in conjunction with U.S. dollar-denominated securities in order to
create a synthetic foreign currency denominated security which approximates
desired risk and return characteristics where the non-synthetic securities
either are not available in foreign markets or possess undesirable
characteristics. For greater detail, see "Foreign Currency Transactions" below.
When the Fund creates a "synthetic" bond with a futures contract, it will
maintain cash, U.S. Government securities or other high grade debt obligations
in a segregated account with its custodian with a value at least equal to the
face amount of the futures contract (less the amount of any initial or variation
margin on deposit).
SYNTHETIC SALES AND PURCHASES. Futures contracts may also be used to reduce
transaction costs associated with short-term restructuring of the Fund's
portfolio. For example, if the Fund's portfolio includes stocks of companies
with medium-sized equity capitalization (e.g., between $300 million and $5.2
billion) and, in the opinion of the Manager, such stocks are likely to
underperform larger capitalization stocks, the Fund might sell some or all of
its mid-capitalization stocks, buy large capitalization stocks with the proceeds
and then, when the expected trend had played out, sell the large capitalization
stocks and repurchase the mid-capitalization stocks with the proceeds. In the
alternative, the Fund may use futures to achieve a similar result with reduced
transaction costs. In that case, the Fund might simultaneously enter into short
futures positions on an appropriate index (e.g., the S&P Mid Cap 400 Index) (to
synthetically "sell" the stocks in the Fund) and long futures positions on
another index (e.g., the S&P 500) (to synthetically buy the larger
capitalization stocks). When the expected trend has played out, the Fund would
then close out both futures contract positions. The Fund will only enter into
these combined positions if (1) the short position (adjusted for historic
volatility) operates as a hedge of existing portfolio holdings, (2) the face
amount of the long futures position is less than or equal to the value of the
portfolio securities that the Fund would like to dispose of, (3) the contract
settlement date for the short futures position is approximately the same as that
for the long futures position and (4) the Fund segregates an amount of cash,
U.S. Government Securities and other high-quality debt obligations whose value,
marked-to-market daily, is equal to the Fund's current obligations in respect of
the long futures contract positions. If the Fund uses such combined short and
long positions, in addition to possible declines in the values of its investment
securities, the Fund may also suffer losses associated with a securities index
underlying the long futures position underperforming the securities index
underlying the short futures position. However, the Manager will enter into
these combined positions only if the Manager expects that, overall, the Fund
will perform as if it had sold the securities hedged by the short position and
purchased the securities underlying the long position. The Fund may also use
swaps and options on futures to achieve the same objective. For more
information, see Appendix A, "Risks and Limitations of Options, Futures and
Swaps."
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SWAP CONTRACTS AND OTHER TWO-PARTY CONTRACTS
As has been described in the "Investment Objectives and Policies" section
above, the Fund may use swap contracts and other two-party contracts for the
same or similar purposes as they may use options, futures and related options.
The use of swap contracts and other two-party contracts involves risk. See
Appendix A, "Risks and Limitations of Options, Futures and Swaps" for a more
detailed discussion of the limits, conditions and risks of the Fund'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 generally 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. The Fund will usually enter into swaps on a net basis, i.e., the two
returns are netted out, with the Fund receiving or paying, as the case may be,
only the net amount of the two returns.
INTEREST RATE AND CURRENCY SWAP CONTRACTS. Interest rate swaps involve the
exchange of the two parties' respective commitments to pay or receive interest
on a notional principal amount (e.g., an exchange of floating rate payments for
fixed rate payments). Currency swaps involve the exchange of the two parties'
respective commitments to pay or receive fluctuations with respect to a notional
amount of two different currencies (e.g., an exchange of payments with respect
to fluctuations in the value of the U.S. dollar relative to the Japanese yen).
EQUITY SWAP CONTRACTS AND CONTRACTS FOR DIFFERENCES. Equity swap contracts
involve the exchange of one party's obligation to pay the loss, if any, with
respect to a notional amount of a particular equity index (e.g., the S&P 500
Index) plus interest on such notional amount at a designated rate (e.g., the
London Inter-Bank Offered Rate) in exchange for the other party's obligation to
pay the gain, if any, with respect to the notional amount of such index.
If the Fund enters into a long equity swap contract, the Fund's net asset
value will fluctuate as a result of changes in the value of the equity index on
which the equity swap is based as if it had purchased the notional amount of
securities comprising the index. The Fund will not use long equity swap
contracts to obtain greater volatility than it could obtain through direct
investment in securities; that is, the Fund will not normally enter an equity
swap contract to increase the volatility (beta) of the Fund's portfolio above
1.00, the volatility that would be present in the stocks comprising the Fund's
benchmark index. However, the Fund may invest in long equity swap contracts
without regard to this limitation if the notional amount of such equity swap
contracts, when aggregated with the Index Futures as described above and the
contracts for differences as described below, does not exceed 10% of the Fund's
net assets.
Contracts for differences are swap arrangements in which the Fund may agree
with a counterparty that its return (or loss) will be based on the relative
performance of two different groups or "baskets" of securities. As to one of the
baskets, the Fund's return is based on theoretical long futures positions in the
securities comprising that basket (with an aggregate face value equal to the
notional amount of the contract for differences) and as to the other basket, the
Fund's return is based on theoretical short futures positions in the securities
comprising the basket. The Fund may also use actual long and short futures
positions to achieve the same market exposure(s) as contracts for differences.
The Fund will only enter into contracts for differences where payment
obligations of the two legs of the contract are netted and thus based on changes
in the relative value of the baskets of securities rather than on the aggregate
change in the value of the two legs. The Fund will only enter into contracts for
differences (and analogous futures positions) when the Manager believes that the
basket of securities constituting the long leg will outperform the basket
constituting the short leg. However, it is possible that the short basket will
outperform the long basket - resulting in a loss to the Fund, even in
circumstances where the securities in both the long and short baskets appreciate
in value.
Except for instances in which the Fund elects to obtain leverage up to the
10% limitation mentioned above, the Fund will maintain cash, U.S. Government
Securities or other high grade debt obligations in a segregated account with its
custodian in an amount equal to the aggregate of net payment obligations on its
swap contracts and contracts for differences, marked to market daily.
The Fund may enter into swaps and contracts for differences for hedging,
investment and risk management. When using swaps for hedging, the Fund may enter
into an interest rate, currency or equity swap,
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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 the Fund 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. The Fund will not normally
enter into a contract for differences to increase the volatility (beta) of the
Fund's portfolio above 1.00. However, the Fund may invest in contracts for
differences without regard to this limitation if the aggregate amount by which
the theoretical long positions of such contracts exceed the theoretical short
positions of such contacts, when aggregated with the Index Futures and equity
swaps contracts as described above, does not exceed 10% of the Fund's net
assets.
INTEREST RATE CAPS, FLOORS AND COLLARS. The Fund 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, the Fund will maintain
cash, U.S. Government Securities or other high grade debt obligations in a
segregated account with its custodian in an amount at least equal to its
obligations, if any, under interest rate cap, floor and collar arrangements. As
with futures contracts, when the Fund uses notional amount contracts for risk
management it is only required to segregate assets equal to its net payment
obligation, not the notional amount of the contract. In those cases, the
notional amount contract will have the effect of providing a degree of
investment leverage similar to the leverage associated with non-segregated
futures contracts. The Fund'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 the Fund'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 and 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 the Fund'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 the Fund's assets are denominated may be
devalued against the U.S. dollar, resulting in a loss to the Fund.
The Fund 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. The Fund 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
the Fund and the Fund's 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
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<PAGE> 18
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.
The Fund may enter into forward contracts for hedging under three
circumstances. First, when the Fund enters into a contract for the purchase or
sale of a security denominated in a foreign currency, it may desire to "lock in"
the U.S. dollar price of the security. By entering into a forward contract for
the purchase or sale, for a fixed amount of dollars, of the amount of foreign
currency involved in the underlying security transaction, the Fund will be able
to protect itself against a possible loss resulting from an adverse change in
the relationship between the U.S. dollar and the subject foreign currency during
the period between the date on which the security is purchased or sold and the
date on which payment is made or received.
Second, when the Manager of the Fund believes that the currency of a
particular foreign country may suffer a substantial decline against the U.S.
dollar, it may enter into a forward contract to sell, for a fixed amount of
dollars, the amount of foreign currency approximating the value of some or all
of the Fund's portfolio securities denominated in such foreign currency.
Maintaining a match between the forward contract amounts and the value of the
securities involved will not generally be possible since the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures.
Third, the Fund may engage in currency "cross hedging" when, in the opinion
of the Manager, the historical relationship among foreign currencies suggests
that the Fund may achieve the same protection for a foreign security at reduced
cost through the use of a forward foreign currency contract relating to a
currency other than the U.S. dollar or the foreign currency in which the
security is denominated. By engaging in cross hedging transactions, the Fund
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."
The Fund is not required to enter into hedging transactions with regard to
its foreign currency-denominated securities and will not do so unless deemed
appropriate by the Manager. By entering into the above hedging transactions, the
Fund may be required to forego the benefits of advantageous changes in the
exchange rates.
The Fund may also enter foreign currency forward contracts for investment
and currency risk management. When the Fund uses currency instruments for such
purposes, the foreign currency exposure of the Fund may differ substantially
from the currencies in which the Fund's investment securities are denominated.
However, the Fund's aggregate foreign currency exposure will not normally exceed
100% of the value of the Fund's securities, except that the Fund may use
currency instruments without regard to this limitation if the amount of such
excess, when aggregated with futures contracts, equity swap contracts and
contracts for differences used in similar ways, does not exceed 10% of the
Fund's net assets.
Except to the extent that the Fund may use such contracts for risk
management, whenever the Fund enters into a foreign currency forward contract,
other than a forward contract entered into for hedging, it will maintain cash,
U.S. Government securities or other high grade debt obligations in a segregated
account with its custodian with a value, marked to market daily, equal to the
amount of the currency required to be delivered. The Fund's ability to engage in
forward contracts may be limited by tax considerations.
The Fund may use currency futures contracts and related options and options
on currencies for the same reasons for which they use currency forwards. Except
to the extent that the Fund may use futures contracts and related options for
risk management, the Fund will, so long as it is obligated as the writer of a
call option on currency futures, own on a contract-for-contract basis an equal
long position in currency futures with the same delivery date or a call option
on currency futures with the difference, if any, between the market value of the
call written and the market value of the call or long currency futures purchased
maintained by the Fund in cash, U.S. Government securities or other high grade
debt obligations in a segregated account with its custodian. If at the close of
business on any day the market value of the call purchased by the Fund falls
below 100% of the market value of the call written by the Fund, the Fund will
maintain an amount of cash, U.S. Government securities or other high grade debt
obligations in a segregated account with its custodian equal in value to the
difference. Alternatively, the Fund may cover the call option by owning
securities denominated in the currency with a value equal to the face amount of
the contract(s) or through segregating with the custodian an amount of the
particular
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<PAGE> 19
foreign currency equal to the amount of foreign currency per futures contract
option times the number of options written by the Fund.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with banks and broker-dealers
by which the Fund acquires a security (usually an obligation of the Government
where the transaction is initiated or in whose currency the agreement is
denominated) for a relatively short period (usually not more than a week) for
cash and obtains a simultaneous commitment from the seller to repurchase the
security at an agreed-on price and date. The resale price is in excess of the
acquisition price and reflects an agreed-upon market rate unrelated to the
coupon rate on the purchased security. Such transactions afford an opportunity
for the Fund to earn a return on temporarily available cash at no market risk,
although there is a risk that the seller may default in its obligation to pay
the agreed-upon sum on the redelivery date. Such a default may subject the Fund
to expenses, delays and risks of loss including: (a) possible declines in the
value of the underlying security during the period while the Fund seeks to
enforce its rights thereto, (b) possible reduced levels of income and lack of
access to income during this period and (c) inability to enforce rights and the
expenses involved in attempted enforcement.
DEBT AND OTHER FIXED INCOME SECURITIES GENERALLY
Debt and other fixed income securities include fixed income securities of
any maturity. 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 the Fund investing in such securities. The net asset value of the Fund's
shares will vary as a result of changes in the value of the securities in its
portfolio and will be affected by the absence and/or success of hedging
strategies.
TEMPORARY HIGH QUALITY CASH ITEMS
As described under "Investment Objectives and Policies" above, the Fund 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 the Fund
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 the Fund to enforce its rights against the foreign government
issuer.
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<PAGE> 20
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 the Fund which holds U.S. Government Securities or Foreign
Government Securities may fall during times of rising interest rates. Yields on
U.S. Government Securities and Foreign Government Securities tend to be lower
than those of corporate securities of comparable maturities.
In addition to investing directly in U.S. Government Securities and Foreign
Government Securities, the Fund may purchase certificates of accrual or similar
instruments evidencing undivided ownership interests in interest payments or
principal payments, or both, in U.S. Government Securities and Foreign
Government Securities. These certificates of accrual and similar instruments may
be more volatile than other government securities.
LOWER RATED SECURITIES
The Fund 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"). The
Fund will not necessarily dispose of a security when its rating is reduced below
its rating at the time of purchase, although the Manager will monitor the
investment to determine whether continued investment in the security will assist
in meeting the Fund's investment objective.
Lower Rated Securities generally provide higher yields, but are subject to
greater credit and market risk, than higher quality fixed income securities.
Lower Rated Securities are considered predominantly speculative with respect to
the ability of the issuer to meet principal and interest payments. Achievement
of the investment objective of the Fund investing in Lower Rated Securities may
be more dependent on the Manager's own credit analysis than is the case with
higher quality bonds. The market for Lower Rated Securities may be more severely
affected than some other financial markets by economic recession or substantial
interest rate increases, by changing public perceptions of this market or by
legislation that limits the ability of certain categories of financial
institutions to invest in these securities. In addition, the secondary market
may be less liquid for Lower Rated Securities. This reduced liquidity at certain
times may affect the values of these securities and may make the valuation and
sale of these securities more difficult. Securities of below investment grade
quality are commonly referred to as "junk bonds." Securities in the lowest
rating categories may be in poor standing or in default. Securities in the
lowest investment grade category (BBB or Baa) have some speculative
characteristics. See Appendix B for more information concerning commercial paper
and corporate debt ratings.
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
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<PAGE> 21
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 the Fund may invest include so-called "inverse
floating obligations" or "residual interest bonds" on which the interest rates
typically decline as short-term market interest rates increase and increase as
short-term market rates decline. Such securities have the effect of providing a
degree of investment leverage, since they will generally increase or decrease in
value in response to changes in market interest rates at a rate which is a
multiple of the rate at which fixed-rate long-term securities increase or
decrease in response to such changes. As a result, the market values of such
securities will generally be more volatile than the market values of fixed rate
securities.
The Fund'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 this Prospectus.
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. The Fund may enter into firm commitment agreements with such banks and
broker-dealers with respect to any of the instruments eligible for purchase by
the Fund. The Fund will only enter into firm commitment arrangements with banks
and broker-dealers which the Manager determines present minimal credit risks.
The Fund will maintain in a segregated account with its custodian cash, U.S.
Government Securities or other liquid high grade debt obligations in an amount
equal to the Fund's obligations under firm commitment agreements.
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLL AGREEMENTS
The Fund may enter into reverse repurchase agreements and dollar roll
agreements with banks and brokers to enhance return. Reverse repurchase
agreements involve sales by the Fund of portfolio assets concurrently with an
agreement by the Fund to repurchase the same assets at a later date at a fixed
price. During the reverse repurchase agreement period, the Fund continues to
receive principal and interest payments on these securities and also has the
opportunity to earn a return on the collateral furnished by the counterparty to
secure its obligation to redeliver the securities.
Dollar rolls are transactions in which the Fund sells securities for
delivery in the current month and simultaneously contracts to repurchase
substantially similar (same type and coupon) securities on a specified future
date. During the roll period, the Fund forgoes principal and interest paid on
the securities. The Fund is compensated by the difference between the current
sales price and the forward price for the future purchase (often referred to as
the "drop") as well as by the interest earned on the cash proceeds of the
initial sale.
If the Fund makes such investments, it will establish segregated accounts
with its custodian in which it 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 the Fund may decline below the price of the securities
the Fund has sold but is obligated to repurchase under the agreement. In the
event the buyer of securities under a reverse repurchase agreement or dollar
roll files for bankruptcy or becomes insolvent, the Fund's use of the proceeds
of the agreement may be restricted pending a determination by the other party or
its trustee or receiver whether to enforce the Fund's obligation to repurchase
the securities. Reverse repurchase agreements and dollar rolls are not
considered borrowings by the Fund for purposes of the Fund's fundamental
investment restriction with respect to borrowings.
ILLIQUID SECURITIES
The Fund may purchase "illiquid securities," i.e., securities which may not
be sold or disposed of in the ordinary course of business within seven days at
approximately the value at which the Fund has valued the investment, which
include securities whose disposition is restricted by securities laws, so long
as no more than 15% of net assets would be invested in such illiquid securities.
The Fund currently intends to invest in accordance with the SEC staff view that
repurchase agreements maturing in more than seven days are illiquid securities.
The SEC staff has stated informally that it is of the view that over-the-counter
options and securities serving as cover
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<PAGE> 22
for over-the-counter options are illiquid securities. While the Trust does not
agree with this view, it will operate in accordance with any relevant formal
guidelines adopted by the SEC.
In addition, the SEC staff considers equity swap contracts, caps, floors
and collars to be illiquid securities. Consequently, while the staff maintains
this position, the Fund will not enter into an equity swap contract or a reverse
equity swap contract or purchase a cap, floor or collar if, as a result of the
investment, the total value (i.e., marked-to-market value) of such investments
(without regard to their notional amount) together with that of all other
illiquid securities which the Fund owns would exceed 15% of the Fund's total
assets.
SPECIAL YEAR 2000 RISK CONSIDERATIONS
Many of the services provided to the Fund 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 service systems fail to
process information properly, that could have an adverse impact on the Fund's
operations and services provided to shareholders. GMO and Dancing Elephant,
Ltd., as well as the Fund'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.
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<PAGE> 23
(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.
(8) Purchase or sell commodities or commodity contracts, except that the
Fund may purchase and sell financial futures contracts and options thereon.
(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 variation margin permitted by non-fundamental policy (5)
below; and the purchase or sale of options, forward contracts, futures contracts
or options on futures contracts.
Non-Fundamental Restrictions:
It is contrary to the present policy of the Fund, which may be changed by
the Trustees without shareholder approval, to:
(1) Invest in warrants or rights excluding options (other than warrants or
rights acquired by the Fund as a part of a unit or attached to securities at the
time of purchase), except that the Fund may invest in such warrants or rights so
long as the aggregate value thereof (taken at the lower of cost or market) does
not exceed 5% of the value of the fund's total net assets; provided that within
this 5%, not more than 2% of its net assets may be invested in warrants that are
not listed on the New York or American Stock Exchange or a recognized foreign
exchange.
(2) Buy or sell oil, gas or other mineral leases, rights or royalty
contracts.
(3) Make investments for the purpose of gaining control of a company's
management.
(4) Invest more than 15% of net assets in illiquid securities. The
securities currently thought to be included as "illiquid securities" are
restricted securities under the Federal securities laws (including illiquid
securities traded under Rule 144A), repurchase agreements and securities that
are not readily marketable. To the extent the Trustees determine that restricted
securities traded under Section 4(2) or Rule 144A under the Securities Act of
1933 are in fact liquid, they will not be included in the 15% limit on
investment in illiquid securities.
(5) Pledge, hypothecate, mortgage or otherwise encumber its assets in
excess of 33 1/3% of the Fund's total assets (taken at cost). (For the purposes
of this restriction, collateral arrangements with respect to swap agreements,
the writing of options, stock index, interest rate, currency or other futures,
options on futures contracts and collateral arrangements with respect to initial
and variation margin are not deemed to be a pledge or other encumbrance of
assets. The deposit of securities or cash or cash equivalents in escrow in
connection with the writing of covered call or put options, respectively is not
deemed to be a pledge or encumbrance.)
Except as indicated above in Fundamental Restriction No. 1, all percentage
limitations on investments set forth herein and in the Prospectus will apply at
the time of the making of an investment and shall not be considered violated
unless an excess or deficiency occurs or exists immediately after and as a
result of such investment.
The phrase "shareholder approval," as used in the Prospectus, and the
phrase "vote of a majority of the outstanding voting securities," as used herein
with respect to the Fund, means the affirmative vote of the lesser of (1) more
than 50% of the outstanding shares of the Fund, or (2) 67% or more of the shares
of the Fund present at a meeting if more than 50% of the outstanding shares are
represented at the meeting in person or by proxy.
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<PAGE> 24
MULTIPLE CLASSES
The Asia Fund has four classes of shares, Class I, Class II, Class III and
Class IV Shares, but is currently offering only Class III Shares. See
"Eligibility for Classes" below.
SHAREHOLDER SERVICE FEES
The principal economic difference among the various classes of shares is
the level of Shareholder Service Fee which the classes bear for client and
shareholder service, reporting and other support. The existence of multiple
classes reflects the fact that, as the size of a client relationship increases,
the cost to service that client decreases as a percentage of the assets in that
account. Thus, the Shareholder Service Fee is lower for classes where
eligibility criteria require greater total assets under GMO's management.
The Trust has adopted a Shareholder Servicing Plan with respect to the
Fund's multiple classes of shares. Pursuant to the terms of the Shareholder
Servicing Plan, the Fund's classes will pay the following Shareholder Service
Fees, expressed as an annual percentage of the average daily net assets
attributable to that class of shares:
<TABLE>
<CAPTION>
Fund Class I Class II Class III Class IV
<S> <C> <C> <C> <C>
Asia Fund 0.28% 0.22% 0.15% .105%
</TABLE>
ELIGIBILITY FOR CLASSES
Class I, Class II, and Class III Shares: With certain exceptions described
below, eligibility for Class I, Class II and Class III Shares depends on a
client's "Total Investment" with GMO.
For clients establishing a relationship with GMO on or after June 1, 1996:
A client's Total Investment will be determined by GMO as of December 31 of each
year and on such other dates as may be determined by GMO (each a "Determination
Date"). Subject to as provided below, a client's Total Investment as of any
Determination Date will equal the greater of (a) the market value of assets
managed by GMO and its affiliates for the client (whether in a pooled vehicle or
otherwise) as of such Determination Date, and (b) the client's Total Investment
as of the previous Determination Date (less the market value of any account
managed by GMO's Domestic Active Division as of the previous Determination
Date), plus contributions made to, and less Large Withdrawals (defined below)
from, any GMO-managed product or account (other than any account managed by
GMO's Domestic Active Division) since the previous Determination Date (plus the
market value of any account managed by GMO's Domestic Active Division as of the
then current Determination Date). For these purposes, "Large Withdrawals" means
the total of all withdrawals made from any GMO-managed product or account (other
than any account managed by GMO's Domestic Active Division) since the previous
Determination Date if such total exceeds 7% of the sum of the client's Total
Investment as of the previous Determination Date and any contributions to any
GMO-managed product or account (other than any account managed by GMO's Domestic
Active Division) made since the previous Determination Date. For clients that
have accounts with GMO as of November 30, 1997, their initial Total Investment
is the greater of the market value of assets managed by GMO and its affiliates
for the client as of the close of business on November 30, 1997 or on December
31, 1997. For clients establishing a relationship with GMO on or after December
1, 1997, their Total Investment will be determined as described above.
Notwithstanding anything to the contrary in this Prospectus, assets invested in
the Pelican Fund will not be considered when determining a client's Total
Investment. For purposes of this Prospectus, accounts managed by GMO's Domestic
Active Division do not include any GMO Trust Funds (other than the Pelican
Fund), and include only certain separate accounts managed by GMO. Clients with
any questions regarding whether certain of their assets are deemed to be managed
by GMO's Domestic Active Division should call GMO at (617) 330-7500.
Subject to the exceptions set forth following this table, the minimum Total
Investment for a new client (establishing a GMO Account after June 1, 1996) to
be eligible for Class I, II or III Shares of the Fund is set forth in the
following table:
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<PAGE> 25
CLASS OF SHARES MINIMUM TOTAL INVESTMENT
Class I N/A*
Class II N/A*
Class III $1 Million
*not presently being offered by the Fund
Investments by defined contribution pension plans (such as 401(k) plans)
will be accepted only in the Class of Shares with the highest Shareholder
Service Fee then available, regardless of the size of the investment, and will
not be eligible to convert to other classes with lower Shareholder Service Fees.
For Clients with Accounts as of May 31, 1996: Any client of GMO whose Total
Investment as of May 31, 1996 was equal to or greater than $7 million will
remain eligible for Class III Shares indefinitely, provided that such client
does not make a withdrawal or redemption that causes the client's Total
Investment to fall below $7 million. Any client whose Total Investment as of May
31, 1996 was less than $7 million, but greater than $0, will convert to Class II
Shares on July 31, 1997 or such later date as may be determined by the Manager.
For clients with GMO accounts as of May 31, 1996, their initial Total Investment
will equal the market value of all of their GMO investments as of the close of
business on May 31, 1996 and will subsequently be calculated as described in the
preceding section.
Class IV Shares: Class IV Shares bear significantly lower Shareholder
Service Fees than other classes and are designed to accommodate clients making
very large investments in the Fund or that are making investments into the Fund
in conjunction with a very large commitment of assets to investment management
by GMO.
Eligibility for Class IV Shares is dependent upon the client meeting either
(i) a minimum "Total Fund Investment" requirement, which includes only a
client's total investment in the Asia Fund or (ii) a minimum "Total Investment"
requirement calculated as described above for Class I, Class II and Class III
Shares.
For clients that have accounts with GMO as of November 30, 1997, their
initial Total Investment or initial Total Fund Investment for purposes of
determining eligibility for Class IV Shares will be the greater of the market
value of all of their investments advised by GMO and its affiliates, or the
market value of their investment in the Fund, as the case may be, as of the
close of business on November 30, 1997 or December 31, 1997. For clients
establishing a relationship with GMO on or after December 1, 1997, their Total
Fund Investment and Total Investment will be determined as described above.
The minimum Total Fund Investment and/or Total Investment for a client to
be eligible for Class IV Shares is set forth in the following table:
<TABLE>
<CAPTION>
CLASS OF SHARES MINIMUM TOTAL FUND INVESTMENT MINIMUM TOTAL INVESTMENT
<S> <C> <C>
Class IV N/A* N/A*
</TABLE>
*not presently being offered by the Fund
There is no minimum for subsequent investments into any class of shares of
the Fund.
The Manager will make all determinations as to aggregation of client
accounts for purposes of determining eligibility.
CONVERSIONS BETWEEN CLASSES
On December 31 of each year and on such other dates as may be determined by
GMO (each a "DETERMINATION DATE") the value of each client's Total Investment
and Total Fund Investment with GMO, as defined above, will be determined. Based
on that determination, each client's shares of the Fund will be automatically
converted to the class of shares of the Fund which is then being offered with
the lowest Shareholder
23
<PAGE> 26
Service Fee for which the client is eligible based on the amount of their Total
Investment or Total Fund Investment, as the case may be, on the Determination
Date. The conversion will occur within 15 business days following the
Determination Date. Also, if a client makes an investment in a GMO Fund (except
for the Pelican Fund) or puts additional assets under GMO's management (except
for accounts managed by GMO Domestic Active Division) so as to cause the client
to be eligible for a new class of shares, such determination will be made as of
the close of business on the last day of the calendar quarter in which the
investment was made, and the conversion will be effected within 15 business days
of that quarter.
The Trust has been advised by counsel that the conversion of a client's
investment from one class of shares to another class of shares in the same Fund
should not result in the recognition of gain or loss in the converted Fund's
shares. The client's tax basis in the new class of shares immediately after the
conversion should equal the client's basis in the converted shares immediately
before conversion, and the holding period of the new class of shares should
include the holding period of the converted shares.
Certain special rules will be applied by the Manager with respect to
clients for whom GMO managed assets prior to the creation of multiple classes on
May 31, 1996. Clients whose Total Investment as of May 31, 1996 is equal to $7
million or more will be eligible to remain invested in Class III Shares
indefinitely (irrespective of whether the Fund has a higher investment minimum),
provided that such client does not make a withdrawal or redemption that causes
the client's Total Investment to fall below $7 million. Clients whose Total
Investment as of May 31, 1996 is less than $7 million but greater than $0 will
be eligible to invest in or convert to Class II Shares indefinitely
(irrespective of whether the Fund has a higher investment minimum), and such
conversion will not occur until on or after July 31, 1997. Notwithstanding the
foregoing special rules, clients shall always remain eligible to remain in
and/or to be converted to any class of shares of the Fund which the client would
be eligible to purchase pursuant to the eligibility requirements set forth
herein.
Investors should be aware that not all classes of the Fund are available in
all jurisdictions.
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 (i) the net asset value next
determined after a purchase order is received in good order plus (ii) a premium,
if any, established from time to time by the Trust for the Fund. All purchase
premiums are paid to and retained by the Fund and are intended to cover the
brokerage and other costs associated with putting the investment to work in the
relevant markets. Each class of shares of the Fund has the same rate of purchase
premium.
The purchase premium currently in effect for the Asia Fund is 1.20%.
Purchase premiums generally apply only to cash transactions. These fees are
paid to and retained by the Fund itself and are designed to allocate transaction
costs caused by shareholder activity to the shareholder generating the activity,
rather than to the Fund as a whole. Purchase premiums are not sales loads.
In certain limited circumstances, the purchase premiums and/or redemption
fees for the Fund may be waived in part or in full. The circumstances are
described in the footnotes to the Schedule of Fees and Expenses in this
Prospectus.
Normally, no purchase premium is charged with respect to in-kind purchases
of Fund shares. However, in the case of in-kind purchases involving transfers of
large positions in markets where the costs of re-registration and/or other
transfer expenses are high, the Fund may charge a premium of 0.20%.
Shares may be purchased (i) in cash, (ii) in exchange for securities on
deposit at The Depository Trust Company ("DTC") (or such other depository
acceptable to the Manager), subject to the determination by the Manager that the
securities to be exchanged are acceptable, or (iii) by a combination of such
securities and cash. In all cases, the Manager reserves the right to reject any
particular investment. Securities acceptable to the Manager as consideration for
Fund shares will be valued as set forth under "Determination of Net Asset Value"
24
<PAGE> 27
(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 a Purchase Order Form 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. This 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 by calling the Trust at (617) 330-7500. If a Purchase Order is mailed to
the Trust, it will be acted upon when received.
(d) Payment: All Federal funds must be transmitted to Investors Bank &
Trust Company for the account of the Fund. "Federal funds" are monies credited
to Investors Bank & Trust Company's account with the Federal Reserve Bank of
Boston.
25
<PAGE> 28
Note: The Trust may attempt to process orders for Trust shares that are
submitted less formally than as described above, but, in such cases, the
investor should carefully review confirmations sent by the Trust to verify that
the order was properly executed. The Trust cannot be held responsible for
failure to execute orders or improperly executing orders that are not submitted
in accordance with these procedures.
REDEMPTION OF SHARES
Shares of 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" less any applicable redemption
fee. All redemption fees are paid to and retained by the Fund and are intended
to cover the brokerage and other Fund costs associated with redemptions. All
classes of the Fund bear the same redemption fee rate, if any.
The redemption fee currently in effect for the Asia Fund is .40%.
Redemption fees apply only to cash transactions. These fees are paid to and
retained by the Fund itself and are employed to allocate transaction costs
caused by shareholder activity to the shareholder generating the activity,
rather than to the Fund as a whole. Redemption fees are not sales loads or
contingent deferred sales charges.
In certain limited circumstances, the purchase premiums and/or redemption
fees for the Fund may be waived in part or in full. The circumstances are
described in the footnotes to the Schedule of Fees and Expenses in this
Prospectus.
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
26
<PAGE> 29
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 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 most recent
quoted bid price, except that debt obligations with sixty days or less remaining
until maturity may be valued at their amortized cost, unless circumstances
dictate otherwise. Circumstances may dictate otherwise, among other times, when
the issuer's creditworthiness has become impaired.
All other fixed income securities (which includes bonds, loans and
structured notes) and options thereon are valued at the closing bid for such
securities as supplied by a primary pricing source chosen by the Manager. While
the Manager evaluates such primary pricing sources on an ongoing basis, and may
change any pricing source at any time, the Manager will not normally evaluate
the prices supplied by the pricing sources on a day-to-day basis. However, the
Manager is kept informed of erratic or unusual movements (including unusual
inactivity) in the prices supplied for a security and has the power to override
any price supplied by a source (by taking a price supplied from another source)
because of such price activity or because the Manager has other reasons to
suspect that a price supplied may not be reliable.
Other assets and securities for which no quotations are readily available
are valued at fair value as determined in good faith by the Trustees or persons
acting at their direction. The values of foreign securities quoted in foreign
currencies are translated into U.S. dollars at current exchange rates or at such
other rates as the Trustees may determine in computing net asset value.
Because of time zone differences, foreign exchanges and securities markets
will usually be closed prior to the time of the closing of the New York Stock
Exchange and values of foreign options and foreign securities will be determined
as of the earlier closing of such exchanges and securities markets. However,
events affecting the values of such foreign securities may occasionally occur
between the earlier closings of such exchanges and securities markets and the
closing of the New York Stock Exchange which will not be reflected in the
computation of the net asset value of the Fund. If an event materially affecting
the value of such foreign securities occurs during such period, then such
securities will be valued at fair value as determined in good faith by the
Trustees or persons acting at their direction.
Because foreign securities, options on foreign securities and foreign
futures are quoted in foreign currencies, fluctuations in the value of such
currencies in relation to the U.S. dollar will affect the net asset value of
shares of the Fund even though there has not been any change in the values of
such securities and options, measured in terms of the foreign currencies in
which they are denominated.
DISTRIBUTIONS
The Fund intends to pay out as dividends, at least annually, substantially
all of its net investment income (which is derived from dividends and interest
it receives from its portfolio investments and net short-term capital gains).
For these purposes and for federal income tax purposes, a portion of the
premiums from certain expired call or put options written by the Fund, net gains
from certain closing purchase and sale transactions with respect to such options
and a portion of net gains from other options and futures transactions are
treated as short-term capital gain. 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
27
<PAGE> 30
taxable investment income and capital gains. The policy of the Fund is to
declare and pay distributions of its dividends, interest and foreign currency
gains semi-annually. The Fund also intends to distribute net short-term capital
gains and net long-term capital gains at least annually. Investors should be
aware that by purchasing shares shortly before the record date of a dividend or
capital gains distribution, they will pay the full price of the shares and
shortly thereafter will receive some portion of the price paid back as a taxable
dividend or taxable capital gains distribution.
All dividends and/or distributions will be paid in shares of the Fund, at
net asset value, unless the shareholder elects to receive cash. There is no
purchase premium on reinvested dividends or distributions. Shareholders may make
this election by marking the appropriate box on the Purchase Order Form or by
writing to the Trust.
Certain of the Fund's investments, including assets "marked to the market"
for federal income tax purposes, investments in so-called passive investment
companies, debt obligations issued or purchased at a discount and, potentially,
so-called "indexed securities," will create taxable income in excess of the cash
they generate. In such cases, the Fund may be required to sell assets (including
when it is not advantageous to do so) to generate the cash necessary to
distribute as dividends to its shareholders all of its income and gains and
therefore to eliminate any tax liability at the Fund level.
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 (the
"Code"), and to meet all other requirements necessary for it to be relieved of
federal taxes on income and gains it distributes to shareholders. So long as the
Fund so qualifies, the Fund itself will not pay federal income taxes on the
amounts distributed.
Fund distributions derived from interest, dividends and certain other
income, including in general short-term capital gains, will be taxable as
ordinary income to shareholders subject to federal income tax whether received
in cash or reinvested shares. Distributions from the Fund will be taxable to
shareholders as ordinary income to the extent derived from the Fund's investment
income and net short-term gains. Distributions of net capital gains (that is,
the excess of net gains from capital assets held for more than one year
("long-term capital assets") over net losses from capital assets held for not
more than one year ("short-term capital assets")) will be taxable to
shareholders as such (generally at a 20% rate for noncorporate shareholders),
regardless of how long a shareholder has held the shares in the Fund. Any loss
realized upon a taxable disposition of shares held for six months or less will
be treated as long-term capital loss to the extent of any long-term capital gain
distributions received by a shareholder with respect to those shares. The
recognition of certain losses upon the sale of shares of the Fund may be limited
to the extent shareholders dispose of shares of one Fund and invest in shares of
the same or another GMO Fund. A distribution paid to shareholders by the Fund in
January of a year generally is deemed to have been received by shareholders on
December 31 of the preceding year, if the distribution was declared and payable
to shareholders of record on a date in October, November or December of that
preceding year. The Trust will provide federal tax information annually,
including information about dividends and distributions paid during the
preceding year to taxable investors and others requesting such information.
Dividends and distributions on the Fund's shares are generally subject to
federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects unrealized
losses.
For corporate shareholders, the dividends-received deduction will generally
apply (subject to a holding period requirement imposed by the Code) to the
Fund's dividends paid from investment income to the extent derived from
dividends received from U.S. corporations.
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
28
<PAGE> 31
in shares of the Fund, and on the amount of the proceeds of any redemption of
Fund shares paid or credited to any shareholder account for which an incorrect
or no taxpayer identification number has been provided, where appropriate
certification has not been provided for a foreign shareholder (as described
below), or where the Trust is notified that the shareholder has underreported
income in the past (or the shareholder fails to certify that he is not subject
to such withholding).
The foregoing is a general summary of the 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).
WITHHOLDING ON DISTRIBUTIONS TO FOREIGN INVESTORS
Dividend distributions (including distributions derived from short-term
capital gains) are in general subject to a U.S. withholding tax of 30% when paid
to a nonresident alien individual, foreign estate or trust, a foreign
corporation, or a foreign partnership ("foreign shareholder"). Persons who are
resident in a country, such as the U.K., that has an income tax treaty with the
U.S. may be eligible for a reduced withholding rate (upon filing of appropriate
forms), and are urged to consult their tax advisors regarding the applicability
and effect of such a treaty. Distributions of net realized long-term capital
gains paid by the Fund to a foreign shareholder, and any gain realized upon the
sale of Fund shares by such a shareholder will ordinarily not be subject to U.S.
taxation, unless the recipient or seller is a nonresident alien individual who
is present in the United States for more than 182 days during the taxable year.
However, such distributions and sale proceeds may be subject to backup
withholding, unless the foreign investor certifies his non-U.S. residency
status. Federal regulations generally require the Funds to withhold ("backup
withholding") and remit to the U.S. Treasury 31% of dividends, distributions
from net realized securities gains and gains realized upon a sale of securities
paid to a shareholder if such shareholder fails to certify either that the
taxpayer identification number ("TIN") furnished in connection with opening an
account is correct or that such shareholder has not received notice from the IRS
of being subject to backup withholding as a result of a failure to properly
report taxable dividend or interest income on a Federal income tax return. Also,
the IRS may notify the Fund to institute backup withholding if the IRS
determines a shareholder's TIN is incorrect or if a shareholder has failed to
properly report taxable dividend and interest income on a Federal income tax
return. A TIN is either the Social Security number or employer identification
number of the record owner of the account. Any tax withheld as a result of
backup withholding does not constitute an additional tax imposed on the record
owner of the account, and may be claimed as a credit on the record owner's U.S.
federal income tax return. Also, foreign shareholders with respect to whom
income from the Fund is "effectively connected" with a U.S. trade or business
carried on by such shareholder will in general be subject to U.S. federal income
tax on the income derived from the Fund at the graduated rates applicable to
U.S. citizens, residents or domestic corporations, whether received in cash or
reinvested in shares, and, in the case of a foreign corporation, may also be
subject to a branch profits tax. Again, foreign shareholders who are resident in
a country with an income tax treaty with the United States may obtain different
tax results, and are urged to consult their tax advisors.
The IRS 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 rates under income tax treaties. Foreign investors in a fund
should consult their tax advisors with respect to the potential application of
these new regulations.
FOREIGN TAX CREDITS
If, at the end of the fiscal year, more than 50% of the total assets of the
Fund is represented by stock of foreign corporations, the Fund intends to make
an election which allows shareholders whose income from the Fund is subject to
U.S. taxation at the graduated rates applicable to U.S. citizens, residents or
domestic corporations to claim a foreign tax credit or deduction (but not both)
on their U.S. income tax return. In such case, the amounts of foreign income
taxes paid by the Fund would be treated as additional income to Fund
shareholders from non-U.S. sources and as foreign taxes paid by Fund
shareholders. Investors should consult their tax advisors for further
information relating to the foreign tax credit and deduction, which are subject
to
29
<PAGE> 32
certain restrictions and limitations (including a holding period requirement
applied at both the Fund and shareholder level imposed by the Code).
Shareholders whose income from the Fund is not subject to U.S. taxation at the
graduated rates applicable to U.S. citizens, residents or domestic corporations
may receive substantially different tax treatment of distributions by the Fund,
and may be disadvantaged as a result of the election described in this
paragraph.
TAX IMPLICATIONS OF CERTAIN INVESTMENTS
As described above under the heading "--Distributions," certain of the
Fund's investments, including assets "marked to the market" for federal income
tax purposes, debt obligations issued or purchased at a discount and,
potentially, so-called "index securities," will create taxable income in excess
of the cash they generate. In such cases, the Fund may be required to sell
assets (including when it is not advantageous to do so) to generate the cash
necessary to distribute as dividends to its shareholders all of its income and
gains and therefore to eliminate any tax liability at the Fund level.
The Fund's transactions in options, futures contracts, hedging
transactions, forward contracts, straddles and foreign currencies may accelerate
income, defer losses, cause adjustments in the holding periods of the Fund's
securities and convert short-term capital gains or losses into long-term capital
gains or losses. These transactions, and these transactions may affect the
amount, timing and character of distributions to shareholders.
Investment by the Fund in certain "passive foreign investment companies"
("PFICs") could subject the Fund to a U.S. federal income tax (including
interest charges) on distributions received from the company or on proceeds
received from the disposition of shares in the company, which tax cannot be
eliminated by making distributions to Fund shareholders. However, the Fund may
elect to treat a passive foreign investment company as a "qualified electing
fund" ("QEF"), in which case the Fund will be required to include its share of
the company's income and net capital gain annually, regardless of whether it
receives any distributions from the company. The Fund may also make an election
to mark the gains (and to a limited extent losses) in such holdings "to the
market" as though it had sold and repurchased its holdings in those PFICs on the
last day of the Fund's taxable year. Such gains and losses are treated as
ordinary income and loss. The QEF and mark-to-market elections may accelerate
the recognition of income (without the receipt of cash) and increase the amount
required to be distributed for the Fund to avoid taxation. Making either of
these elections may therefore require the Fund to liquidate other investments
(including when it is not advantageous to do so) to meet its distribution
requirement, which may also accelerate the recognition of gain and affect the
Fund's total return.
LOSS OF REGULATED INVESTMENT COMPANY STATUS
The Fund may experience particular difficulty qualifying as a regulated
investment company in the case of highly unusual market movements, in the case
of high redemption levels and/or during the first year of its operations. If the
Fund does not qualify for taxation as a regulated investment company for any
taxable year, the Fund's income will be taxed at the Fund level at regular
corporate rates, and all distributions from earnings and profits, including
distributions of net long-term capital gains, will be taxable to shareholders as
ordinary income and subject to withholding in the case of non-U.S. shareholders.
In addition, in order to requalify for taxation as a regulated investment
company 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 the other thirty-five series currently offered by
the Trust. 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 the Fund, the Manager selects and reviews
the Fund's investments and provides executive and other personnel for the
management of the Trust. Pursuant to the Trust's Agreement and Declaration of
Trust, the Board of Trustees supervises the affairs of the Trust as conducted by
the Manager.
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In the event that the Manager ceases to be the manager of the Fund, the right of
the Trust to use the identifying name "GMO" may be withdrawn.
The Manager has entered into a Consulting Agreement (the "Consulting
Agreement") with Dancing Elephant, Ltd., 1936 University Avenue, Berkeley,
California 94704 (the "Consultant"), with respect to the management of the
portfolio of the Asia Fund. The Consultant is wholly-owned by Mr. Arjun Divecha.
Under the Consulting Agreement, the Manager pays the Consultant a monthly fee at
an annual rate equal to the lesser of 0.50% of the Fund's average daily net
assets or $250,000. The Consultant may from time to time waive all or a portion
of its fee. Payments made by the Manager to the Consultant will not affect the
amounts payable by the Fund to the Manager or the Fund's expense ratio. The
Manager has entered into similar separate Consulting Agreements with the
Consultant with respect to two other Funds of the Trust, the GMO Emerging
Markets Fund and the GMO Evolving Countries Fund.
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. While the
fee paid to the Manager by the Fund is higher than that paid by most funds, each
is comparable to the fees paid by many funds with similar investment objectives.
In addition, with respect to 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 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. Arjun Divecha will be primarily responsible for the day-to-day
management of the Fund.
During the period from February 18, 1998 (the inception of the Fund's
operations) to February 28, 1998, the Manager received, as compensation for
management services rendered in such year (after waiver), 0.00% of the Fund's
average daily net assets.
Pursuant to an Administrative Services Agreement with GMO, Investors Bank &
Trust Company provides administrative services to the Fund. GMO pays Investors
Bank & Trust Company an annual fee for its services to the Fund.
Pursuant to a Servicing Agreement with the Trust on behalf of each class of
shares of each Fund of the Trust, Grantham, Mayo, Van Otterloo & Co. LLC, in its
capacity as the Trust's shareholder servicer (the "Shareholder Servicer"),
provides direct client service, maintenance and reporting to shareholders of
each class of shares. Such servicing and reporting services include, without
limitation, professional and informative reporting, client account information,
personal and electronic access to Fund information, access to analysis and
explanations of Fund reports, and assistance in the correction and maintenance
of client-related information.
ORGANIZATION AND CAPITALIZATION
OF THE TRUST
The Trust was established on June 24, 1985 as a business trust under
Massachusetts law. The Trust has an unlimited authorized number of shares of
beneficial interest which may, without shareholder approval, be divided into an
unlimited number of series and classes of such shares. The Trusts's shares are
presently divided into thirty-seven series of shares, one for the Asia Fund, and
one for each of the Emerging Country Debt Share 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, Emerging Country Debt 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)
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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 November 1, 1998, Bankers Trust Company, as Trustee for GTE Service
Corp. Pension Trust, 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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Appendix A
RISKS AND LIMITATIONS OF OPTIONS, FUTURES AND SWAPS
Limitations on the Use of Options and Futures Portfolio Strategies. As
noted in "Descriptions and Risks of Fund Investment Practices--Futures and
Options" above, the Fund 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, the
Fund's long futures contract positions (less its short positions) together with
the Fund's cash (i.e., equity or fixed income) positions will not exceed the
Fund's total net assets.
The Fund'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 the Fund will be able to utilize these
instruments effectively for the purposes set forth above. Furthermore, the
Fund's ability to engage in options and futures transactions may be limited by
tax considerations.
Risk Factors in Options Transactions. The option writer has no control over
when the underlying securities or futures contract must be sold, in the case of
a call option, or purchased, in the case of a put option, since the writer may
be assigned an exercise notice at any time prior to the termination of the
obligation. If an option expires unexercised, the writer realizes a gain in the
amount of the premium. Such a gain, of course, may, in the case of a covered
call option, be offset by a decline in the market value of the underlying
security or futures contract during the option period. If a call option is
exercised, the writer realizes a gain or loss from the sale of the underlying
security or futures contract. If a put option is exercised, the writer must
fulfill the obligation to purchase the underlying security or futures contract
at the exercise price, which will usually exceed the then market value of the
underlying security or futures contract.
An exchange-traded option may be closed out only on a national securities
exchange ("Exchange") which generally provides a liquid secondary market for an
option of the same series. An over-the-counter option may be closed out only
with the other party to the option transaction. If a liquid secondary market for
an exchange-traded option does not exist, it might not be possible to effect a
closing transaction with respect to a particular option with the result that the
Fund holding the option would have to exercise the option in order to realize
any profit. For example, in the case of a written call option, if the Fund is
unable to effect a closing purchase transaction in a secondary market (in the
case of a listed option) or with the purchaser of the option (in the case of an
over-the-counter-option), the Fund will not be able to sell the underlying
security (or futures contract) until the option expires or it delivers the
underlying security (or futures contract) upon exercise. Reasons for the absence
of a liquid secondary market on an Exchange include the following: (i) there may
be insufficient trading interest in certain options; (ii) restrictions may be
imposed by an Exchange on opening transactions or closing transactions or both;
(iii) trading halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options or underlying securities;
(iv) unusual or unforeseen circumstances may interrupt normal operations on an
Exchange; (v) the facilities of an Exchange or the Options Clearing Corporation
may not at all times be adequate to handle current trading volume; or (vi) one
or more Exchanges could, for economic or other reasons, decide or be compelled
at some future date to discontinue the trading of options (or a particular class
or series of options), in which event the secondary market on that Exchange (or
in that class or series of options) would cease to exist, although outstanding
options on that Exchange that had been issued by the Options Clearing
Corporation as a result of trades on that Exchange should continue to be
exercisable in accordance with their terms.
The Exchanges have established limitations governing the maximum number of
options which may be written by an investor or group of investors acting in
concert. It is possible that the Fund, the Manager and other clients of the
Manager may be considered to be such a group. These position limits may restrict
the Fund's ability to purchase or sell options on a particular security.
The amount of risk the Fund assumes when it purchases an option is the
premium paid for the option plus related transaction costs. In addition to the
correlation risks discussed below, the purchase of an option also entails the
risk that changes in the value of the underlying security or futures contract
will not be fully reflected in the value of the option purchased.
Risk Factors in Futures Transactions. Investment in futures contracts
involves risk. If the futures are used for hedging, some of that risk may be
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caused by an imperfect correlation between movements in the price of the futures
contract and the price of the security or currency being hedged. The correlation
is higher between price movements of futures contracts and the instrument
underlying that futures contract. The correlation is lower when futures are used
to hedge securities other than such underlying instrument, such as when a
futures contract on an index of securities is used to hedge a single security, a
futures contract on one security (e.g., U.S. Treasury bonds) is used to hedge a
different security (e.g., a mortgage-backed security) or when a futures contract
in one currency (e.g., the German Mark) is used to hedge a security denominated
in another currency (e.g., the Spanish Peseta). In the event of an imperfect
correlation between a futures position and a portfolio position (or anticipated
position) which is intended to be protected, the desired protection may not be
obtained and the Fund may be exposed to risk of loss. In addition, it is not
always possible to hedge fully or perfectly against currency fluctuations
affecting the value of the securities denominated in foreign currencies because
the value of such securities also is likely to fluctuate as a result of
independent factors not related to currency fluctuations. The risk of imperfect
correlation generally tends to diminish as the maturity date of the futures
contract approaches.
A hedge will not be fully effective where there is such imperfect
correlation. To compensate for imperfect correlations, the Fund may purchase or
sell futures contracts in a greater amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, the Fund may purchase or sell fewer
contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contract.
As noted in the Prospectus, the Fund may also purchase futures contracts
(or options thereon) as an anticipatory hedge against a possible increase in the
price of currency in which is denominated the securities the Fund anticipates
purchasing. In such instances, it is possible that the currency may instead
decline. If the Fund does not then invest in such securities because of concern
as to possible further market and/or currency decline or for other reasons, the
Fund may realize a loss on the futures contract that is not offset by a
reduction in the price of the securities purchased.
The liquidity of a secondary market in a futures contract may be adversely
affected by "daily price fluctuation limits" established by commodity exchanges
which limit the amount of fluctuation in a futures contract price during a
single trading day. Once the daily limit has been reached in the contract, no
trades may be entered into at a price beyond the limit, thus preventing the
liquidation of open futures positions. Prices have in the past exceeded the
daily limit on a number of consecutive trading days. Short positions in index
futures may be closed out only by entering into a futures contract purchase on
the futures exchange on which the index futures are traded.
The successful use of transactions in futures and related options for
hedging and risk management also depends on the ability of the Manager to
forecast correctly the direction and extent of exchange rate, interest rate and
stock price movements within a given time frame. For example, to the extent
interest rates remain stable during the period in which a futures contract or
option is held by the Fund investing in fixed income securities (or such rates
move in a direction opposite to that anticipated), the Fund may realize a loss
on the futures transaction which is not fully or partially offset by an increase
in the value of its portfolio securities. As a result, the Fund's total return
for such period may be less than if it had not engaged in the hedging
transaction.
Unlike trading on domestic commodity exchanges, trading on foreign
commodity exchanges is not regulated by the CFTC and may be subject to greater
risks than trading on domestic exchanges. For example, some foreign exchanges
may be principal markets so that no common clearing facility exists and a trader
may look only to the broker for performance of the contract. In addition, unless
the Fund hedges against fluctuations in the exchange rate between the U.S.
dollar and the currencies in which trading is done on foreign exchanges, any
profits that the Fund might realize in trading could be eliminated by adverse
changes in the exchange rate, or the Fund could incur losses as a result of
those changes.
Risk Factors in Swap Contracts, OTC Options and other Two-Party Contracts.
The Fund may only close out a swap, contract for differences, cap floor or
collar or OTC option, with the particular counterparty. Also, if the
counterparty defaults, the Fund will have contractual remedies pursuant to the
agreement related to the transaction, but there is no assurance that contract
counterparties will be able to meet their obligations pursuant to such contracts
or that, in the event of default, the Fund will succeed in pursuing contractual
remedies. The Fund thus assumes the risk that it may be delayed or prevented
from obtaining payments owed to it pursuant to swap contracts. The Manager will
closely monitor subject to the oversight of the Trustees, the creditworthiness
of contract counterparties, and the Fund will not enter into any swaps, caps,
floors or collars, unless the unsecured senior debt or the claims-paying ability
of the other party thereto is rated at least A by Moody's Investors Service or
Standard and Poor's Corporation at the time of entering into such transaction or
if the
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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 the Fund as
provided in the Prospectus in futures contracts and related options for purposes
other than bona fide hedging are limited such that the aggregate amount that the
Fund 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 the Fund's respective
obligations under equity swap contracts, reverse equity swap contracts or Index
Futures are senior securities and, accordingly, the Fund will not treat them as
being subject to its borrowing restrictions. However, the net amount of the
excess, if any, of the Fund's obligations over its entitlements with respect to
each equity swap contract will be accrued on a daily basis and an amount of
cash, U.S. Government Securities or other high grade debt obligations having an
aggregate market value at least equal to the accrued excess will be maintained
in a segregated account by the Fund's custodian. Likewise, when the Fund takes a
short position with respect to an Index Futures contract the position must be
covered or the Fund must maintain at all times while that position is held by
the Fund, cash, U.S. government securities or other high grade debt obligations
in a segregated account with its custodian, in an amount which, together with
the initial margin deposit on the futures contract, is equal to the current
delivery or cash settlement value.
The use of unsegregated futures contracts, related written options,
interest rate floors, caps and collars and interest rate and currency swap
contracts for risk management by the Fund permitted to engage in any or all of
such practices is limited to no more than 10% of the Fund's total net assets
when aggregated with such Fund's traditional borrowings in accordance with SEC
pronouncements. This 10% limitation applies to the face amount of unsegregated
futures contracts and related options and to the amount of the Fund's net
payment obligation that is not segregated against in the case of interest rate
floors, caps and collars and interest rate and currency swap contracts.
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APPENDIX B
COMMERCIAL PAPER AND CORPORATE DEBT RATINGS
COMMERCIAL PAPER RATINGS
Commercial paper ratings of Standard & Poor's Ratings Service ("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 Ratings Service. A Standard & Poor's corporate debt
rating is a current assessment of the creditworthiness of an obligor with
respect to a specific obligation. The following is a summary of the ratings used
by Standard & Poor's for corporate debt:
AAA - This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay interest and repay
principal.
AA - Bonds rated AA also qualify as high quality debt obligations. Capacity to
pay interest and repay principal is very strong, and in the majority of
instances they differ from AAA issues only in small degree.
A - Bonds rated A have a strong capacity to pay interest and repay principal,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB - Bonds rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to repay principal and pay interest for
bonds in this category than for bonds in higher rated categories.
BB, B, CCC, CC - Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominately speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and CC the highest degree of speculation. While
such bonds will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
C - The rating C is reserved for income bonds on which no interest is being
paid.
D - Bonds rated D are in default, and payment of interest and/or repayment of
principal is in arrears.
Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Moody's Investors Service, Inc. The following is a summary of the ratings
used by Moody's Investor Services, Inc. for corporate debt:
Aaa - Bonds that are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge." Interest payments are protected by a large, or by an exceptionally
stable, margin, and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa - Bonds that are rated Aa are judged to be high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds
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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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SHAREHOLDER INQUIRIES
Shareholders may direct inquiries
to Grantham, Mayo, Van Otterloo & Co. LLC,
40 Rowes Wharf, Boston, MA 02110
(1-617-330-7500)
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GMO ASIA 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 Asia 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 free of charge by writing to
GMO Trust, 40 Rowes Wharf, Boston, Massachusetts 02110, or by calling (617)
330-7500.
<PAGE> 42
Table of Contents
Caption Page
INVESTMENT OBJECTIVES AND POLICIES.............................................1
MISCELLANEOUS INVESTMENT PRACTICES.............................................1
MANAGEMENT OF THE TRUST........................................................1
INVESTMENT ADVISORY AND OTHER SERVICES.........................................3
PORTFOLIO TRANSACTIONS.........................................................6
DESCRIPTION OF THE TRUST AND OWNERSHIP OF SHARES...............................7
FINANCIAL STATEMENTS..........................................................10
PERFORMANCE INFORMATION.......................................................11
SPECIMEN PRICE MAKE-UP SHEET..................................................13
-i-
<PAGE> 43
INVESTMENT OBJECTIVES AND POLICIES
The investment objective and policies of the GMO Asia Fund (the "Asia 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 stated in the Prospectus under the heading "Description
and Risks of Fund Investments -- Futures and Options," the Fund may purchase
futures contracts on various securities indexes ("Index Futures"). As indicated
in the Prospectus, 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 the Fund 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, the Fund will
gain $5,000 (500 units x gain of $10).
MANAGEMENT OF THE TRUST
The names and ages of the Trustees and officers of the Trust and their
principal occupations during the past five years are as follows:
R. Jeremy Grantham* (60). President-Quantitative and Chairman of the
Trustees of the Trust. Member, Grantham, Mayo, Van Otterloo & Co. LLC.
Harvey R. Margolis (55). Trustee of the Trust. Mathematics Professor,
Boston College.
Jay O. Light (56). Trustee of the Trust. Professor of Business
Administration, Harvard University; Senior Associate Dean, Harvard
University (1988-1992).
Eyk del Mol Van Otterloo (61). President-International of the Trust.
Member, Grantham, Mayo, Van Otterloo & Co. LLC.
<PAGE> 44
Richard Mayo (56). President-Domestic Active of the Trust. Member,
Grantham, Mayo, Van Otterloo & Co. LLC.
Kingsley Durant (66). Vice President and Secretary of the Trust.
Member, Grantham, Mayo, Van Otterloo & Co. LLC.
Susan Randall Harbert (41). Secretary and Treasurer of the Trust.
Member, Grantham, Mayo, Van Otterloo & Co. LLC.
William R. Royer, Esq. (33). Vice President and Assistant Treasurer of
the Trust. General Counsel, Grantham, Mayo, Van Otterloo & Co. LLC
(January 1995 - Present). Associate, Ropes & Gray, Boston,
Massachusetts (September 1992 - January 1995).
Jui Lai (49). Secretary of the Trust. Member, Grantham, Mayo, Van
Otterloo & Co. LLC.
Ann Spruill (44). Secretary of the Trust. Member, Grantham, Mayo, Van
Otterloo & Co. LLC.
Alison E. Baur, Esq. (34). Vice President and Clerk of the Trust.
Associate General Counsel, Grantham, Mayo, Van Otterloo & Co. LLC
(February 1997 - Present). Attorney, Securities and Exchange
Commission (April 1991 - January 1997).
Robert V. Brokaw, Jr. (54). Secretary of the Trust. Member, Grantham,
Mayo, Van Otterloo & Co. LLC.
Forrest Berkley (44). Vice President of the Trust. Member, Grantham,
Mayo, Van Otterloo & Co. LLC.
Scott Eston (42). Vice President of the Trust. Chief Financial
Officer, Grantham, Mayo, Van Otterloo & Co. LLC (September 1997 -
present). Senior Partner, Coopers & Lybrand (1987 - 1997).
Brent Arvidson (29). Assistant Treasurer. Senior Fund Administrator,
Grantham, Mayo, Van Otterloo & Co. LLC (September 1997 - present).
Senior Financial Reporting Analyst, John Hancock Funds (August 1996 -
September 1997). Account Supervisor/Senior Account Specialist,
Investors Bank and Company (June 1993 - August 1996).
*Trustee is deemed to be an "interested person" of the Trust and Grantham, Mayo,
Van Otterloo & Co. LLC, as defined by the 1940 Act.
The mailing address of each of the officers and Trustees is c/o GMO Trust,
40 Rowes Wharf, Boston, Massachusetts 02110. As of November 1, 1998, the
Trustees and officers of the Trust as a group own 3.71% of the Class III Shares
of the Fund.
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<PAGE> 45
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 table below, no Trustee or officer of the
Trust receives any direct compensation from the Trust or any series thereof:
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 and Brokaw, and Mses.
Harbert and Spruill, as members of Grantham, Mayo, Van Otterloo & Co. LLC ("GMO"
or 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 Trust,"
under a separate Management Contract (the "Management Contract") between the
Trust and the Manager, subject to such policies as the Trustees of the Trust may
determine, the Manager will furnish continuously an investment program for the
Fund and will make investment decisions on behalf of the Fund 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.
The Manager has entered into a Consulting Agreement (the "Consulting
Agreement") with Dancing Elephant, Ltd., 1936 University Avenue, Berkeley,
California 94704 (the "Consultant"), with respect to the management of the
portfolio of the Asia Fund. The Consultant is wholly-owned by Mr. Arjun Divecha.
Under the Consulting Agreement, the Manager pays the Consultant a monthly fee at
an annual rate equal to the lesser of 0.50% of the Fund's average daily net
assets or $250,000. The Consultant may from time to time waive all or a portion
of its fee. Payments made by the Manager to the Consultant will not affect the
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<PAGE> 46
amounts payable by the Fund to the Manager or the Fund's expense ratio. The
Manager has entered into similar separate Consulting Agreements with the
Consultant with respect to two other Funds of the Trust, the GMO Emerging
Markets Fund and the GMO Evolving Countries Fund.
As is disclosed in the Prospectus, the Manager's compensation will be
reduced to the extent that the Fund's annual expenses incurred in the operation
of the Fund (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 the Fund's average daily
net assets described therein. Because the Manager's compensation is fixed at an
annual rate equal to this expense limitation, it is expected that the Manager
will pay such expenses (with the exceptions noted) as they arise. In addition,
the Manager's compensation under each Management Contract is subject to
reduction to the extent that in any year the expenses of the Fund exceed the
limits on investment company expenses imposed by any statute or regulatory
authority of any jurisdiction in which shares of the Fund 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. The Fund is not 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 the Fund's initial sole shareholder in connection with the
organization of the Trust and the establishment of the Fund. 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 the Fund. 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.
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<PAGE> 47
The Fund has paid the following amount as the Management Fee to the Manager
pursuant to the Management Contract:
<TABLE>
<CAPTION>
Gross Reduction Net
<S> <C> <C> <C>
Period from February $3,209 $3,209 $0
18, 1998 (the Fund's
inception date) to
February 28, 1998
</TABLE>
Custodial Arrangements. Brown Brothers Harriman & Co. ("BBH"), 40 Water
Street, Boston, Massachusetts 02109 serves as the Trust's custodian on behalf of
the Fund. As such, BBH 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, BBH
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. BBH 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, GMO
provides direct client service, maintenance and reporting to shareholders of the
Fund. The Servicing Agreement was approved by the Trustees of the Trust
(including a majority of the Trustees who are not "interested persons" of the
Manager or the Trust). The Servicing Agreement will continue in effect for a
period more than one year from the date of its execution only so long as its
continuance is approved at least annually by (i) vote, cast in person at a
meeting called for the purpose, of a majority of those Trustees who are not
"interested persons" of the Manager or the Trust, and by (ii) the majority vote
of the full Board of Trustees. The Servicing Agreement automatically terminates
on assignment (except as specifically provided in the Servicing Agreement) and
is terminable by either party upon not more than 60 days written notice to the
other party.
The Trust initially entered into the Servicing Agreement with GMO on May
30, 1996.
During the period from February 18, 1998 (commencement of the Fund's
operations) to February 28, 1998, the Fund paid $481 to GMO for services
rendered pursuant to the Servicing Agreement.
Independent Accountants. The Trust's independent accountants are
PricewaterhouseCoopers LLP, 160 Federal Street, Boston, Massachusetts 02110.
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<PAGE> 48
PricewaterhouseCoopers LLP 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 the Fund 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 the Fund, 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 the Fund
(involving price paid or received and any commissions and other costs paid), the
efficiency with which the transaction is effected, the ability to effect the
transaction at all where a large block is involved, availability of the broker
to stand ready to execute possibly difficult transactions in the future and the
financial strength and stability of the broker. Because of such factors, a
broker-dealer effecting a transaction may be paid a commission higher than that
charged by another broker-dealer. Most of the foregoing are judgmental
considerations.
Over-the-counter transactions often involve dealers acting for their own
account.
-6-
<PAGE> 49
Although the Manager does not consider the receipt of research services as
a factor in selecting brokers to effect portfolio transactions for the Fund, the
Manager will receive such services from brokers who are expected to handle a
substantial amount of the Fund'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 the Fund.
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.
During the period from February 18, 1998 (commencement of the Fund's
operations) to February 28, 1998, the Fund paid $154,375 in brokerage
commissions.
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 each Fund of
the Trust 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 Asia Fund, and one for each of the Emerging
Country Debt Share Fund, International Core Plus Allocation Fund, Fundamental
Value Fund, Pelican Fund, U.S. Core Fund, Tobacco-Free Core 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, Emerging
Country Debt 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, Global Balanced Allocation Fund;
Tax-Managed U.S. Equities Fund; and 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
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<PAGE> 50
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 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.
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<PAGE> 51
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 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
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<PAGE> 52
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 Asia Fund as of November 1, 1998:
<TABLE>
<CAPTION>
Name Address % Ownership
<S> <C> <C>
Bankers Trust Company TR, Attn: Marshall Jones 26.59%
GTE Service Corp. Pension GTE Investment Management
Trust One Stamford Forum
Stamford, CT 06902
The Trustees of Princeton Attn: John D. Sweeney 24.12%
University P.O. Box 35
Princeton, NJ 08544
The Trustees of Columbia Columbia University 13.18%
University 475 Riverside Drive
Suite 401
New York, NY 10115
Leland Stanford Junior Stanford Management Company 9.96%
University II 2770 Sand Hill Road
Menlo Park, CA 94025
SDI Investments LLC 232 Court Street 9.35%
Reno, NV 89501
</TABLE>
FINANCIAL STATEMENTS
The Fund's audited financial statements for the fiscal year ended February
28, 1998 included in the Fund's Annual Report filed with the Securities and
Exchange Commission on May 8, 1998 pursuant to Section 30(d) of the Investment
Company Act of 1940, as amended, and the rules promulgated thereunder, and the
Fund's unaudited financial statements for the six month period ended August 31,
1998 included in the Fund's Semi-Annual Report filed with the
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<PAGE> 53
Securities and Exchange Commission on November 6, 1998 pursuant to Section 30(d)
of the Investment Company Act of 1940, as amended, and the rules promulgated
thereunder, are hereby incorporated in this Statement of Additional Information
by reference.
PERFORMANCE INFORMATION
The Fund may from time to time include its total return in advertisements
or in information furnished to present or prospective shareholders.
Quotations of average annual total return for the Fund will be expressed in
terms of the average annual compounded rate of return of a hypothetical
investment in the Fund or class over periods of one, three, five, and ten years
(or for such shorter or longer periods as shares of the Fund have been offered),
calculated pursuant to the following formula: P (1 + T)n = ERV (where P = a
hypothetical initial payment of $1,000, T = the average annual total return, n =
the number of years, and ERV = the ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the period). Except as noted below, all
total return figures reflect the deduction of a proportional share of Fund
expenses on an annual basis, and assume that (i) the maximum purchase premium is
deducted from the initial $1,000 payment, (ii) all dividends and distributions
are reinvested when paid and (iii) the maximum redemption fee is charged at the
end of the relevant period. Quotations of total return may also be shown for
other periods. The Fund may also, with respect to certain periods of less than
one year, provide total return information for that period that is unannualized.
Any such information would be accompanied by standardized total return
information.
The Fund may also from time to time advertise net return and gross return
data for each month and calendar quarter since the Fund's inception. Monthly and
quarterly return data is calculated by linking daily performance for the Fund
(current net asset value divided by prior net asset value), and assumes
reinvestment of all dividends and gains. Monthly and quarterly performance data
does not reflect payment of any applicable purchase premiums or redemption 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)
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<PAGE> 54
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, fixed income or
other relevant indices. For example, the Fund may compare its total return to
rankings prepared by Lipper Analytical Services, Inc., a widely recognized
independent service which monitors mutual fund performance.
Performance rankings, listings and ratings reported in national financial
publications, such as Money Magazine, Barron's, Morningstar and Changing Times,
may also be cited (if the Fund is listed in any such publication) or used for
comparison, as well as performance listings and rankings from various other
sources including No Load Fund X, CDA Investment Technologies, Inc.,
Weisenberger Investment Companies Service, and Donoghue's Mutual Fund Almanac.
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<PAGE> 55
GMO TRUST - ASIA 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.
<TABLE>
<CAPTION>
Asia Fund - Class III
<S> <C>
Net Assets at Value (Equivalent to $5.31 per share based on $52,919,340
9,961,321 shares of beneficial interest outstanding)
Offering Price ($5.31 x 100/98.8)* $5.37
</TABLE>
* Represents maximum offering price charged on certain cash purchases. See
"Purchase of Shares" in the Prospectus.
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