<PAGE> 1
GMO TAX-MANAGED U.S. EQUITIES FUND
GMO TAX-MANAGED INTERNATIONAL EQUITIES FUND
GMO TAX-MANAGED SMALL COMPANIES FUND
40 Rowes Wharf, Boston, Massachusetts 02110
The GMO TAX-MANAGED U.S. EQUITIES FUND (the "TAX-MANAGED U.S. EQUITIES
FUND"), the GMO TAX-MANAGED INTERNATIONAL EQUITIES FUND (the "TAX-MANAGED
INTERNATIONAL EQUITIES FUND") and the GMO TAX-MANAGED SMALL COMPANIES FUND (THE
"TAX-MANAGED SMALL COMPANIES FUND") (each a "FUND" and collectively the "FUNDS")
are three of thirty-eight 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. GRANTHAM, MAYO, VAN
OTTERLOO & CO. LLC (the "MANAGER" or "GMO") is the investment manager for each
of the Funds.
INVESTMENT MANAGER &
CLIENT SERVICE PROVIDER
GRANTHAM, MAYO, VAN OTTERLOO & CO. LLC
Tel: (617) 346-7646 (call collect)
Fax: (617) 439-4192
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 OCTOBER 18, 1999
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TABLE OF CONTENTS
SUMMARY OF FUND OBJECTIVES AND PRINCIPAL INVESTMENT STRATEGIES.................3
GMO TAX-MANAGED U.S. EQUITIES FUND..........................................4
GMO TAX-MANAGED INTERNATIONAL EQUITIES FUND.................................5
GMO TAX-MANAGED SMALL COMPANIES FUND........................................6
SUMMARY OF PRINCIPAL RISKS.....................................................7
FEES AND EXPENSES.............................................................11
BENCHMARKS AND INDEXES........................................................13
DETERMINATION OF NET ASSET VALUE..............................................13
SPECIAL INFORMATION ON REDEMPTIONS IN KIND....................................14
TAXES.........................................................................14
MANAGEMENT OF THE TRUST.......................................................15
FINANCIAL HIGHLIGHTS..........................................................17
ADDITIONAL INFORMATION................................................BACK COVER
PURCHASE AND SALE INFORMATION.........................................BACK COVER
SHAREHOLDER INQUIRIES.................................................BACK COVER
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SUMMARY OF FUND OBJECTIVES AND
PRINCIPAL INVESTMENT STRATEGIES
This summary describes each Fund's investment objective and principal
investment strategies. Each Fund may make other investments and engage in other
investment strategies that are not specifically described in the Summary. The
INVESTMENT GUIDELINES contain a more complete description of each Fund's
possible investments and strategies. These Guidelines are in the Statement of
Additional Information or are available separately. See the back cover of the
Prospectus for information about how to receive the Statement of Additional
Information or the Investment Guidelines.
PRINCIPAL RISKS. Investing in mutual funds involves risk and it is
possible to lose money on an investment in a Fund. Each Fund is subject to
certain risks based on the types of investments in the Fund's portfolio and on
the investment strategies the Fund employs. Because each of the Funds has
different investments and employs different strategies, each Fund's risk profile
is different. Investors should refer to the SUMMARY OF PRINCIPAL RISKS in the
Prospectus at page 7 for a discussion of the principal risks of investing in a
Fund. See the Statement of Additional Information for more complete information
about the risks of specific Fund investments and strategies.
An investment in the Funds is not a deposit of a bank and is not
insured or guaranteed by the Federal Deposit Insurance Corporation or any other
government agency.
In many of the Fund summaries that follow, it is noted that a
particular Fund will "invest primarily in" a particular type of securities or
other assets. Investors should understand that this Prospectus uses the word
"invest" to mean not only direct investment in a particular asset but also
indirect investment in or exposure to the asset through the use of derivatives
and related instruments.
The Funds are managed and/or meant to be measured relative to a
specified benchmark or index. While the Funds may be managed or measured
relative to these benchmarks or indexes, the Funds are not managed as "index
funds" or "index-plus funds," and the actual composition of a Fund's portfolio
may differ substantially from that of its benchmark or index. The benchmark or
index against which the Manager measures its performance (the "GMO Benchmark")
is listed immediately below the relevant Fund's name under "Fund Objectives and
Principal Investment Strategies" and may be changed from time to time. Some
general information about the benchmarks and indexes is provided under
"Benchmarks and Indexes" later in this Prospectus.
Each Fund may employ various strategies designed to minimize the impact
of taxes on investors' returns. The Manager will seek to control portfolio
turnover in order to defer the realization and minimize the distributions of
capital gains. The Manager may, when appropriate, sell securities in order to
realize capital losses. Losses may be used at various times to offset realized
capital gains, thus reducing net capital gains distributions. In addition, when
making sales of specific securities, the Manager considers strategies, such as
selling securities with the highest cost basis, to minimize capital gains. The
Manager also plans to meet redemption requests through in-kind redemptions, that
is, to pay the redemption price in whole or in part by a distribution of
appreciated securities held by the Fund in lieu of cash. By redeeming a
shareholder in-kind with appreciated securities, the Fund will generally not be
required to distribute the capital gains in those securities to the shareholders
in the Fund. The effect to the redeeming shareholder is the same for federal
income tax purposes as a redemption in cash.
Except for certain policies that are explicitly described as
fundamental in this Prospectus or in the Statement of Additional Information,
each Fund's investment objective and policies may be changed by the Trustees
without shareholder approval.
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- ------------------------------------ FUND CODES
GMO TAX-MANAGED U.S. EQUITIES FUND -------------------------------------
- ------------------------------------ TICKER SYMBOL CUSIP
Fund Inception Date: 7/23/98 ------ ------ -----------
Class III n/a n/a 362008 71 6
OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
INVESTMENT OBJECTIVE: The GMO Tax-Managed U.S. Equities Fund seeks high
after-tax total return primarily through investment in U.S. equity securities.
The Fund's current benchmark is the GMO S&P 500 (After Tax).
INVESTMENT UNIVERSE: The Fund invests primarily in the equity securities of
companies chosen from among the 1000 companies with the largest equity
capitalization and whose securities are listed on a United States national
securities exchange. The Fund may also use derivatives.
PRINCIPAL INVESTMENTS: The Fund intends to be fully invested, and will not
generally take temporary defensive positions through investment in cash and high
quality money market instruments. The Fund may use exchange-traded and
over-the-counter derivatives and related instruments to: (i) hedge equity
exposure; (ii) replace direct investing; and (iii) implement shifts in
investment exposure as a substitute for buying and selling securities. The Fund
will not use derivative instruments to expose on a net basis more than 100% of
its net assets to equity securities or markets.
METHODOLOGY/PORTFOLIO CONSTRUCTION: The Fund pursues a disciplined long-term
value approach that emphasizes high quality companies (those less affected by
adverse economic conditions) and undervalued sectors. The Manager uses a
macroeconomic approach to analyze and allocate to sectors that represent the
best long-term value. The Manager selects individual stocks based, in part, on a
proprietary dividend discount model. The Manager then uses a tax-sensitive
optimization process to evaluate a stock's return forecast and how much risk the
stock adds to the portfolio, and to weigh the risk of the entire portfolio
relative to the Fund's benchmark. In addition, the Manager explicitly considers
expected transaction costs in the tax-sensitive portfolio optimization.
RISKS: The most significant risks of an investment in the Fund are Market Risk,
Derivatives Risk, Leveraging Risk and Credit and Counterparty Risk. For more
information about these risks and other principal risks of an investment in the
Fund, see "Summary of Principal Risks" on page 7.
No performance information is included in this section because the Fund
commenced operations in 1998.
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- ------------------------------- FUND CODES
GMO TAX-MANAGED INTERNATIONAL ---------------------------------------
EQUITIES FUND TICKER SYMBOL CUSIP
- ------------------------------- ------ ------ -----------
Fund Inception Date: 7/29/98 Class III GTMIX n/a 362008 66 6
OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
INVESTMENT OBJECTIVE: The GMO Tax-Managed International Equities Fund seeks high
after-tax total return primarily through investment in non-U.S. equity
securities. The Fund's current benchmark is the GMO EAFE (After Tax).
INVESTMENT UNIVERSE: The Fund invests primarily in the equity securities of
companies in developed markets in the MSCI Perspectives universe, which includes
issuers in the MSCI EAFE index, small companies and Canadian companies. The Fund
may also use derivatives.
PRINCIPAL INVESTMENTS: The Fund intends to be fully invested, and will not
generally take temporary defensive positions through investment in cash and high
quality money market instruments. The Fund may invest a portion of its assets in
securities of emerging markets issuers chosen from the IFC Global Emerging
Markets database. The Fund may use exchange-traded and over-the-counter
derivatives and related instruments to: (i) hedge equity exposure; (ii) replace
direct investing; (iii) implement shifts in investment exposure as a substitute
for selling and buying securities; and (iv) adjust its foreign currency
exposure. The Fund will not use derivative instruments to expose on a net basis
more than 100% of its net assets to equity securities or markets, or to hold net
aggregate foreign currency exposure in excess of the net assets of the Fund.
However, the Fund's foreign currency exposure may differ significantly from the
currency exposure represented by its equity investments.
METHODOLOGY/PORTFOLIO CONSTRUCTION: The Fund pursues a disciplined long-term
value approach that emphasizes high quality companies (those less affected by
adverse economic conditions). The Manager uses a macroeconomic approach to
analyze and allocate to countries, sectors and currencies that represent the
best long-term value. The Manager selects individual stocks based, in part, on a
proprietary dividend discount model. The Manager then uses a tax-sensitive
optimization process to weigh the trade off between a stock's return forecast
and how much risk the stock adds to the portfolio, the risk and forecasted
return of all active currency positions and the risk of the entire portfolio
relative to the Fund's benchmark. In addition, the Manager explicitly considers
expected transaction costs in the tax-sensitive portfolio optimization.
RISKS: The most significant risks of an investment in GMO Tax-Managed
International Equities Fund are Market Risk, Derivatives Risk, Foreign
Investment Risk, Currency Risk, Leveraging Risk and Credit and Counterparty
Risk. For more information about these risks and other principal risks of an
investment in the Fund, see "Summary of Principal Risks" on page 7.
No performance information is included in this section because the Fund
commenced operations in 1998.
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- -------------------------------------- FUND CODES
GMO TAX-MANAGED SMALL COMPANIES FUND -----------------------------------
- -------------------------------------- TICKER SYMBOL CUSIP
Fund Inception Date: 6/1/99 ------ ------ -----
Class III n/a n/a n/a
OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES
INVESTMENT OBJECTIVE: The GMO Tax-Managed Small Companies Fund seeks to maximize
after-tax total return through investment in a portfolio of common stocks of
smaller companies primarily traded in the U.S. The Fund's current benchmark is
the Russell 2500 Index.
INVESTMENT UNIVERSE: The Fund invests primarily in the equity securities of
companies included in, or with total market capitalizations similar to those
companies included in, the Russell 2500 Index ("small companies"). The Russell
2500 Index is comprised of the smaller companies among the largest U.S.
companies. These small companies have average market capitalizations of less
than $1 billion. Companies in the Fund's portfolio may have market
capitalizations that are larger or smaller. The Fund may also use derivatives.
PRINCIPAL INVESTMENTS: The Fund intends to be fully invested, and will not
generally take temporary defensive positions through investment in cash and high
quality money market instruments. The Fund may use exchange-traded and
over-the-counter derivatives and related instruments to: (i) hedge equity
exposure; (ii) replace direct investing; and (iii) implement shifts in
investment exposure as a substitute for buying and selling securities. The Fund
will not use derivative instruments to expose on a net basis more than 100% of
its net assets to equity securities or markets.
METHODOLOGY/PORTFOLIO CONSTRUCTION: The Manager uses fundamental, quantitative
and tax-sensitive analysis to construct the Fund's portfolio. The Manager
analyzes the U.S. market sectors to identify those sectors it believes represent
the best long-term value. The Manager then selects companies for the portfolio
based on a value-driven analysis of several factors including:
- - Price to fair value (GMO's proprietary tax-aware dividend discount model),
which indicates the discounted net present value of future earnings, cash
flows, and dividends after taxes which can flow to shareholders over time.
- - Price to book value, which compares a stock's current market value with the
amount shareholders would theoretically receive if the company liquidated.
The Manager always considers the tax effects to the Fund of proposed portfolio
trades. The Manager also considers strategies such as selling securities with
the highest cost basis to minimize capital gains, or selling securities to
realize capital losses.
RISKS: The most significant risks of an investment in the Fund are Market Risk,
Derivatives Risk, Smaller Company Risk, Leveraging Risk and Credit and
Counterparty Risk. For more information about these risks and other principal
risks of an investment in the Fund, see "Summary of Principal Risks" on page 7.
No performance information is included in this section because the Fund
commenced operations in 1999.
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SUMMARY OF PRINCIPAL RISKS
The value of your investment in a Fund changes with the values of that
Fund's investments. Many factors can affect those values, and you can lose money
by investing in the Funds. Factors that may affect a particular Fund's portfolio
as a whole are called "principal risks" and are summarized in this section. This
summary describes the nature of these risks but is not intended to include every
potential risk. The Funds could be subject to additional principal risks because
the types of investments made by each Fund change over time. The "Investment
Guidelines" for each Fund set forth in the Statement of Additional Information
include more information about the Funds and their investments. Copies of the
Investment Guidelines and copies of the complete Statement of Additional
Information are available free of charge by contacting the Manager.
- MARKET RISK. All of the Funds are subject to market risk, which is
the risk of unfavorable market-induced changes in the value of the securities
owned by a Fund. The following summarizes certain general market risks
associated with investments in equity securities.
EQUITY SECURITIES. A principal risk of each Fund is that the equity
securities held by the Fund will decline in value due to factors affecting the
issuing companies, their industries, or the economy and equity markets
generally. The values of equity securities may decline for a number of reasons
that directly relate to the issuing company, such as management performance,
financial leverage and reduced demand for the issuer's goods or services. They
may also decline due to factors that affect a particular industry or industries,
such as labor shortages or increased production costs and competitive conditions
within an industry. In addition, they may decline due to general market
conditions which are not specifically related to a company or industry, such as
real or perceived adverse economic conditions, changes in the general outlook
for corporate earnings, changes in interest or currency rates or adverse
investor sentiment generally.
The Funds maintain substantial exposure to equities and generally do
not attempt to time the market. Because of this exposure, the possibility that
stock market prices in general will decline over short or even extended periods
subjects the Funds to unpredictable declines in the value of their shares, as
well as periods of poor performance.
Value Securities Risk. Some equity securities (generally referred to as
"value securities") are purchased primarily because they are selling at a price
lower than what is believed to be their true value and not necessarily because
the issuing companies are expected to experience significant earnings growth.
Such companies may have experienced adverse business developments or may be
subject to special risks. Other factors may also have caused their securities to
be out of favor. However, these securities bear the risk that the companies may
not overcome the adversity or that the market does not recognize the value of
the company, such that the price of the securities may decline or may not
approach the value that the Manager anticipates. Since value criteria are used
extensively by the Manager with each Fund, each Fund will be exposed to these
risks.
Growth Securities Risk. Some equity securities (generally known as
"growth securities") are purchased primarily because it is believed that the
companies issuing the securities will experience relatively rapid earnings
growth. Growth securities typically trade at higher multiples of current
earnings than other types of stocks. As a general rule, growth securities often
are more sensitive to general market movements than other types of stocks
because their market prices tend to place greater emphasis on future earnings
expectations. At times when it appears that these expectations may not be met,
growth stock prices typically fall. Each of the Funds may invest to a
significant extent in growth securities, and therefore each Fund is subject to
these risks.
- LIQUIDITY RISK. Liquidity risk exists when particular investments
are difficult to purchase or sell due to a limited market or to legal
restrictions, such that a Fund may be prevented from selling particular
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<PAGE> 8
securities at the price at which the Fund values them. All of the Funds are
subject to liquidity risk. Funds with principal investment strategies that
involve securities of companies with smaller market capitalizations, foreign
securities, derivatives or securities with substantial market and/or credit risk
tend to have the greatest exposure to liquidity risk.
- SMALLER COMPANY RISK. Market risk and liquidity risk are particularly
pronounced for securities of companies with smaller market capitalizations.
These companies may have limited product lines, markets or financial resources
or they may depend on a few key employees. Securities of smaller companies may
trade less frequently and in lesser volume than more widely held securities and
their values may fluctuate more sharply than other securities. They may also
trade in the over-the-counter market or on a regional exchange, or may otherwise
have limited liquidity. Investments in smaller, less seasoned companies may
present greater opportunities for growth and capital appreciation, but also
involve greater risks than customarily are associated with larger, more
established companies. Each Fund may invest to a significant extent in the
securities of smaller companies. The Tax-Managed Small Companies Fund invests
primarily in the securities of smaller companies and therefore these risks may
be particularly pronounced for this Fund.
- DERIVATIVES RISK. The Funds may use derivatives, which are financial
contracts whose value depends upon, or is derived from, the value of an
underlying asset, reference rate or index. Derivatives may relate to stocks,
bonds, interest rates, currencies or currency exchange rates, commodities, and
related indexes. The Funds may use derivatives for many purposes, including for
hedging and as a substitute for direct investment in securities or other assets.
The Funds may also use derivatives as a way to efficiently adjust the exposure
of the Funds to various securities, indexes and currencies without actually
selling current assets and purchasing different assets. This is generally done
either because the adjustment is expected to be relatively temporary or in
anticipation of effecting the sales and purchases of Fund assets over time. For
a description of the various derivative instruments that may be utilized by the
Funds, please see "Description and Risks of Fund Investments" and "Investment
Guidelines" in the Statement of Additional Information.
The use of derivative instruments involves risks different from, or
greater than, the risks associated with investing directly in securities and
other more traditional investments. Derivatives are subject to a number of risks
described elsewhere in this section, including market risk, liquidity risk and
the credit risk of the counterparty to the derivatives contract. Since their
value is calculated and derived from the value of other assets, instruments or
references, there is greater risk that derivatives will be improperly valued.
Derivatives also involve the risk that changes in the value of the derivative
may not correlate perfectly with relevant assets, rates or indexes they are
designed to hedge or to closely track. Also, suitable derivative transactions
may not be available in all circumstances and there can be no assurance that a
Fund will engage in these transactions to reduce exposure to other risks when
that would be beneficial.
- FOREIGN INVESTMENT RISK. Funds that invest in securities traded
principally in securities markets outside the United States are subject to
additional and more varied risks, and may experience more rapid and extreme
changes in value. The securities markets of many foreign countries are
relatively small, with a limited number of companies representing a small number
of industries. Additionally, issuers of foreign securities may not be subject to
the same degree of regulation as U.S. issuers. Reporting, accounting and
auditing standards of foreign countries differ, in some cases significantly,
from U.S. standards. There are generally higher commission rates on foreign
portfolio transactions, transfer taxes, higher custodial costs and the
possibility that foreign taxes will be charged on dividends and interest payable
on foreign securities. Also, for lesser developed countries, nationalization,
expropriation or confiscatory taxation, adverse changes in investment or
exchange control regulations (which may include suspension of the ability to
transfer currency from a country), political changes or diplomatic developments
could adversely affect a Fund's investments. In the event of nationalization,
expropriation or other confiscation, a Fund could lose its entire investment in
foreign securities.
While all of the Funds are exposed to these risks to some extent, these
risks will be particularly
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<PAGE> 9
pronounced for the Tax-Managed International Equities Fund, which expects to
invest a significant portion of its assets in foreign securities.
- CURRENCY RISK. Currency risk is the risk that fluctuations in the
exchange rates may negatively affect the value of a Fund's investments. Currency
risk includes both the risk that currencies in which a Fund's investments are
denominated or currencies in which a Fund has taken an active investment
position will decline in value relative to the U.S. Dollar and, in the case of
hedging positions, that the U.S. Dollar will decline in value relative to the
currency being hedged. Currency rates in foreign countries may fluctuate
significantly for a number of reasons, including the forces of supply and demand
in the foreign exchange markets, actual or perceived changes in interest rates,
and 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.
The Tax-Managed International Equity Fund may engage in proxy hedging
of currencies by entering into derivative transactions with respect to a
currency whose value is expected to correlate to the value of a currency the
Fund owns or wants to own. In the case of cross-hedging positions, currency risk
also includes the risk that the two currencies may not move in relation to one
another as expected. In that case, the Fund could lose money on its investment
and also lose money on the position designed to act as a proxy-hedge. This Fund
may also take active currency positions and may cross-hedge currency exposure
represented by its securities exposure into another foreign currency. This may
result in the Fund's currency exposure being substantially different than that
suggested by its securities investments.
All Funds that invest or trade in foreign currencies or in securities
denominated in foreign currencies or related derivative instruments may be
adversely affected by changes in foreign currency exchange rates. Currency risk
is particularly pronounced for the Tax-Managed International Equities Fund,
which regularly enters into derivative foreign currency transactions and may
take active long and short currency positions through exchange traded and
over-the-counter ("OTC") foreign currency transactions for investment purposes.
Derivative foreign currency transactions (such as futures, forwards and swaps)
may also involve leveraging risk in addition to currency risk as described below
under "Leveraging Risk."
- NON-DIVERSIFICATION RISK. Most analysts believe that overall risk can
be reduced through diversification, while concentration of investments in a
small number of securities increases risk. None of the Funds are "diversified"
within the meaning of the 1940 Act. This means they are permitted to invest in a
relatively small number of issuers and/or foreign currencies with greater
concentration of risk.
- LEVERAGING RISK. Each Fund's portfolio may at times be economically
leveraged when the Fund temporarily borrows money to meet redemption requests
and/or to settle investment transactions.
Additionally, the Funds may invest in derivatives and may enter into
reverse repurchase agreements. While none of the Funds intend to use derivatives
to create net exposure to securities, currencies or other assets in amounts
greater than the total assets of the relevant Fund, the Funds will often
consider derivative instruments as offsetting one another or other assets such
that only the net difference in the value of the derivatives and/or assets that
are offsetting will be considered for these purposes. In these cases, to the
extent that the offsetting positions do not behave in relation to one another as
expected, the Funds may perform as if they were leveraged.
This same compounding of risks can occur in the Tax-Managed
International Equities Fund, which may take on simultaneous long and short
positions in different currencies. While these long and short positions are
managed such that the Fund's net investment in foreign currency does not exceed
the Fund's net assets, a lack of correlation between currencies (which may or
may not be anticipated by the Manager) may expose more than one hundred percent
of the Fund's assets to currency risk. Similarly, the Funds may take long and
short positions on equity securities and/or "baskets" of equity securities,
including simultaneous positions through the use of a single derivative
instrument such as a swap contract or other over-the-counter derivative
instrument. A lack of
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<PAGE> 10
correlation between the equity securities that are the subject of these
instruments (which may or may not be anticipated by the Manager) could expose
more than 100% of the Fund's portfolio to equity securities risk.
- CREDIT AND COUNTERPARTY RISK. This is the risk that the issuer or
guarantor of a fixed income security, the counterparty to an OTC derivatives
contract, or a borrower of the Fund's securities, will be unable or unwilling to
make timely principal, interest or settlement payments, or to otherwise honor
its obligations.
Although the Funds do not expect to have a significant portion of their
portfolios invested in fixed income securities, the Funds are nonetheless
exposed to credit risk because they may make substantial use of OTC derivatives
(such as forward foreign currency contracts and swap contracts) and because they
may engage to a significant extent in the lending of Fund securities or use of
repurchase agreements.
- MANAGEMENT RISK. Each Fund is subject to management risk because it
relies on the Manager's ability to pursue its objective. The Manager will apply
investment techniques and risk analyses in making investment decisions for the
Funds, but there can be no guarantee that these will produce the desired
results. As noted above, the Manager may also fail to use derivatives
effectively, for example, choosing to hedge or not to hedge positions precisely
when it is least advantageous to do so. As indicated above, however, the Funds
are generally not subject to the risk of market timing because they generally
stay fully invested in the relevant asset class, such as domestic equities and
foreign equities.
- SPECIAL YEAR 2000 RISK CONSIDERATIONS. Many of the services provided
to the Funds 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 Funds' service systems fail to process information properly, that
could have an adverse impact on the Funds' operations and services provided to
shareholders. GMO, as well as the Funds' administrator, transfer agent,
custodian and other service providers, have reported that each is working toward
mitigating the risks associated with the "Year 2000 problem." However, there can
be no assurance that the problems will be corrected in all respects and that the
Funds' operations and services provided to shareholders will not be adversely
affected, nor can there be any assurance that the Year 2000 problem will not
have an adverse effect on the entities whose securities are held by the Fund or
on U.S. or global markets generally.
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FEES AND EXPENSES
This table describes the fees and expenses you may pay if you buy and hold
shares of a Fund.
<TABLE>
<CAPTION>
- ---------------- ------------------------------ ---------------------------------------------------------------------------------
GMO FUND PURCHASE AND ANNUAL FUND OPERATING EXPENSES
NAME REDEMPTION FEES (expenses that are deducted from Fund assets)
(fees paid directly to Fund at
purchase or redemption)
- ---------------- ------------- ---------------- ------------ -------------- ----------- ----------- ---------------- ------------
Cash Redemption Investment Shareholder Other TOTAL Expense NET
Purchase Fees Management Service Fee(3) Expenses OPERATING Reimbursement(5) EXPENSES
Premium (as a % of Fee EXPENSES
(as a % amount
of amount redeemed)
invested)(1)
- ---------------- ------------- ---------------- ------------ -------------- ----------- ----------- ---------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Tax-Managed 0.14%(2) None 0.33% 0.15% 1.29% 1.77% 1.29% 0.48%
U.S. Equities
Fund - Class III
- ---------------- ------------- ---------------- ------------ -------------- ----------- ----------- ---------------- ------------
Tax-Managed 0.60%(2) None 0.54% 0.15% 2.16% 2.85% 2.16% 0.69%
International
Equities Fund -
Class III
- ---------------- ------------- ---------------- ------------ -------------- ----------- ----------- ---------------- ------------
Tax-Managed 0.50%(2) None 0.55% 0.15% 0.20%(4) 0.90% 0.20% 0.70%
Small Companies
Fund - Class III
- ---------------- ------------- ---------------- ------------ -------------- ----------- ----------- ---------------- ------------
</TABLE>
NOTES TO FEES AND EXPENSES
1. Purchase premiums fees 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. The Manager may reduce these fees in certain limited
circumstances described below.
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 other transfer expenses are high, the
Tax-Managed International Equities Fund may charge a premium of up to
0.10% on in-kind purchases.
2. The purchase premium for this Fund may generally not be waived due to
offsetting transactions, and may be waived in only rare circumstances.
The premium will only be waived for this Fund (i) if the purchase is
part of a transfer from another Fund where the Manager is able to
transfer securities among the Funds as part of effecting the
transaction, (ii) during periods (expected to exist only rarely) when
the Manager determines that the Fund is either substantially
overweighted or underweighted with respect to its cash position so that
a purchase will not require a securities transaction or (iii) in
certain other instances (not including offsetting transactions) where
it is compelling to the Manager that the purchase will not result in
transaction costs to the Fund. Any waiver with respect to this Fund
must be arranged in advance with the Manager.
3. 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.
4. Based on estimated amounts for the Fund's first fiscal year.
-11-
<PAGE> 12
5. The Manager has contractually agreed to reimburse each Fund with
respect to certain Fund expenses through at least June 30, 2000 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 and transfer taxes) would
otherwise exceed the percentage of that Fund's daily net assets set
forth under the heading "Investment Management Fee" for each Fund.
EXAMPLES
The examples below illustrate the expenses you would incur on a $10,000
investment over the stated periods, assuming your investment had a 5% return
each year and the Fund's operating expenses remained the same. The examples are
for comparative purposes only; they do not represent past or future expenses or
performance, and your actual expenses and performance may be higher or lower.
Except as otherwise noted, the expenses shown assume no reimbursement of
expenses by the Manager.
<TABLE>
<CAPTION>
- ----------------------------------- ---------------------------------------------- ----------------------------------------------
EXAMPLE 1:
Assuming you redeem your shares EXAMPLE 2:
GMO FUND NAME At the end of each period Assuming you do not redeem your shares
- ----------------------------------- ---------------------------------------------- ----------------------------------------------
1 Year 3 Years 5 Years 10 Years 1 Year 3 Years 5 Years 10 Years
(after reimbursement) (after reimbursement)
- ----------------------------------- --------------------- ------- ------- -------- --------------------- ------- ------- --------
Tax-Managed U.S Equities Fund -
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Class III $ 63 $445 $ 851 $1,988 $ 63 $445 $ 851 $1,988
- ----------------------------------- --------------------- ------- ------- -------- --------------------- ------- ------- --------
Tax-Managed International Equities
Fund - Class III $130 $734 $1,364 $3,062 $130 $734 $1,364 $3,062
- ----------------------------------- --------------------- ------- ------- -------- --------------------- ------- ------- --------
Tax-Managed Small Companies Fund -
Class III $121 $316 n/a n/a $121 $316 n/a n/a
- ----------------------------------- --------------------- ------- ------- -------- --------------------- ------- ------- --------
</TABLE>
-12-
<PAGE> 13
BENCHMARKS AND INDEXES
For each of the Funds, the GMO benchmark differs from the broad-based
index that the SEC requires each Fund to use in the average annual return table
in that it is measured on an "after tax" basis. This means that the Manager
measures the relevant Fund's after tax performance against the Manager's
calculation of the after tax performance of the relevant benchmark. Some general
information about each benchmark and index referred to in this Prospectus is
provided in the table below.
<TABLE>
<CAPTION>
- ----------------------- -------------------------- ---------------------- ----------------------------------------------------------
ABBREVIATION FULL NAME SPONSOR OR PUBLISHER DESCRIPTION
- ----------------------- -------------------------- ---------------------- ----------------------------------------------------------
<S> <C> <C> <C>
GMO S&P 500 (After Tax) GMO S&P 500 Index (After GMO GMO calculates this index by applying a 40% tax (credit)
Tax) on short-term realized capital gains (losses), a 40% tax
on income, and a 20% tax (credit) on long-term realized
capital gains (losses) on the securities comprising the
S&P 500 Index
- ----------------------- -------------------------- ---------------------- ----------------------------------------------------------
GMO EAFE (After Tax) GMO EAFE Index (After Tax) GMO GMO calculates this index by applying a 40% tax (credit)
on short-term realized capital gains (losses), a 40% tax
on income, and a 20% tax (credit) on long-term realized
capital gains (losses) on the securities comprising the
MSCI EAFE Index
- ----------------------- -------------------------- ---------------------- ----------------------------------------------------------
GMO Russell 2500 Index GMO Russell 2500 Index GMO GMO calculates this index by applying a 40% tax (credit)
(After Tax) (After Tax) on short-term realized capital gains (losses), a 40% tax
on income, and a 20% tax (credit) on long-term realized
capital gains (losses) on the securities comprising the
Russell 2500 Index. The Russell 2500 Index is an
independently maintained and published index composed of
the 2,500 smallest companies in the Russell 3000 Index
(which in turn measures the performance of the 3,000
largest U.S. companies based on total market
capitalization; these 3,000 companies represent
approximately 98% of the investable U.S. equity market),
which represents approximately 22% of the total market
capitalization of the Russell 3000 Index. As of the latest
reconstitution, the average market capitalization was
approximately $931.0 million; the median market
capitalization was approximately $630.0 million. The
largest company in the index had an approximate market
capitalization of $3.7 billion.
- ----------------------- -------------------------- ---------------------- ----------------------------------------------------------
</TABLE>
DETERMINATION OF NET ASSET VALUE
The net asset value of a share is determined for each Fund once on each
day on which the New York Stock Exchange is open for regular business, except
that a Fund may not determine its net asset value on days during which no
security is tendered for redemption and no order to purchase or sell such
security is received by the relevant Fund. Net asset value is determined as of
the close of regular trading on the New York Stock Exchange, generally 4:00 p.m.
New York City Time. A Fund's net asset value is determined by dividing the total
market value of the Fund's portfolio investments and other assets, less any
liabilities, by the total outstanding shares of the Fund. Portfolio securities
listed on a securities exchange for which market quotations are available are
valued at the last quoted sale price on each business day or, if there is no
such reported sale, at the most recent quoted bid price. However, for those
securities that are listed on an exchange but that exchange is less relevant in
determining the market value of such securities than is the private market, a
broker bid will be used. Criteria for relevance include where the securities are
principally traded and what their intended market for disposition is. 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.
-13-
<PAGE> 14
All other fixed income securities (which include 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) 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 Funds' net asset value. If an event materially affecting the
value of such foreign securities occurs during such period, then such securities
may 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 Funds even though there has not been any change in the values of
such securities and options measured in terms of the foreign currencies in which
they are denominated.
SPECIAL INFORMATION ON REDEMPTIONS IN KIND
General information relating to the purchase and redemption of Fund
shares is contained in the GMO Trust Shareholder's Manual. In addition,
investors in the Tax-Managed Funds should be aware that they may be more likely
to have a redemption request honored "in kind" than shareholders of other funds.
More specifically, if the Manager determines, in its sole discretion, that it
would be detrimental to the best interests of the remaining shareholders of a
Fund to make payment wholly or partly in cash, the Fund may pay the redemption
price in whole or in part by a distribution in kind of securities held by the
Fund in lieu of cash. 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 a Fund in kind
will be selected by the Manager in light of the Fund's objective and will not
generally represent a pro rata distribution of each security held in the Fund's
portfolio. Any in kind redemptions will be of readily marketable securities to
the extent available. Investors may incur brokerage charges on the sale of any
such securities so received in payment of redemptions.
TAXES
The following is a general summary of the principal federal income tax
consequences of investing in a 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 a Fund in light
of each shareholder's particular tax situation, including possible foreign,
state, local or other applicable tax laws (including the federal alternative
minimum tax).
-14-
<PAGE> 15
- - Each Fund is treated as a separate taxable entity for federal income tax
purposes and intends to qualify each year as a regulated investment company
under Subchapter M of the Internal Revenue Code of 1986, as amended.
- - 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. Properly designated Fund
distributions derived from net long-term capital gains will be taxable as
such (generally at a 20% rate for noncorporate shareholders). Distributions
by a Fund result in a reduction in the net asset value of the Fund's
shares. Should a distribution reduce the net asset value below a
shareholder's cost basis, such distribution nevertheless may be taxable to
the shareholder as described above, even though, from an investment
standpoint, it may constitute a partial return of capital. In particular,
shareholders should be careful to consider the tax implications of buying
shares just prior to a taxable distribution. The price of shares purchased
at that time includes the amount of any forthcoming distribution.
Shareholders purchasing shares just prior to a taxable distribution will
receive a return of investment upon distribution that nevertheless will be
taxable to them.
- - A Fund's investments in foreign securities may be subject to foreign
withholding taxes on dividends or interest. In that case, such Fund's yield
on those securities would be decreased. In certain instances, shareholders
may be entitled to claim a credit or deduction with respect to foreign
taxes.
- - In addition, a Fund's investments in foreign securities, foreign
currencies, debt obligations issued or purchased at a discount, assets
"marked to the market" for federal income tax purposes and, potentially,
so-called "indexed securities" (including inflation indexed bonds) may
increase or accelerate such Fund's recognition of income, including the
recognition of taxable income in excess of the cash generated by such
investments. These investments may, therefore, affect the timing or amount
of such Fund's distributions and may cause such Fund to liquidate other
investments to satisfy the distribution requirements that apply to entities
taxed as regulated investment companies.
- - Any gain resulting from the sale or exchange of your shares, including a
redemption in kind, will generally also be subject to tax.
MANAGEMENT OF THE TRUST
The Funds are 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. 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 separate Management Contracts with each Fund, the Manager selects
and reviews each Fund's investments and provides executive and other personnel
for the management of the Trust. Pursuant to the Trust's Agreement and
Declaration of Trust, the Board of Trustees supervises the affairs of the Trust
as conducted by the Manager. In the event that the Manager ceases to be the
manager of the Fund, the right of the Trust to use the identifying name "GMO"
may be withdrawn.
Each Management Contract provides for payment to the Manager of a
management fee at the stated annual rates set forth under "Fees and Expenses."
The management fee is computed and accrued daily, and paid monthly. In addition,
with respect to each Fund, the Manager has contractually agreed to reimburse
each Fund and to bear certain Fund expenses until at least June 30, 2000 in
order to limit each Fund's annual expenses to
-15-
<PAGE> 16
specified limits (with certain exclusions). These limits and the terms
applicable to them are described under "Fees and Expenses."
Mr. R. Jeremy Grantham and Mr. Nardin Baker have been primarily
responsible for the day-to-day management of the Tax-Managed U.S. Equities Fund
and the Tax-Managed International Equities Fund since the Funds' inception in
1998. Mr. Grantham, Mr. Baker and Mr. Christopher Darnell have been primarily
responsible for the day-to-day management of the Tax-Managed Small Companies
Fund since the Fund's inception in 1999. Mr. Grantham is a founding partner of
the Manager, currently serves as a member of the Manager, and has been engaged
by the Manager in portfolio management since the Manager's inception in 1977.
Mr. Baker has been engaged by the Manager in portfolio management since 1995.
Before that, Mr. Baker was the Director of the Quantitative Equity group at
National Investment Services. Mr. Darnell joined the Manager in 1984, currently
serves as a member of the Manager, and has been engaged by the Manager in
portfolio management since 1984.
Pursuant to a Servicing Agreement with the Trust on behalf of each
class of shares of each Fund of the Trust, GMO, 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.
-16-
<PAGE> 17
FINANCIAL HIGHLIGHTS
(For a Share outstanding throughout each period shown)
CLASS III SHARES
TAX-MANAGED U.S. EQUITIES FUND Period from July 23, 1998
(commencement of operations)
through February 28, 1999
-------------------------
Net asset value, beginning of period............................$10.00
Income from investment operations:
Net investment income....................................... 0.09
Net realized and unrealized gain............................ 0.65
------
Total from investment operations...................... 0.74
------
Less distributions to shareholders:
From net investment income................................. (0.07)
------
Total distributions................................... (0.07)
------
Net asset value, end of period..................................$10.67
======
Total Return (a)................................................ 7.48%
Ratios/Supplemental Data:
Net assets, end of period (000's)..........................$8,116
Net expenses to average daily net assets................... 0.48%*
Net investment income to average daily net
assets................................................... 1.30%*
Portfolio turnover rate.................................... 33%
Fees and expenses voluntarily waived or borne by the
Manager consisted of the following per share amount:..........$ 0.10
* Annualized.
(a) Calculation excludes purchase premiums. The total return would have been
lower had certain expenses not been waived during the period shown.
The financial highlight tables are intended to help you understand each Fund's
financial performance since inception. Certain information reflects financial
results for a single Fund share. The total returns in the tables represent the
rate that an investor would have earned (or lost) on an investment in the Fund
(assuming reinvestment of all dividends and distributions). This information has
been audited by PricewaterhouseCoopers LLP, independent accountants, whose
report, along with the Fund's financial statements, is included in the Trust's
Annual Reports, which are incorporated by reference in the Statement of
Additional Information and available upon request.
CLASS III SHARES
TAX-MANAGED U.S. INTERNATIONAL EQUITIES FUND Period from July 29, 1998
(commencement of operations)
through February 28, 1999
-------------------------
Net asset value, beginning of period...........................$ 10.00
Income (loss) from investment operations:
Net investment income...................................... 0.04
Net realized and unrealized loss........................... (0.28)
Total from investment operations..................... (0.24)
Less distributions to shareholders:
From net investment income................................ (0.04)
In excess of net investment income........................ (0.01)
Total distributions.................................. (0.05)
Net asset value, end of period.................................$ 9.71
Total Return (a)............................................... (2.44%)
Ratios/Supplemental Data:
Net assets, end of period (000's).........................$18,529
Net expenses to average daily net assets.................. 0.69%*
Net investment income to average daily net
assets.................................................. 0.87%*
Portfolio turnover rate................................... 20%
Fees and expenses voluntarily waived or borne by the
Manager consisted of the following per share amount:.........$ 0.12
* Annualized
(a) Calculation excludes purchase premiums. The total return would have been
lower had certain expenses not been waived during the period shown.
The financial highlight tables are intended to help you understand each Fund's
financial performance since inception. Certain information reflects financial
results for a single Fund share. The total returns in the tables represent the
rate that an investor would have earned (or lost) on an investment in the Fund
(assuming reinvestment of all dividends and distributions). This information has
been audited by PricewaterhouseCoopers LLP, independent accountants, whose
report, along with the Fund's financial statements, is included in the Trust's
Annual Reports, which are incorporated by reference in the Statement of
Additional Information and available upon request.
-17-
<PAGE> 18
ADDITIONAL INFORMATION
Additional information about each Fund's investments is available in
the relevant Fund's annual and semi-annual reports to shareholders. In each
Fund's annual report, you will find a discussion of the market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. The most recent annual and semi-annual reports, the Funds'
Statement of Additional Information dated October 18, 1999, as revised from time
to time (the "Statement"), and the Fund's Investment Guidelines are available
free of charge by writing to GMO, 40 Rowes Wharf, Boston, Massachusetts 02110 or
by calling collect (617) 346-7646. The Statement, which contains more detailed
information about each Fund, has been filed with the Securities and Exchange
Commission ("SEC") and is incorporated by reference into this Prospectus.
Information about each Fund (including the Statement) can be reviewed
and copied at the SEC's Public Reference Room in Washington, D.C. Information
regarding the operation of the Public Reference Room may be obtained by calling
the SEC at 1-800-SEC-0330. Reports and other information about the Funds are
available on the Commission's Internet site at http://www.sec.gov. Copies of
this information may be obtained, upon payment of a duplicating fee, by writing
the Public Reference Section of the SEC, Washington, D.C. 20549-6009.
PURCHASE AND SALE INFORMATION
Information regarding the purchase and sale of Fund shares and
eligibility requirements for other classes of shares is contained in a separate
document, the GMO Trust Shareholder's Manual. The Manual accompanies this
Prospectus, has been filed with the SEC and is incorporated by reference into
this Prospectus. Additional copies of the Manual are available free of charge by
contacting the Manager.
SHAREHOLDER INQUIRIES
Shareholders may request additional
information from and direct inquiries to:
GRANTHAM, MAYO, VAN OTTERLOO & CO. LLC,
40 ROWES WHARF, BOSTON, MA 02110
(617) 346-7646 (CALL COLLECT)
INVESTMENT COMPANY ACT FILE NO. 811-4347
<PAGE> 19
GMO TAX-MANAGED U.S. EQUITIES FUND
GMO TAX-MANAGED INTERNATIONAL EQUITIES FUND
GMO TAX-MANAGED SMALL COMPANIES FUND
STATEMENT OF ADDITIONAL INFORMATION
October 18, 1999
This Statement of Additional Information is not a prospectus. It relates to the
combined GMO Tax-Managed U.S. Tax-Managed Equities, GMO Tax-Managed
International Equities Fund and GMO Tax-Managed Small Companies Fund Prospectus
dated October 18, 1999, as amended from time to time (the "Prospectus"), and
should be read in conjunction therewith. Information from the Prospectus
(including the GMO Trust Shareholder's Manual dated October 18, 1999) is
incorporated by reference into this Statement of Additional Information. The
Prospectus and Shareholder's Manual may be obtained free of charge from GMO
Trust, 40 Rowes Wharf, Boston, Massachusetts 02110, or by calling the Trust
collect at (617) 346-7646.
<PAGE> 20
TABLE OF CONTENTS
PAGE
----
INVESTMENT OBJECTIVES AND POLICIES.............................................1
DESCRIPTIONS AND RISKS OF FUND INVESTMENTS.....................................1
INVESTMENT RESTRICTIONS.......................................................24
MANAGEMENT OF THE TRUST.......................................................26
INVESTMENT ADVISORY AND OTHER SERVICES........................................29
PORTFOLIO TRANSACTIONS........................................................31
DETERMINATION OF NET ASSET VALUE .............................................33
DESCRIPTION OF THE TRUST AND OWNERSHIP OF SHARES..............................33
VOTING RIGHTS.................................................................34
SHAREHOLDER AND TRUSTEE LIABILITY.............................................35
BENEFICIAL OWNERS OF 5% OR MORE OF THE FUND'S SHARES..........................37
DISTRIBUTIONS.................................................................38
TAXES.........................................................................38
PERFORMANCE INFORMATION.......................................................43
INVESTMENT GUIDELINES.........................................................45
FINANCIAL STATEMENTS..........................................................60
SPECIMEN PRICE-MAKE-UP SHEET..................................................60
i
<PAGE> 21
INVESTMENT OBJECTIVES AND POLICIES
The principal strategies and risks of investing in the GMO Tax-Managed
U.S. Equities Fund, GMO Tax-Managed Equities International Equities Fund and GMO
Tax-Managed Small Companies Fund (each a "Fund" and together the "Funds") are
described in the Prospectus. Unless otherwise indicated in the Prospectus or
this Statement of Additional Information, the investment objective and policies
of the Funds may be changed without shareholder approval.
DESCRIPTIONS AND RISKS OF FUND INVESTMENTS
The following is a detailed description of the various investment
practices in which the Funds may engage and the risks associated with their use.
Each Fund may not necessarily engage in all practices described below. Please
refer to "Fund Objectives and Principal Investment Strategies" in the Prospectus
and "Investment Guidelines" in this Statement of Additional Information for
additional information regarding which practices a particular Fund may engage
in.
PORTFOLIO TURNOVER
The after-tax impact of portfolio turnover will be considered when
making investment decisions for the Funds. The historical portfolio turnover
rates for each Fund are shown under the heading "Financial Highlights" in the
Prospectus, except for the GMO Tax-Managed Small Companies Fund, which commenced
operations in 1999.
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 relevant Fund, and may involve realization of
capital gains that would be taxable when distributed to shareholders of the
relevant Fund unless such shareholders are themselves exempt. See "Taxes" in the
Prospectus and "Distributions" and "Taxes" in this Statement of Additional
Information. To the extent that portfolio turnover results in the recognition of
short-term capital gains, such gains are typically taxed to shareholders at
ordinary income tax rates.
DIVERSIFIED AND NON-DIVERSIFIED PORTFOLIOS
The Funds are "non-diversified" funds under the 1940 Act, and as such
are not required to satisfy the "diversified" fund requirement set forth in the
1940 Act. As non-diversified funds, each of the Funds 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 each 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 investment in a
diversified fund. Each Fund, however, must meet certain diversification
standards to qualify as a "regulated investment company" under the Internal
Revenue Code of 1986, as amended.
<PAGE> 22
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 a Fund's
ability to invest in securities of certain issuers located in these foreign
countries. There are also special tax considerations which apply to securities
of foreign issuers and securities principally traded overseas. Investors should
also be aware that under certain circumstances, markets which are perceived to
have similar characteristics to troubled markets may be adversely affected
whether or not similarities actually exist.
EMERGING MARKETS. The risks described above apply to an even greater
extent to investments in emerging markets. The securities markets of emerging
countries are generally smaller, less developed, less liquid, and more volatile
than the U.S. and developed foreign securities markets. Disclosure and
regulatory standards in many respects are less stringent than in the U.S. and
developed foreign securities markets. There also may be a lower level of
monitoring and regulation of securities markets in emerging market countries and
the activities of investors in such markets, and enforcement of existing
regulations has been extremely limited. Many emerging countries have experienced
substantial, and in some periods extremely high, rates of inflation for many
years. Inflation and rapid fluctuations in inflation rates have had and may
continue to have very negative effects on the economies and securities markets
of certain emerging countries. Economies in emerging markets generally are
heavily dependent upon international trade and, accordingly, have been and may
continue to be affected adversely by trade barriers, exchange controls, managed
adjustments in relative currency values, and other protectionist measures
imposed or negotiated by the countries with which they trade. These economies
also have been and may continue to be adversely affected by economic conditions
in the countries in which they trade. The economies of countries with emerging
markets may also be predominantly based on only a few industries or dependent on
revenues from particular commodities. In addition, custodial services and other
costs relating to investment in foreign markets may be more expensive in
emerging markets than in many developed foreign markets, which could reduce a
Fund's income from such securities. Finally, because publicly traded debt
instruments of emerging markets represent a relatively recent innovation in the
world debt markets, there is little historical data or related market experience
concerning the attributes of such instruments under all economic, market and
political conditions.
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
2
<PAGE> 23
instruments to make payments on their debt obligations, regardless of their
financial condition. In addition, there is a heightened possibility of
expropriation or confiscatory taxation, imposition of withholding taxes on
interest payments, or other similar developments that could affect investments
in those countries. There can be no assurance that adverse political changes
will not cause a Fund to suffer a loss of any or all of its investments or, in
the case of fixed-income securities, interest thereon.
INVESTMENTS IN ASIA. In addition to the foregoing risks of foreign
investments and risks specific to emerging markets, investments by the
Tax-Managed International Equities Fund in Asia involve additional risks
specific to investment in the region. 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.
Investments in Asia are 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 will
continue to affect the region.
Some countries in the region are heavily dependent upon foreign trade.
The economies of some Asian countries are not diversified and are based upon
only a few commodities or industries. Markets in some of these countries are in
the early stages of development, exhibit a high concentration of market
capitalization, have less trading volume, lower liquidity and more volatility
than more developed markets.
In the latter half of 1997, the region began experiencing increased
market volatility and declines in foreign currency exchange rates. Fluctuation
in currency exchange rates can affect a country's ability to service its debt.
Currency fluctuation will affect the value of the securities in the Fund's
portfolio because the prices of these securities are generally denominated or
quoted in currencies other than the U.S. dollar.
DIRECT INVESTMENT IN RUSSIAN SECURITIES. The Tax-Managed International
Equities Fund may invest directly in securities of Russian issuers. Investment
in securities of such issuers presents many of the same risks as investing in
securities of issuers in other emerging market economies, as described in the
immediately preceding section. However, the political, legal and operational
risks of investing in Russian issuers, and of having assets custodied within
Russia, may be particularly acute.
A risk of particular note with respect to direct investment in Russian
securities is the way in which ownership of shares of private companies is
recorded. When the Fund invests in a
3
<PAGE> 24
Russian issuer, it will receive a "share extract," but that extract is not
legally determinative of ownership. The official record of ownership of a
company's share is maintained by the company's share registrar. Such share
registrars are completely under the control of the issuer, and investors are
provided with few legal rights against such registrars.
SECURITIES LENDING
A 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 liquid
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 liquid 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. A Fund may also call such loans in order to sell the
securities involved. The Manager has retained lending agents on behalf of the
Funds that are compensated based on a percentage of each Fund's return on the
securities lending activity. The Funds also pay 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
A 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
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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
The Funds may use futures and options for various purposes. Such transactions
may involve options, futures and related options on futures contracts, and those
instruments may relate to particular equity and fixed income securities, equity
and fixed income indexes, and foreign currencies. The Funds may also enter into
a combination of long and short positions (including spreads and straddles) for
a variety of investment strategies, including protecting against changes in
certain yield relationships.
The use of futures contracts, option contracts and options on futures
contracts involves risk. Thus, while a Fund may benefit from the use of futures,
options 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, options and
options on futures and the costs of these transactions will affect a Fund's
performance.
OPTIONS. As has been noted above, the Funds (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. A Fund may seek to increase its return by writing
covered call or put options on optionable securities or indexes. A call option
written by a Fund on a security gives the holder the right to buy the underlying
security from the Fund at a stated exercise price; a put option gives the holder
the right to sell the underlying security to the Fund at a stated exercise
price. In the case of options on indexes, the options are usually cash settled
based on the difference between the strike price and the value of the index.
Each such Fund will receive a premium for writing a put or call option,
which increases the Fund's return in the event the option expires unexercised or
is closed out at a profit. The amount of the premium will reflect, among other
things, the relationship of the market price and volatility of the underlying
security or securities index to the exercise price of the option, the remaining
term of the option, supply and demand and interest rates. By writing a call
option on a security, the Fund limits its opportunity to profit from any
increase in the market value of the underlying security above the exercise price
of the option. By writing a put option on a security,
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the Fund assumes the risk that it may be required to purchase the underlying
security for an exercise price higher than its then current market value,
resulting in a potential capital loss unless the security subsequently
appreciates in value. In the case of options on an index, if a Fund writes a
call, any profit by the Fund in respect of portfolio securities expected to
correlate with the index will be limited by an increase in the index above the
exercise price of the option. If the Fund writes a put on an index, the Fund may
be required to make a cash settlement greater than the premium received if the
index declines.
A call option on a security is "covered" if the relevant 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 on a security
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 call option on an index is "covered" if
a Fund maintains cash, U.S. Government Securities or other liquid assets with a
value equal to the exercise price in a segregated account with its custodian. A
put option is "covered" if the Fund maintains cash, U.S. Government Securities
or other liquid assets 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 a Fund will be able to effect a closing purchase or a
closing sale transaction at any particular time. Also, an over-the-counter
option may be closed out only with the other party to the option transaction.
Effecting a closing transaction in the case of a written call option
will permit a 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 a Fund to write another put option to the
extent that the exercise price thereof is secured by deposited cash or high
grade debt obligations. Also, effecting a closing transaction will permit the
cash or proceeds from the concurrent sale of any securities subject to the
option to be used for other Fund investments. If a Fund desires to sell a
particular security from its portfolio on which it has written a call option, it
will effect a closing transaction prior to or concurrent with the sale of the
security.
A Fund will realize a profit from a closing transaction if the price of
the transaction is less than the premium received from writing the option or is
more than the premium paid to
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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 written call option is likely to be offset in
whole or in part by appreciation of the underlying security or securities owned
by the Fund.
A Fund may write options in connection with buy-and-write transactions;
that is, a Fund may purchase a security and then write a call option against
that security. The exercise price of the call the Fund determines to write will
depend upon the expected price movement of the underlying security. The exercise
price of a call option may be below ("in-the-money"), equal to ("at-the-money")
or above ("out-of-the-money") the current value of the underlying security at
the time the option is written. Buy-and-write transactions using in-the-money
call options may be used when it is expected that the price of the underlying
security will remain flat or decline moderately during the option period.
Buy-and-write transactions using at-the-money call options may be used when it
is expected that the price of the underlying security will remain fixed or
advance moderately during the option period. Buy-and-write transactions using
out-of-the-money call options may be used when it is expected that the premiums
received from writing the call option plus the appreciation in the market price
of the underlying security up to the exercise price will be greater than the
appreciation in the price of the underlying security alone. If the call options
are exercised in such transactions, the Fund's maximum gain will be the premium
received by it for writing the option, adjusted upward or downward by the
difference between the Fund's purchase price of the security and the exercise
price. If the options are not exercised and the price of the underlying security
declines, the amount of such decline will be offset in part, or entirely, by the
premium received.
The writing of covered put options is similar in terms of risk/return
characteristics to buy-and-write transactions. If the market price of the
underlying security rises or otherwise is above the exercise price, the put
option will expire worthless and the Fund's gain will be limited to the premium
received. If the market price of the underlying security declines or otherwise
is below the exercise price, the Fund may elect to close the position or take
delivery of the security at the exercise price. In that event, the Fund's return
will be the premium received from the put option minus the cost of closing the
position or, if it chooses to take delivery of the security, the premium
received from the put option minus the amount by which the market price of the
security is below the exercise price. Out-of-the-money, at-the-money and
in-the-money put options may be used by the Fund in market environments
analogous to those in which call options are used in buy-and-write transactions.
The extent to which a Fund will be able to write and purchase call and
put options may be restricted by the Fund's intention to qualify as a regulated
investment company under the Internal Revenue Code.
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
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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 a Fund is unable to effect a closing purchase transaction in a
secondary market (in the case of a listed option) or with the purchaser of the
option (in the case of an over-the-counter option), the Fund will not be able to
sell the underlying security (or futures contract) until the option expires or
it delivers the underlying security (or futures contract) upon exercise. Reasons
for the absence of a liquid secondary market on an Exchange include the
following: (i) there may be insufficient trading interest in certain options;
(ii) restrictions may be imposed by an Exchange on opening transactions or
closing transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or series of
options or underlying securities; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an Exchange; (v) the facilities of an Exchange or
the Options Clearing Corporation may not at all times be adequate to handle
current trading volume; or (vi) one or more Exchanges could, for economic or
other reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options), in which event
the secondary market on that Exchange (or in that class or series of options)
would cease to exist, although outstanding options on that Exchange that had
been issued by the Options Clearing Corporation as a result of trades on that
Exchange should continue to be exercisable in accordance with their terms.
The Exchanges have established limitations governing the maximum number
of options which may be written by an investor or group of investors acting in
concert. It is possible that the Funds, the Manager and other clients of the
Manager may be considered to be such a group. These position limits may restrict
a Fund's ability to purchase or sell options on a particular security.
The amount of risk a Fund assumes when it purchases an option is the
premium paid for the option plus related transaction costs. In addition to the
correlation risks discussed below, the purchase of an option also entails the
risk that changes in the value of the underlying security or futures contract
will not be fully reflected in the value of the option purchased.
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
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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.
The purchase or sale of a futures contract differs from the purchase or
sale of a security or option in that no price or premium is paid or received.
Instead, an amount of cash or U.S. Government Securities generally not exceeding
5% of the face amount of the futures contract must be deposited with the broker.
This amount is known as initial margin. Subsequent payments to and from the
broker, known as variation margin, are made on a daily basis as the price of the
underlying futures contract fluctuates making the long and short positions in
the futures contract more or less valuable, a process known as "marking to
market." Prior to the settlement date of the futures contract, the position may
be closed out by taking an opposite position which will operate to terminate the
position in the futures contract. A final determination of variation margin is
then made, additional cash is required to be paid to or released by the broker,
and the purchaser realizes a loss or gain. In addition, a commission is paid on
each completed purchase and sale transaction.
In most cases futures contracts are closed out before the settlement
date without the making or taking of delivery. Closing out a futures contract
sale is effected by purchasing a futures contract for the same aggregate amount
of the specific type of financial instrument or commodity and the same delivery
date. If the price of the initial sale of the futures contract exceeds the price
of the offsetting purchase, the seller is paid the difference and realizes a
gain. Conversely, if the price of the offsetting purchase exceeds the price of
the initial sale, the seller realizes a loss. Similarly, the closing out of a
futures contract purchase is effected by the purchaser entering into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the
purchaser realizes a gain, and if the purchase price exceeds the offsetting sale
price, a loss will be realized.
The ability to establish and close out positions on options on futures
will be subject to the development and maintenance of a liquid secondary market.
It is not certain that this market will develop or be maintained.
INDEX FUTURES. Each of the Funds may purchase futures contracts on various
securities indexes ("Index Futures"). For example, the Tax-Managed U.S. Equities
Fund and the Tax-Managed Small Companies Fund may purchase Index Futures on such
domestic stock indexes as the Manager may deem appropriate, and the
The Tax-Managed International Equities Fund may purchase Index Futures on such
foreign stock indexes as the Manager may deem appropriate,
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including those which trade outside the United States. A Fund's purchase and
sale of Index Futures is limited to contracts and exchanges which have been
approved by the CFTC.
An Index Future may call for "physical delivery" or be "cash settled."
An Index Future that calls for physical delivery is a contract to buy an
integral number of units of the particular securities index at a specified
future date at a price agreed upon when the contract is made. A unit is the
value from time to time of the relevant index. While a Fund that purchases an
Index Future that calls for physical delivery is obligated to pay the face
amount on the stated date, such an Index Future may be closed out on that date
or any earlier date by selling an Index Future with the same face amount and
contract date. This will terminate the Fund's position and the Fund will realize
a profit or a loss based on the difference between the cost of purchasing the
original Index Future and the price obtained from selling the closing Index
Future. The amount of the profit or loss is determined by the change in the
value of the relevant index while the Index Future was held.
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 a 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).
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.
A 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) with settlement made, in the
case of S&P 500 Index Futures, with the Commodities Clearing House. Additional
or different margin requirements as well as settlement procedures may be
applicable to foreign stock Index Futures at the time a 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 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
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perfectly to hours of trading on the foreign exchange to which a particular
foreign stock Index Futures relates. This may result in a disparity between the
price of Index Futures and the value of the relevant index due to the lack of
continuous arbitrage between the Index Futures price and the value of the
underlying index.
OPTIONS ON FUTURES CONTRACTS. Options on futures contracts give the purchaser
the right in return for the premium paid to assume a position in a futures
contract at the specified option-exercise price at any time during the period of
the option. Funds may use options on futures contracts in lieu of writing or
buying options directly on the underlying securities or purchasing and selling
the underlying futures contracts. For example, to hedge against a possible
decrease in the value of its portfolio securities, a Fund may purchase put
options or write call options on futures contracts rather than selling futures
contracts. Similarly, a Fund may purchase call options or write put options on
futures contracts as a substitute for the purchase of futures contracts to hedge
against a possible increase in the price of securities which the Fund expects to
purchase. Such options generally operate in the same manner as options purchased
or written directly on the underlying investments. See "Foreign Currency
Transactions" below for a description of the Funds' use of options on currency
futures.
RISK FACTORS IN FUTURES TRANSACTIONS. Investment in futures contracts involves
risk. If the futures are used for hedging, some of that risk may be caused by an
imperfect correlation between movements in the price of the futures contract and
the price of the security or currency being hedged. The correlation is higher
between price movements of futures contracts and the instrument underlying that
futures contract. The correlation is lower when futures are used to hedge
securities other than such underlying instrument, such as when a futures
contract on an index of securities is used to hedge a single security, a futures
contract on one security (e.g., U.S. Treasury bonds) is used to hedge a
different security (e.g., a mortgage-backed security) or when a futures contract
in one currency is used to hedge a security denominated in another currency. 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 a Fund may be exposed to risk of
loss. In addition, it is not always possible to hedge fully or perfectly against
currency fluctuations affecting the value of the securities denominated in
foreign currencies because the value of such securities also is likely to
fluctuate as a result of independent factors not related to currency
fluctuations. The risk of imperfect correlation generally tends to diminish as
the maturity date of the futures contract approaches.
A hedge will not be fully effective where there is such imperfect
correlation. To compensate for imperfect correlations, a Fund may purchase or
sell futures contracts in a greater amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, a Fund may purchase or sell fewer
contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contract.
A Fund may also purchase futures contracts (or options thereon) as an
anticipatory hedge against a possible increase in the price of currency in which
is denominated the securities the Fund anticipates purchasing. In such
instances, it is possible that the currency may instead decline. If the Fund
does not then invest in such securities because of concern as to possible
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further market and/or currency decline or for other reasons, the Fund may
realize a loss on the futures contract that is not offset by a reduction in the
price of the securities purchased.
The liquidity of a secondary market in a futures contract may be
adversely affected by "daily price fluctuation limits" established by commodity
exchanges which limit the amount of fluctuation in a futures contract price
during a single trading day. Once the daily limit has been reached in the
contract, no trades may be entered into at a price beyond the limit, thus
preventing the liquidation of open futures positions. Prices have in the past
exceeded the daily limit on a number of consecutive trading days. Short
positions in index futures may be closed out only by entering into a futures
contract purchase on the futures exchange on which the index futures are traded.
The successful use of transactions in futures and related options for
hedging and risk management also depends on the ability of the Manager to
forecast correctly the direction and extent of exchange rate, interest rate and
stock price movements within a given time frame. For example, to the extent
interest rates remain stable during the period in which a futures contract or
option is held by a Fund investing in fixed income securities (or such rates
move in a direction opposite to that anticipated), the Fund may realize a loss
on the futures transaction which is not fully or partially offset by an increase
in the value of its portfolio securities. As a result, the Fund's total return
for such period may be less than if it had not engaged in the hedging
transaction.
Unlike trading on domestic commodity exchanges, trading on foreign
commodity exchanges is not regulated by the CFTC and may be subject to greater
risks than trading on domestic exchanges. For example, some foreign exchanges
may be principal markets so that no common clearing facility exists and a trader
may look only to the broker for performance of the contract. In addition, unless
a Fund hedges against fluctuations in the exchange rate between the U.S. dollar
and the currencies in which trading is done on foreign exchanges, any profits
that a Fund might 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.
USES OF OPTIONS, FUTURES AND OPTIONS ON FUTURES
RISK MANAGEMENT. When futures and options on futures are used for risk
management, a Fund will generally take long positions (e.g., purchase call
options, futures contracts or options thereon) in order to increase the Fund's
exposure to a particular market, market segment or foreign currency. For
example, if a Fund holds a portfolio of stocks with an average volatility (beta)
lower than that of the Fund's benchmark securities index as a whole (deemed to
be 1.00), the Fund may purchase Index Futures to increase its average volatility
to 1.00. In the case of futures and options on futures, a Fund is only required
to deposit the initial and variation margin as required by relevant CFTC
regulations and the rules of the contract markets. Because the Fund will then be
obligated to purchase the security or index at a set price on a future date, the
Fund's net asset value will fluctuate with the value of the security as if it
were already included in the Fund's portfolio. Risk management transactions have
the effect of providing a degree of investment leverage, particularly when a
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
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options) will increase or decrease in value at a rate which is a multiple of the
rate of increase or decrease in the value of the initial and variation margin
that the Fund is required to deposit. As a result, the value of the Fund's
portfolio will generally be more volatile than the value of comparable
portfolios which do not engage in risk management transactions. A Fund will not,
however, use futures and options on futures to obtain greater volatility than it
could obtain through direct investment in securities; that is, a Fund will not
normally engage in risk management to increase the average volatility (beta) of
that Fund's portfolio above 1.00, the level of risk (as measured by volatility)
that would be present if the Fund were fully invested in the securities
comprising the relevant index. However, a Fund may invest in futures and options
on futures without regard to this limitation if the face value of such
investments, when aggregated with the Index Futures, equity swaps and contracts
for differences as described below does not exceed 10% of a Fund's assets.
HEDGING. To the extent indicated elsewhere, a Fund may also enter into options
and futures contracts and buy and sell options on futures for hedging. For
example, a Fund may sell equity index futures if it wants to hedge its equity
securities against a general decline in the relevant equity market(s). The Funds
may also use futures contracts in anticipatory hedge transactions by taking a
long position in a futures contract with respect to a security, index or foreign
currency that a Fund intends to purchase (or whose value is expected to
correlate closely with the security or currency to be purchased) pending receipt
of cash from other transactions to be used for the actual purchase. Then if the
cost of the security or foreign currency to be purchased by the Fund increases
and if the anticipatory hedge is effective, that increased cost should be
offset, at least in part, by the value of the futures contract. Options on
futures contracts may be used for hedging as well. For example, if the value of
a fixed-income security in a Fund's portfolio is expected to decline as a result
of an increase in rates, the Fund might purchase put options or write call
options on futures contracts rather than selling futures contracts. Similarly,
for anticipatory hedging, a Fund may purchase call options or write put options
as a substitute for the purchase of futures contracts. See "Foreign Currency
Transactions" below for more information regarding the currency hedging
practices of the Funds.
INVESTMENT PURPOSES. To the extent indicated elsewhere, a Fund may also enter
into futures contracts and buy and sell options thereon for investment. For
example, a Fund may invest in futures when its Manager believes that there are
not enough attractive securities available to maintain the standards of
diversity and liquidity set for a Fund pending investment in such securities if
or when they do become available. Through this use of futures and related
options, a Fund may diversify risk in its portfolio without incurring the
substantial brokerage costs which may be associated with investment in the
securities of multiple issuers. This use may also permit a Fund to avoid
potential market and liquidity problems (e.g., driving up the price of a
security by purchasing additional shares of a portfolio security or owning so
much of a particular issuer's stock that the sale of such stock depresses that
stock's price) which may result from increases in positions already held by the
Fund.
When any Fund purchases futures contracts for investment, it will
maintain cash, U.S. Government Securities or other liquid assets 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.
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Incidental to other transactions in fixed income securities, for
investment purposes a Fund may also combine futures contracts or options on
fixed income securities with cash, cash equivalent investments or other fixed
income securities in order to create "synthetic" bonds which approximate desired
risk and return profiles. This may be done where a "non-synthetic" security
having the desired risk/return profile either is unavailable (e.g., short-term
securities of certain foreign governments) or possesses undesirable
characteristics (e.g., interest payments on the security would be subject to
foreign withholding taxes). A Fund may also purchase forward foreign exchange
contracts in conjunction with U.S. dollar-denominated securities in order to
create a synthetic foreign currency denominated security which approximates
desired risk and return characteristics where the non-synthetic securities
either are not available in foreign markets or possess undesirable
characteristics. For greater detail, see "Foreign Currency Transactions" below.
When a Fund creates a "synthetic" bond with a futures contract, it will maintain
cash, U.S. Government Securities or other liquid assets in a segregated account
with its custodian with a value at least equal to the face amount of the futures
contract (less the amount of any initial or variation margin on deposit).
SYNTHETIC SALES AND PURCHASES. Futures contracts may also be used to reduce
transaction costs associated with short-term restructuring of a Fund's
portfolio. For example, if a Fund's portfolio includes stocks of companies with
medium-sized equity capitalization 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, a Fund may use futures to achieve a
similar result with reduced transaction costs. In that case, the Fund might
simultaneously enter into short futures positions on an appropriate index (e.g.,
the S&P Mid Cap 400 Index) (to synthetically "sell" the stocks in the Fund) and
long futures positions on another index (e.g., the S&P 500) (to synthetically
"buy" the larger capitalization stocks). When the expected trend has played out,
the Fund would then close out both futures contract positions. A Fund will only
enter into these combined positions if (1) the short position (adjusted for
historic volatility) operates as a hedge of existing portfolio holdings, (2) the
face amount of the long futures position is less than or equal to the value of
the portfolio securities that the Fund would like to dispose of, (3) the
contract settlement date for the short futures position is approximately the
same as that for the long futures position and (4) the Fund segregates an amount
of cash, U.S. Government Securities and other liquid assets whose value,
marked-to-market daily, is equal to the Fund's current obligations in respect of
the long futures contract positions. If a Fund uses such combined short and long
positions, in addition to possible declines in the values of its investment
securities, the Fund may also suffer losses associated with a securities index
underlying the long futures position underperforming the securities index
underlying the short futures position. However, the Manager will enter into
these combined positions only if the Manager expects that, overall, the Fund
will perform as if it had sold the securities hedged by the short position and
purchased the securities underlying the long position. A Fund may also use swaps
and options on futures to achieve the same objective.
LIMITATIONS ON THE USE OF OPTIONS AND FUTURES PORTFOLIO STRATEGIES. As noted
above, the Funds may use futures contracts and related options for hedging and,
in some circumstances, for risk
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management or investment but not for speculation. Thus, except when used for
risk management or investment, a Fund's long futures contract positions (less
its short positions) together with the Fund's cash (i.e., equity or fixed
income) positions will not exceed the Fund's total net assets.
The Funds' ability to engage in the options and futures strategies
described above will depend on the availability of liquid markets in such
instruments. Markets in options and futures with respect to currencies are
relatively new and still developing. It is impossible to predict the amount of
trading interest that may exist in various types of options or futures.
Therefore no assurance can be given that a Fund will be able to utilize these
instruments effectively for the purposes set forth above. Furthermore, each
Fund's ability to engage in options and futures transactions may be limited by
tax considerations.
SWAP CONTRACTS AND OTHER TWO-PARTY CONTRACTS
A 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.
SWAP CONTRACTS. Swap agreements are two-party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to
more than one year. In a standard "swap" transaction, two parties agree to
exchange returns (or differentials in rates of return) calculated with respect
to a "notional amount," e.g., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. A Fund
will usually enter into swaps on a net basis, i.e., the two returns are netted
out, with the Fund receiving or paying, as the case may be, only the net amount
of the two returns.
INTEREST RATE AND CURRENCY SWAPS. 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 a Fund enters into a long equity swap contract, the Fund's net asset
value will fluctuate as a result of changes in the value of the equity index on
which the equity swap is based as if it had purchased the notional amount of
securities comprising the index. A Fund will not use long equity swap contracts
to obtain greater volatility than it could obtain through direct investment in
securities; that is, a Fund will not normally enter into 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
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stocks comprising the Fund's benchmark index. However, a Fund may invest in long
equity swap contracts without regard to this limitation if the notional amount
of such equity swap contracts, when aggregated with the Index Futures as
described above and the contracts for differences as described below, does not
exceed 10% of the Fund's net assets.
Contracts for differences are swap arrangements in which a Fund may
agree with a counterparty that its return (or loss) will be based on the
relative performance of two different groups or "baskets" of securities. As to
one of the baskets, the Fund's return is based on theoretical long futures
positions in the securities comprising that basket (with an aggregate face value
equal to the notional amount of the contract for differences) and as to the
other basket, the Fund's return is based on theoretical short futures positions
in the securities comprising the basket. A Fund may also use actual long and
short futures positions to achieve the same market exposure(s) as contracts for
differences. A 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. A 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 a Fund, even in circumstances
where the securities in both the long and short baskets appreciate in value.
Except for instances in which a Fund elects to obtain leverage up to
the 10% limitation mentioned above, the Funds will maintain cash, U.S.
Government Securities or liquid assets in a segregated account with its
custodian in an amount equal to the aggregate of net payment obligations on its
swap contracts and contracts for differences, marked to market daily.
A Fund may enter into swaps and contracts for differences for hedging,
investment and risk management. When using swaps for hedging, a Fund may enter
into an interest rate, currency or equity swap, as the case may be, on either an
asset-based or liability-based basis, depending on whether it is hedging its
assets or its liabilities. For risk management or investment purposes a Fund may
also enter into a contract for differences in which the notional amount of the
theoretical long position is greater than the notional amount of the theoretical
short position. A Fund will not normally enter into a contract for differences
to increase the volatility (beta) of the Fund's portfolio above 1.00. However, a
Fund may invest in contracts for differences without regard to this limitation
if the aggregate amount by which the theoretical long positions of such
contracts exceed the theoretical short positions of such contracts, 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. A Fund may use interest rate
caps, floors and collars for the same purposes or similar purposes as 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
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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, a Fund will
maintain cash, U.S. Government Securities or other liquid assets in a segregated
account with its custodian in an amount at least equal to its obligations, if
any, under interest rate cap, floor and collar arrangements. As with futures
contracts, when a Fund uses notional amount contracts for risk management it is
only required to segregate assets equal to its net payment obligation, not the
notional amount of the contract. In those cases, the notional amount contract
will have the effect of providing a degree of investment leverage similar to the
leverage associated with non-segregated futures contracts. A 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 presents the same risks
and similar opportunities as those associated with futures and related options.
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 each Fund's limitation on
investment in 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, uncertainty surrounds the recent introduction of the "euro"
(a common currency unit for the European Union) in January 1999. These and other
currencies in which a Fund's assets are denominated may be devalued against the
U.S. dollar, resulting in a loss to the Fund.
A Fund may be 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. A 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 a Fund and a
Fund's performance benchmark.
Forward foreign currency contracts are contracts between two parties to
purchase and sell a specific quality 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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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.
A Fund may enter into forward contracts for hedging under three
circumstances. First, when a Fund enters into a contract for the purchase or
sale of a security denominated in a foreign currency, it may desire to "lock in"
the U.S. dollar price of the security. By entering into a forward contract for
the purchase or sale, for a fixed amount of dollars, of the amount of foreign
currency involved in the underlying security transaction, a Fund will be able to
protect itself against a possible loss resulting from an adverse change in the
relationship between the U.S. dollar and the subject foreign currency during the
period between the date on which the security is purchased or sold and the date
on which payment is made or received.
Second, when the Manager of a Fund believes that the currency of a
particular foreign country may suffer a substantial decline against the U.S.
dollar, it may enter into a forward contract to sell, for a fixed amount of
dollars, the amount of foreign currency approximating the value of some or all
of the Fund's portfolio securities denominated in such foreign currency.
Maintaining a match between the forward contract amounts and the value of the
securities involved will not generally be possible since the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures.
Third, a 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, a 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.
A Fund is not required to enter into hedging transactions with regard
to its foreign currency-denominated securities and will not do so unless deemed
appropriate by the Manager. By entering into the above hedging transactions, a
Fund may be required to forego the benefits of advantageous changes in the
exchange rates.
A Fund may also enter foreign currency forward contracts for investment
and currency risk management. When a Fund uses currency instruments for such
purposes, the foreign currency exposure of the Fund may differ substantially
from the currencies in which the Fund's investment securities are denominated.
However, a Fund's aggregate foreign currency exposure will not normally exceed
100% of the value of the Fund's securities, except that a Fund may use currency
instruments without regard to this limitation if the amount of such excess, when
aggregated with futures contracts, equity swap contracts and contracts for
differences used in similar ways, does not exceed 10% of the Fund's net assets.
Except to the extent that a Fund may use such contracts for risk
management, whenever a Fund enters into a foreign currency forward contract,
other than a forward contract entered into
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for hedging, it will maintain cash, U.S. Government Securities or other liquid
assets in a segregated account with its custodian with a value, marked to market
daily, equal to the amount of the currency required to be delivered. A Fund's
ability to engage in forward contracts may be limited by tax considerations.
A Fund may use currency futures contracts and related options and
options on currencies for the same reasons for which it uses currency forwards.
Except to the extent that a Fund may use futures contracts and related options
for risk management, a Fund will, so long as it is obligated as the writer of a
call option on currency futures, own on a contract-for-contract basis an equal
long position in currency futures with the same delivery date or a call option
on currency futures with the difference, if any, between the market value of the
call written and the market value of the call or long currency futures purchased
maintained by the Fund in cash or other liquid assets in a segregated account
with its custodian. If at the close of business on any day the market value of
the call purchased by a Fund falls below 100% of the market value of the call
written by the Fund, such Fund will maintain an amount of cash or other liquid
assets in a segregated account with its custodian equal in value to the
difference. Alternatively, a Fund may cover the call option by owning securities
denominated in the currency with a value equal to the face amount of the
contract(s) or through segregating with the custodian an amount of the
particular foreign currency equal to the amount of foreign currency per futures
contract option times the number of options written by the Fund.
REPURCHASE AGREEMENTS
A Fund may enter into repurchase agreements with banks and
broker-dealers by which it 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 a 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 a 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.
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Fixed income securities are subject to market and credit risk. Market
risk relates to changes in a security's value as a result of changes in interest
rates generally. In general, the values of fixed income securities increase when
prevailing interest rates fall and decrease when interest rates rise. Credit
risk relates to the ability of the issuer to make payments of principal and
interest. Obligations of issuers are subject to the provisions of bankruptcy,
insolvency and other laws, such as the Federal Bankruptcy Reform Act of 1978,
affecting the rights and remedies of creditors. Fixed income securities
denominated in foreign currencies are also subject to the risk of a decline in
the value of the denominating currency.
Because interest rates vary, it is impossible to predict the future
income of a Fund investing in such securities. The net asset value of a 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
To the extent noted under "Investment Guidelines," a 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 in high quality money market securities a Fund may 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 a Fund to enforce its rights against the foreign government issuer.
Supra-national agencies are agencies whose member nations make capital
contributions to support the agencies' activities, and include such entities as
the International Bank for Reconstruction and Development (the World Bank), the
Asian Development Bank, the European Coal and Steel Community and the
Inter-American Development Bank.
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Like other fixed income securities, U.S. Government Securities and
Foreign Government Securities are subject to market risk and their market values
fluctuate as interest rates change. Thus, for example, the value of an
investment in a Fund which holds U.S. Government Securities or Foreign
Government Securities may fall during times of rising interest rates. Yields on
U.S. Government Securities and Foreign Government Securities tend to be lower
than those of corporate securities of comparable maturities.
In addition to investing directly in U.S. Government Securities and
Foreign Government Securities, a Fund may purchase certificates of accrual or
similar instruments evidencing undivided ownership interests in interest
payments or principal payments, or both, in U.S. Government Securities and
Foreign Government Securities. These certificates of accrual and similar
instruments may be more volatile than other government securities.
ADJUSTABLE RATE SECURITIES
Adjustable rate securities are securities that have interest rates that
are reset at periodic intervals, usually by reference to some interest rate
index or market interest rate. They may be U.S. Government Securities or
securities of other issuers. Some adjustable rate securities are backed by pools
of mortgage loans. Although the rate adjustment feature may act as a buffer to
reduce sharp changes in the value of adjustable rate securities, these
securities are still subject to changes in value based on changes in market
interest rates or changes in the issuer's creditworthiness. Because the interest
rate is reset only periodically, changes in the interest rates on adjustable
rate securities may lag changes in prevailing market interest rates. Also, some
adjustable rate securities (or, in the case of securities backed by mortgage
loans, the underlying mortgages) are subject to caps or floors that limit the
maximum change in interest rate during a specified period or over the life of
the security. Because of the resetting of interest rates, adjustable rate
securities are less likely than non-adjustable rate securities of comparable
quality and maturity to increase significantly in value when market interest
rates fall.
LOWER RATED SECURITIES
A 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"). A Fund
will not necessarily dispose of a security when its rating is reduced below its
rating at the time of purchase, although the Manager will monitor the investment
to determine whether continued investment in the security will assist in meeting
the Fund's investment objective.
Lower Rated Securities generally provide higher yields, but are subject
to greater credit and market risk, than higher quality fixed income securities.
Lower Rated Securities are considered predominantly speculative with respect to
the ability of the issuer to meet principal and interest payments. Achievement
of the investment objective of a Fund investing in Lower Rated Securities may be
more dependent on the Manager's own credit analysis than is the case with higher
quality bonds. The market for Lower Rated Securities may be more severely
affected than some other financial markets by economic recession or substantial
interest rate
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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.
INDEXED SECURITIES
Indexed securities are securities the redemption values and/or the
coupons of which are indexed to the prices of a specific instrument or
statistic. Indexed securities typically, but not always, are debt securities or
deposits whose value at maturity or coupon rate is determined by reference to
other securities, securities indexes, currencies, precious metals or other
commodities, or other financial indicators. Gold-indexed securities, for
example, typically provide for a maturity value that depends on the price of
gold, resulting in a security whose price tends to rise and fall together with
gold prices. Currency-indexed securities typically are short-term to
intermediate-term debt securities whose maturity values or interest rates are
determined by reference to the values of one or more specified foreign
currencies, and may offer higher yields than U.S. dollar-denominated securities
of equivalent issuers. Currency-indexed securities may be positively or
negatively indexed; that is, their maturity value may increase when the
specified currency value increases, resulting in a security that performs
similarly to a foreign-denominated instrument, or their maturity value may
decline when foreign currencies increase, resulting in a security whose price
characteristics are similar to a put on the underlying currency.
Currency-indexed securities may also have prices that depend on the values of a
number of different foreign currencies relative to each other.
The performance of indexed securities depends to a great extent on the
performance of the security, currency, or other instrument to which they are
indexed, and may also be influenced by interest rate changes in the U.S. and
abroad. At the same time, indexed securities are subject to the credit risks
associated with the issuer of the security, and their values may decline
substantially if the issuer's creditworthiness deteriorates. Recent issuers of
indexed securities have included banks, corporations, and certain U.S.
government agencies.
Indexed securities in which a 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.
A Fund's investment in indexed securities may also create taxable
income in excess of the cash such investments generate. See "Taxes" in the
Prospectus.
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FIRM COMMITMENTS
A firm commitment agreement is an agreement with a bank or
broker-dealer for the purchase of securities at an agreed-upon price on a
specified future date. A Fund may enter into firm commitment agreements with
such banks and broker-dealers with respect to any of the instruments eligible
for purchase by the Fund. A Fund will only enter into firm commitment
arrangements with banks and broker-dealers which the Manager determines present
minimal credit risks. A Fund will maintain in a segregated account with its
custodian cash, U.S. Government Securities or other liquid assets in an amount
equal to the Fund's obligations under firm commitment agreements.
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLL AGREEMENTS
A Fund may enter into reverse repurchase agreements and dollar roll
agreements with banks and brokers to enhance return. Reverse repurchase
agreements involve sales by a Fund of portfolio assets concurrently with an
agreement by the Fund to repurchase the same assets at a later date at a fixed
price. During the reverse repurchase agreement period, the Fund continues to
receive principal and interest payments on these securities and also has the
opportunity to earn a return on the collateral furnished by the counterparty to
secure its obligation to redeliver the securities.
Dollar rolls are transactions in which a Fund sells securities for
delivery in the current month and simultaneously contracts to repurchase
substantially similar (same type and coupon) securities on a specified future
date. During the roll period, the Fund forgoes principal and interest paid on
the securities. The Fund is compensated by the difference between the current
sales price and the forward price for the future purchase (often referred to as
the "drop") as well as by the interest earned on the cash proceeds of the
initial sale.
A Fund which makes such investments will establish segregated accounts
with its custodian in which it will maintain cash, U.S. Government Securities or
other liquid assets equal in value to its obligations in respect of reverse
repurchase agreements and dollar rolls. Reverse repurchase agreements and dollar
rolls involve the risk that the market value of the securities retained by a
Fund may decline below the price of the securities the Fund has sold but is
obligated to repurchase under the agreement. In the event the buyer of
securities under a reverse repurchase agreement or dollar roll files for
bankruptcy or becomes insolvent, 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
a Fund for purposes of a Fund's fundamental investment restriction with respect
to borrowings.
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ILLIQUID SECURITIES
A 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 Funds currently intend to invest in accordance with the SEC staff view that
repurchase agreements maturing in more than seven days are illiquid securities.
The SEC staff has stated informally that it is of the view that over-the-counter
options and securities serving as cover for over-the-counter options are
illiquid securities. While the Trust does not agree with this view, it will
operate in accordance with any relevant formal guidelines adopted by the SEC.
In addition, the SEC staff considers equity swap contracts, caps,
floors and collars to be illiquid securities. Consequently, while the staff
maintains this position, a 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.
INVESTMENT RESTRICTIONS
FUNDAMENTAL RESTRICTIONS:
Without a vote of the majority of the outstanding voting securities of
the relevant Fund, the Trust will not take any of the following actions with
respect to such Fund as indicated:
(1) Borrow money except under the following circumstances: (i) A 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) A
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) A 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 assets equal in value to its
obligations in respect of these transactions.
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<PAGE> 45
(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 a
Fund's account unless at all times when a short position is open the Fund owns
an equal amount of such securities or owns securities which, without payment of
any further consideration, are convertible into or exchangeable for securities
of the same issue as, and equal in amount to, the securities sold short.
(4) Underwrite securities issued by other persons except to the extent
that, in connection with the disposition of its portfolio investments, it may be
deemed to be an underwriter under federal securities laws.
(5) Purchase or sell real estate, although it may purchase securities
of issuers which deal in real estate, including securities of real estate
investment trusts, and may purchase securities which are secured by interests in
real estate.
(6) Make loans, except by purchase of debt obligations or by entering
into repurchase agreements or through the lending of a Fund's portfolio
securities. Loans of portfolio securities may be made with respect to up to 100%
of a 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 a
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 a 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 (4) below; any
borrowing permitted by restriction 1 above; any collateral arrangements with
respect to initial and variation margin permitted by non-fundamental policy (4)
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 policies of each Fund which may be
changed by the Trustees without shareholder approval, to:
(1) Buy or sell oil, gas or other mineral leases, rights or royalty
contracts.
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<PAGE> 46
(2) Make investments for the purpose of gaining control of a company's
management.
(3) 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.
(4) Pledge, hypothecate, mortgage or otherwise encumber its assets in
excess of 33 1/3% of a 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 a 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. Except for policies that are
explicitly described as fundamental in the Prospectus or this Statement of
Additional Information, the investment policies of each Fund (including all
policies, restrictions and limitations set forth under "Investment Guidelines")
may be changed by the Trust's Trustees without the approval of shareholders.
MANAGEMENT OF THE TRUST
Subject to the provisions of the GMO Declaration of Trust, the business
of the GMO Trust (the "Trust") shall be managed by the Trustees, and they shall
have all powers necessary or convenient to carry out that responsibility
including the power to engage in securities transactions of all kinds on behalf
of the Trust. Without limiting the foregoing, the Trustees may adopt By-Laws not
inconsistent with the Declaration of Trust providing for the regulation and
management of the affairs of the Trust and may amend and repeal them to the
extent that such By-Laws do not reserve that right to the Shareholders; they may
fill vacancies in or remove from their number (including any vacancies created
by an increase in the number of Trustees); they may remove from their number
with or without cause; they may elect and remove such officers and appoint and
terminate such agents as they consider appropriate; they may appoint from their
own number and terminate one or more committees consisting of two or more
Trustees which
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<PAGE> 47
may exercise the powers and authority of the Trustees to the extent that the
Trustees determine; they may employ one or more custodians of the assets of the
Trust and may authorize such custodians to employ subcustodians and to deposit
all or any part of such assets in a system or systems for the central handling
of securities or with a Federal Reserve Bank, retain a transfer agent or a
shareholder servicing agent, or both, provide for the distribution of Shares by
the Trust, through one or more principal underwriters or otherwise, set record
dates for the determination of Shareholders with respect to various matters, and
in general delegate such authority as they consider desirable to any officer of
the Trust, to any committee of the Trustees and to any agent or employee of the
Trust or to any such custodian or underwriter.
The Trustees and officers of the Trust and their principal occupations
during the past five years are as follows:
R. JEREMY GRANTHAM* (D.O.B. 10/6/38). President-Quantitative and
Chairman of the Trustees of the Trust. Member, Grantham, Mayo, Van
Otterloo & Co. LLC.
HARVEY R. MARGOLIS (D.O.B. 12/12/42). Trustee of the Trust. Mathematics
Professor, Boston College.
JAY O. LIGHT (D.O.B. 10/3/41). Trustee of the Trust. Professor of
Business Administration, Harvard University; Senior Associate Dean,
Harvard University (1988-1992).
EYK DEL MOL VAN OTTERLOO (D.O.B. 2/27/37). President-International of
the Trust. Member, Grantham, Mayo, Van Otterloo & Co. LLC.
RICHARD MAYO (D.O.B. 6/18/42). President-U.S. Active of the Trust.
Member, Grantham, Mayo, Van Otterloo & Co. LLC.
KINGSLEY DURANT (D.O.B. 1/19/32). Vice President and Secretary of the
Trust. Member, Grantham, Mayo, Van Otterloo & Co. LLC.
SUSAN RANDALL HARBERT (D.O.B. 4/25/57). Secretary and Treasurer of the
Trust. Member, Grantham, Mayo, Van Otterloo & Co. LLC.
WILLIAM R. ROYER, ESQ. (D.O.B. 7/20/65). 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 (D.O.B. 1/21/49). Secretary of the Trust. Member, Grantham,
Mayo, Van Otterloo & Co. LLC.
ANN SPRUILL (D.O.B. 8/30/54). Secretary of the Trust. Member, Grantham,
Mayo, Van Otterloo & Co. LLC.
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ROBERT V. BROKAW, JR. (D.O.B. 10/7/43). Secretary of the Trust. Member,
Grantham, Mayo, Van Otterloo & Co. LLC.
FORREST BERKLEY (D.O.B. 4/25/54). Vice President of the Trust. Member,
Grantham, Mayo, Van Otterloo & Co. LLC.
SCOTT ESTON (D.O.B. 1/20/56). Vice President of the Trust. Chief
Financial Officer and Member, Grantham, Mayo, Van Otterloo & Co. LLC
(September 1997 - present). Senior Partner, Coopers & Lybrand (1987 -
1997).
ELAINE M. HARTNETT, ESQ. (D.O.B. 2/18/45). Vice President and Clerk of
the Trust. Associate General Counsel, Grantham, Mayo, Van Otterloo &
Co. LLC (June 1999-Present). Associate/Junior Partner, Hale and Dorr
LLP, Boston, Massachusetts (1991-1999).
BRENT ARVIDSON (D.O.B. 6/26/69). 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 ("GMO" or the "Manager"), as defined by the 1940 Act.
The mailing address of each of the officers and Trustees is c/o GMO
Trust, 40 Rowes Wharf, Boston, Massachusetts 02110. As of June 1, 1999, the
Trustees and officers of the Trust as a group owned less than 1% of the
outstanding shares of each class of shares of the Tax-Managed U.S. Equities Fund
and the Tax-Managed International Equities Fund. As of July 21, 1999, the
Trustees and officers of the Trust as a group owned less than 1% of the
outstanding shares of each class of shares of the Tax-Managed Small Companies
Fund.
Except as stated above, the principal occupations of the officers and
Trustees for the last five years have been with the employers as shown above,
although in some cases they have held different positions with such employers.
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<PAGE> 49
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, Brokaw, Eston and
Berkley, and Mses. Harbert and Spruill, as members of the Manager, will benefit
from the management fees paid by each Fund of the Trust.
INVESTMENT ADVISORY AND OTHER SERVICES
MANAGEMENT CONTRACTS
As disclosed in the Prospectus under the heading "Management of the
Trust," under separate Management Contracts (each a "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 each Fund and will make investment decisions on behalf of the Funds
and place all orders for the purchase and sale of portfolio securities. Subject
to the control of the Trustees, the Manager also manages, supervises and
conducts the other affairs and business of the Trust, furnishes office space and
equipment, provides bookkeeping and certain clerical services and pays all
salaries, fees and expenses of officers and Trustees of the Trust who are
affiliated with the Manager. As indicated under "Portfolio
Transactions--Brokerage and Research Services," the Trust's portfolio
transactions may be placed with broker-dealers which furnish the Manager, at no
cost, certain research, statistical and quotation services of value to the
Manager in advising the Trust or its other clients.
As is disclosed in the Prospectus, the Manager has contractually agreed
to reimburse each Fund with respect to certain Fund expenses through June 30,
2000 to the extent that a Fund's total annual operating expenses (excluding
Shareholder Service Fees, brokerage commissions and other investment-related
costs, interest expenses, hedging transaction fees, extraordinary, non-recurring
and certain other unusual expenses (including taxes), securities lending fees
and expenses and transfer taxes) would otherwise exceed a specified percentage
of that Fund's daily net assets.
Each 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.
Each 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 relevant
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<PAGE> 50
Fund's sole shareholder in connection with the organization of the Trust and the
establishment of the Funds. Each 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 relevant Fund. Each Management Contract automatically
terminates on assignment, and is terminable on not more than 60 days' notice by
the Trust to the Manager. In addition, each Management Contract may be
terminated on not more than 60 days' written notice by the Manager to the Trust.
For each Fund, the Management Fee is calculated based on a fixed
percentage of the Fund's average daily net assets. In the last year the
Tax-Managed U.S. Equities Fund and the Tax-Managed International Equities Fund
paid the following amounts as Management Fees to the Manager pursuant to the
relevant Management Contract:
GROSS REDUCTION NET
----- --------- ---
TAX-MANAGED
U.S. EQUITIES FUND
Commencement of Operations
(7/23/98) through 2/28/99 $16,961 $16,961 $0
TAX-MANAGED INTERNATIONAL
EQUITIES FUND
Commencement of Operations
(7/29/98) through 2/28/99 $50,861 $50,861 $0
CUSTODIAL ARRANGEMENTS. Investors Bank & Trust Company ("IBT"), 200
Clarendon Street, Boston, Massachusetts 02116, serves as the Trust's custodian
on behalf of the Tax-Managed U.S. Equities Fund and the Tax-Managed Small
Companies Fund. Brown Brothers Harriman & Co. ("BBH"), 40 Water Street, Boston,
Massachusetts 02109, serves as the Trust's custodian on behalf of the
Tax-Managed International Equities Fund. As such, IBT or BBH holds in
safekeeping certificated securities and cash belonging to the relevant Fund and,
in such capacity, is the registered owner of securities in book-entry form
belonging to the relevant Fund. Upon instruction, IBT or BBH receives and
delivers cash and securities of the relevant Fund in connection with Fund
transactions and collects all dividends and other distributions made with
respect to Fund portfolio securities. Each of IBT and 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 each Fund for which it acts as
custodian on a daily basis.
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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 Funds. 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 entered into the Servicing Agreement with GMO on May 30,
1996. Pursuant to the terms of the Servicing Agreement, the Tax-Managed U.S.
Equities Fund and the Tax-Managed International Equities Fund paid GMO the
amounts set forth in the table below:
FISCAL YEAR ENDED 2/28/99
-------------------------
Tax-Managed U.S. Equities Fund $ 4,846
Tax-Managed International Equities Fund $10,172
INDEPENDENT ACCOUNTANTS. The Trust's independent accountants are
PricewaterhouseCoopers LLP, 160 Federal Street, Boston, Massachusetts 02110.
PricewaterhouseCoopers LLP conducts annual audits of the Trust's financial
statements, assists in the preparation of each 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 each 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 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
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<PAGE> 52
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 each 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. It is the Manager's policy to place over-the-counter market orders
for the Tax-Managed U.S. Equity Fund with primary market makers unless better
prices or executions are available elsewhere.
Although the Manager does not consider the receipt of research services
as a factor in selecting brokers to effect portfolio transactions for a Fund,
the Manager will receive such services from brokers who are expected to handle a
substantial amount of the Funds' 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 as
well as the Funds.
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 fiscal year ended February 28, 1999, the Trust paid, on
behalf of the Tax-Managed U.S. Equities Fund and the Tax-Managed International
Equities Fund, the following amounts in brokerage commissions:
Fund 1999
- --------------------------------------- -------
Tax-Managed U.S. Equities Fund $ 5,964
Tax-Managed International Equities Fund $27,729
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DETERMINATION OF NET ASSET VALUE
The net asset value per share of each Fund of GMO Trust will be
determined on each day the New York Stock Exchange (the "Exchange") is open for
regular business as of the close of regular trading on the Exchange, generally
4:00 p.m. New York City Time. However, equity options held by the Funds are
priced as of the close of trading at 4:10 p.m., and futures contracts on U.S.
government and other fixed-income securities and index options held by the Funds
are priced as of their close of trading at 4:15 p.m. Please refer to
"Determination of Net Asset Value" in the Prospectus for additional information.
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 ends on February 28/29.
Pursuant to the Declaration of Trust, the Trustees have currently
authorized the issuance of an unlimited number of full and fractional shares of
thirty-nine series, one for each of the Funds described in this Statement of
Additional Information, and for each of U.S. Core Fund; Tobacco-Tobacco-Free
Core Fund; Value Fund; Growth Fund; U.S. Sector Fund; Small Cap Value Fund;
Small Cap Growth Fund; Fundamental Value 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; International Core Plus Allocation Fund;
Emerging Country Debt Share Fund; Pelican Fund; Asia Fund; Tax Managed U. S.
Small Cap Fund; and Intrinsic Value Fund. Interests in each portfolio (Fund) are
represented by shares of the corresponding series. Each share of each series
represents an equal proportionate interest, together with each other share, in
the corresponding Fund. The shares of such series do not have any preemptive
rights. Upon liquidation of a Fund, shareholders of the corresponding series are
entitled to share pro rata in the net assets of the Fund available for
distribution to shareholders. The Declaration of Trust also permits the Trustees
to charge shareholders directly for custodial and transfer agency expenses, but
there is no present intention to make such charges.
The Declaration of Trust also permits the Trustees, without shareholder
approval, to subdivide any series of shares into various sub-series or classes
of shares with such dividend preferences and other rights as the Trustees may
designate. This power is intended to allow the Trustees to provide for an
equitable allocation of the impact of any future regulatory requirements which
might affect various classes of shareholders differently. The Trustees have
currently authorized the establishment and designation of up to eight classes of
shares for each series of the Trust (except for the Pelican Fund): Class I
Shares, Class II Shares, Class III Shares, Class IV Shares, Class V Shares,
Class VI Shares, Class VII Shares and Class VIII Shares.
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<PAGE> 54
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 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.
On June 1, 1999 the following shareholders held greater than 25% of the
outstanding shares of a series of the Trust:
FUND SHAREHOLDERS
---- ------------
Tax-Managed U.S. Equities Fund Dovecote Fund LLC; Bob & Co. FBO Metcalf
Tax-Managed Small Companies Fund MAC & Co.
As a result, such shareholders may be deemed to "control" their
respective series as such term is defined in the 1940 Act.
Shareholders could, under certain circumstances, be held personally
liable for the obligations of the Trust. However, the risk of a shareholder
incurring financial loss on account of that liability is considered remote since
it may arise only in very limited circumstances.
VOTING RIGHTS
As summarized in the Shareholder Manual, 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 Investment Company Act of 1940, shares shall be voted in
the aggregate and not by individual Fund, and (ii) when the Trustees have
determined that the matter affects only the interests of one or more Funds, then
only shareholders of such affected Funds shall be entitled to vote thereon.
Shareholders of one Fund shall not be entitled to vote on matters exclusively
affecting another Fund, such matters including, without limitation, the adoption
of or change in the investment objectives, policies or restrictions of the other
Fund and the approval of the investment advisory contracts of the other Fund.
Shareholders of a particular class of shares do not have separate class voting
rights except with respect to matters that affect only that class of shares and
as otherwise required by law.
There will normally be no meetings of shareholders for the purpose of
electing Trustees except that in accordance with the 1940 Act (i) the Trust will
hold a shareholders' meeting for the election of Trustees at such time as less
than a majority of the Trustees holding office have been elected by
shareholders, and (ii) if, as a result of a vacancy in the Board of Trustees,
less than
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<PAGE> 55
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 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.
35
<PAGE> 56
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 Tax-Managed U.S. Equities Fund as of June 1,
1999:
<TABLE>
<CAPTION>
- ------------------------------------------ -------------------------------------------------- -----------------------------
NAME ADDRESS % OWNERSHIP
- ------------------------------------------ -------------------------------------------------- -----------------------------
<S> <C> <C>
Dovecote Fund LLC 37 Spencer Hill Road 44.34
Corning, NY 14830
- ------------------------------------------ -------------------------------------------------- -----------------------------
Bob & Co. c/o Bank Boston 36.45
FBO Metcalf Attn: Mutual Fund Department 45-02-93
P.O. Box 1809
Boston, MA 02105-1809
- ------------------------------------------ -------------------------------------------------- -----------------------------
Janet H. Geary 1211 SW 5th Avenue, Suite 2980 18.31
Portland, OR 97204
- ------------------------------------------ -------------------------------------------------- -----------------------------
</TABLE>
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 Tax-Managed International Equities Fund as
of June 1, 1999:
<TABLE>
<CAPTION>
- ------------------------------------------ ---------------------------------------------------- ---------------------------
NAME ADDRESS % OWNERSHIP
- ------------------------------------------ ---------------------------------------------------- ---------------------------
<S> <C> <C>
Dumaines Trust C/O Gerard Sarnie, CPA 23.22
201 Devonshire St., 4th Floor
Boston, MA 02110
- ------------------------------------------ ---------------------------------------------------- ---------------------------
Dovecote Fund LLC 37 Spencer Hill Road 18.11
Corning, NY 14830
- ------------------------------------------ ---------------------------------------------------- ---------------------------
Melvin B. and Joan F. Lane Trust 3000 Sand Hill Road 17.57
U/A DTD 09/14/93 Building 2, Suite 215
Melvin and Joan Lane Revocable Menlo Park, CA 94025
Trust I
- ------------------------------------------ ---------------------------------------------------- ---------------------------
Bob & Co. C/O Bank Boston 16.53
FBO Metcalf Attn: Mutual Fund Department 45-02-93
P.O. Box 1809
Boston, MA 02105-1809
- ------------------------------------------ ---------------------------------------------------- ---------------------------
Richard Geary 1211 SW 5th Avenue 12.85
Suite 2980
Portland, OR 97024
- ------------------------------------------ ---------------------------------------------------- ---------------------------
</TABLE>
36
<PAGE> 57
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 Tax-Managed Small Companies Fund as of July
21, 1999:
<TABLE>
<CAPTION>
- ------------------------------------------ -------------------------------------------------- -----------------------------
NAME ADDRESS % OWNERSHIP
- ------------------------------------------ -------------------------------------------------- -----------------------------
<S> <C> <C>
MAC & Co. Attn: Mutual Fund Operations 30.68
P.O. Box 3198
Pittsburgh, PA 15230-3198
- ------------------------------------------ -------------------------------------------------- -----------------------------
William Barron Hilton 9336 Civic Center Drive 23.56
Charitable Remainder Unitrust Beverly Hills, CA 90210
- ------------------------------------------ -------------------------------------------------- -----------------------------
Francis W. Hatch, S. Parker Gilbert & Attn: Lois B. Wetzel 13.72
Robert M. Pennoyer Trust Sullivan & Cromwell
FBO John H. C. Merck 125 Broad Street
New York, NY 10004-2498
- ------------------------------------------ -------------------------------------------------- -----------------------------
Francis W. Hatch, S. Parker Gilbert & Attn: Lois B. Wetzel 11.16
Robert M. Pennoyer Trust Sullivan & Cromwell
FBO John H. C. Merck 125 Broad Street
New York, NY 10004-2498
- ------------------------------------------ -------------------------------------------------- -----------------------------
S. Parker Gilbert & Robert M. Pennoyer Attn: Lois B. Wetzel 6.41
Trust Sullivan & Cromwell
FBO George W. Merck 125 Broad Street
New York, NY 10004-2498
- ------------------------------------------ -------------------------------------------------- -----------------------------
</TABLE>
DISTRIBUTIONS
The Shareholder's Manual describes the distribution policies of each
Fund under the heading "Distributions".
TAXES
TAX STATUS AND TAXATION OF EACH FUND
Each Fund is treated as a separate taxable entity for federal income
tax purposes. Each Fund intends to qualify each year as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"). In order to qualify for the special tax treatment accorded regulated
investment companies and their shareholders, each Fund must, among other things:
(a) derive at least 90% of its gross income from dividends, interest, payments
with respect to certain securities loans, and gains from the sale of stock,
securities and foreign currencies, or other income (including but not
limited to gains from options, futures or forward contracts) derived with
respect to its business of investing in such stock, securities, or
currencies;
37
<PAGE> 58
(b) distribute with respect to each taxable year at least 90% of the sum of its
taxable net investment income, its net tax-exempt income, and the excess,
if any, of net short-term capital gains over net long-term capital losses
for such year; and
(c) diversify its holdings so that at the end of each fiscal quarter, (i) at
least 50% of the market value of the Fund's assets is represented by cash
and cash items, U.S. Government Securities, securities of other regulated
investment companies, and other securities limited in respect of any one
issuer to a value not greater than 5% of the value of the Fund's total net
assets and to not more than 10% of the outstanding voting securities of
such issuer, and (ii) not more than 25% of the value of its assets is
invested in the securities (other than those of the U.S. Government or
other regulated investment companies) of any one issuer or of two or more
issuers which the Fund controls and which are engaged in the same, similar,
or related trades or businesses.
If a Fund qualifies as a regulated investment company that is accorded
special tax treatment, the Fund will not be subject to federal income tax on
income paid to its shareholders in the form of dividends (including capital gain
dividends).
If a Fund fails to distribute in a calendar year substantially all of
its ordinary income for such year and substantially all of its capital gain net
income for the one-year period ending October 31 (or later if a Fund is
permitted so to elect and so elects), plus any retained amount from the prior
year, such Fund will be subject to a 4% excise tax on the undistributed amounts.
A dividend paid to shareholders by a Fund in January of a year generally is
deemed to have been paid by the Fund on December 31 of the preceding year, if
the dividend was declared and payable to shareholders of record on a date in
October, November or December of that preceding year. Each Fund intends
generally to make distributions sufficient to avoid imposition of the 4% excise
tax.
TAXATION OF FUND DISTRIBUTIONS AND SALES OF FUND SHARES
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. Properly designated Fund distributions derived
from net long-term capital gains (I.E., net gains derived from the sale of
securities held for more than 12 months) will be taxable as such (generally at a
20% rate for noncorporate shareholders), regardless of how long a shareholder
has held the shares in the Fund.
Dividends and distributions on each 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.
The sale, exchange or redemption of Fund shares may give rise to a gain
or loss. In general, any gain or loss realized upon a taxable disposition of
shares will be treated as long-term
38
<PAGE> 59
capital gains if the shares have been held for more than 12 months and as
short-term capital gains if the shares have been held for not more than 12
months.
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. All or a portion of any loss realized upon a taxable disposition
of Fund shares will be disallowed if other shares of the same Fund are purchased
within 30 days before or after the disposition. In such a case, the basis of the
newly purchased shares will be adjusted to reflect the disallowed loss.
A distribution paid to shareholders by a Fund in January of a year
generally is deemed to have been received by shareholders on December 31 of the
preceding year, if the distribution was declared and payable to shareholders of
record on a date in October, November or December of that preceding year. The
Trust will provide federal tax information annually, including information about
dividends and distributions paid during the preceding year to taxable investors
and others requesting such information.
If a Fund makes a distribution to you in excess of its current and
accumulated "earnings and profits" in any taxable year, the excess distribution
will be treated as a return of capital to the extent of your tax basis in your
shares, and thereafter as capital gain. A return of capital is not taxable, but
it reduces your tax basis in your shares, thus reducing any loss or increasing
any gain on a subsequent taxable disposition by you of your shares.
For corporate shareholders, the dividends-received deduction will
generally apply (subject to a holding period requirement imposed by the Code) to
a Fund's dividends paid from investment income to the extent derived from
dividends received from U.S. corporations. However, any distributions received
by a Fund from REITs will not qualify for the corporate dividends-received
deduction. A Fund's investments in REIT equity securities may require such Fund
to accrue and distribute income not yet received. In order to generate
sufficient cash to make the requisite distributions, the Fund may be required to
sell securities in its portfolio that it otherwise would have continued to hold
(including when it is not advantageous to do so). A Fund's investments in REIT
equity securities may at other times result in the Fund's receipt of cash in
excess of the REIT's earnings; if the Fund distributes such amounts, such
distribution could constitute a return of capital to Fund shareholders for
federal income tax purposes.
The backup 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 backup withholding at a rate of 31%
on all distributions of net investment income and capital gain, whether received
in cash or reinvested in shares of the relevant Fund, and on the amount of the
proceeds of any redemption of Fund shares paid or credited to any shareholder
account for which an incorrect or no taxpayer identification number has been
provided, where appropriate certification has not been provided for a foreign
shareholder, or where the Trust is notified that the shareholder has
underreported income in the past (or the shareholder fails to certify that he is
not subject to such withholding). A "taxpayer identification number" is either
the Social Security number of employer identification number of the record owner
of the account.
39
<PAGE> 60
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 a 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. Foreign investors are subject to the backup withholding rules described
above. 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 Federal income tax return. Also, foreign
shareholders with respect to whom income from a Fund is "effectively connected"
with a U.S. trade or business carried on by such shareholder will in general be
subject to U.S. federal income tax on the income derived from the Fund at the
graduated rates applicable to U.S. citizens, residents or domestic corporations,
whether received in cash or reinvested in shares, and, in the case of a foreign
corporation, may also be subject to a branch profits tax. Again, foreign
shareholders who are resident in a country with an income tax treaty with the
United States may obtain different tax results, and are urged to consult their
tax advisors.
FOREIGN TAX CREDITS
If, at the end of the fiscal year, more than 50% of the value of the
total assets of any Fund is represented by stock or securities of foreign
corporations, the Fund intends to make an election with respect to the relevant
Fund which allows shareholders whose income from the Fund is subject to U.S.
taxation at the graduated rates applicable to U.S. citizens, residents or
domestic corporations to claim a foreign tax credit or deduction (but not both)
on their U.S. income tax return. In such case, the amounts of foreign income
taxes paid by the Fund would be treated as additional income to Fund
shareholders from non-U.S. sources and as foreign taxes paid by Fund
shareholders. Investors should consult their tax advisors for further
information relating to the foreign tax credit and deduction, which are subject
to certain restrictions and limitations (including a holding period requirement
applied at both the Fund and shareholder level imposed by the Code).
Shareholders of any of the International Funds whose income from the Fund is not
subject to U.S. taxation at the graduated rates applicable to U.S. citizens,
residents or domestic corporations may receive substantially different tax
treatment of distributions by the relevant Fund, and may be disadvantaged as a
result of the election described in this paragraph.
40
<PAGE> 61
TAX IMPLICATIONS OF CERTAIN INVESTMENTS
Certain of the Funds' 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" (including inflation
indexed bonds), will create taxable income in excess of the cash they generate.
In such cases, a 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 Funds' 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 Funds'
securities and convert long-term capital gains into short-term capital gains and
short-term capital losses into long-term capital losses. 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," 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 distribution form the company. The Fund also may 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 have the
effect of accelerating 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 therefore may require a Fund to
liquidate other investments (including when it is not advantageous to do so) to
meet its distribution requirement, which also may accelerate the recognition of
gain and affect a Fund's total return.
A PFIC is any foreign corporation (i) 75% or more of the income of
which for the taxable year is passive income, or (ii) the average percentage of
the assets of which (generally by value, but by adjusted tax basis in certain
cases) that produce or are held for the production of passive income is at least
50%. Generally, passive income for this purposes means dividends, interest
(including income equivalent to interest), royalties, rents, annuities, the
excess of gains over losses from certain property transactions and commodities
transactions, and foreign currency gains. Passive income for this purpose does
not include rents and royalties received by the foreign corporation from active
business and certain income received from related persons.
LOSS OF REGULATED INVESTMENT COMPANY STATUS
A Fund may experience particular difficulty qualifying as a regulated
investment company in the case of highly unusual market movements, in the case
of high redemption levels
41
<PAGE> 62
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.
PERFORMANCE INFORMATION
Each 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 a 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 $10,000, T = the average annual total return, n
= the number of years, and ERV = the ending redeemable value of a hypothetical
$10,000 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 $10,000 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 Funds 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 table below sets forth the average annual total return for Class
III Shares of the Tax-Managed U.S. Equities Fund and the Tax-Managed
International Equities Fund for the period from the commencement of the relevant
Fund's operations until February 28, 1999:
- --------------------------------------- ---------------- -----------------------
FUND INCEPTION DATE SINCE
INCEPTION (%)
- --------------------------------------- ---------------- -----------------------
Tax-Managed U.S. Equities Fund 7/23/98 7.33%
- --------------------------------------- ---------------- -----------------------
Tax-Managed International Equities Fund 7/29/98 (3.02)%
- --------------------------------------- ---------------- -----------------------
Each 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
a 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.
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<PAGE> 63
Information relating to a 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, a Fund may compare its respective performance to that
of other mutual funds with similar investment objectives and to stock or other
relevant indices. For example, a Fund may compare its total return to rankings
prepared by Lipper Analytical Services, Inc. or Morningstar, Inc., widely
recognized independent services, that monitor mutual fund performance; the
Standard & Poor's 500 Stock Index ("S&P 500"), MSCI EAFE or the Russell 2500
Index, indices of unmanaged groups of common stock; or the Dow Jones Industrial
Average, a recognized unmanaged index of common stocks of 30 industrial
companies listed on the New York Stock Exchange.
Performance rankings and listings reported in national financial
publications, such as MONEY MAGAZINE, BARRON'S 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 Services, and DONOGHUE'S MUTUAL FUND ALMANAC.
Quotations of a 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 a Fund for a particular
month or quarter will be calculated in accordance with the following formula:
Gross Return =
Net Return + (Total Annual Operating Expense Ratio) (# of days in relevant
period/365)
Information relating to a 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.
43
<PAGE> 64
INVESTMENT GUIDELINES
- --------------------------------------------------------------------------------
GMO TAX-MANAGED U. S. EQUITIES FUND
- --------------------------------------------------------------------------------
TAX-SENSITIVE STRATEGIES THAT MAY BE EMPLOYED(1)
- - Manager may control portfolio turnover in order to defer the realization
and minimize the distributions of capital gains.
- - Manager may, when appropriate, sell securities in order to realize capital
losses. Losses may be used to offset realized capital gains, thus reducing
net capital gains distributions.
- - When making sales of specific securities, the Manager considers strategies,
such as selling securities with the highest cost basis, to minimize capital
gains.
- - In lieu of redeeming in cash, the Manager may meet redemption requests
through in-kind redemptions in whole or in part by a distribution of
appreciated securities held by the Fund, so that the Fund will generally
not be required to distribute the capital gains in those securities to the
remaining shareholders in the Fund. The effect to the redeeming shareholder
is the same for federal income tax purposes as a redemption in cash.
Shareholders receiving the redemption in kind would pay tax on the capital
gains realized, if any, on the Fund shares redeemed.
================================================================================
ANY NUMERICAL OR PERCENTAGE LIMITATION SET FORTH IN THIS DOCUMENT WILL BE
APPLIED ONLY AT THE TIME OF INITIAL INVESTMENT IN A SECURITY OR OTHER
INVESTMENT. THE FUND DOES NOT UNDERTAKE TO ADJUST ITS PORTFOLIO IN THE CASE
WHERE MARKET MOVEMENTS, CASH FLOWS OR OTHER FACTORS CAUSE ANY OF SUCH
LIMITATIONS TO BE EXCEEDED. EXCEPT AS OTHERWISE INDICATED, NUMERICAL AND
PERCENT LIMITATIONS ARE EXPRESSED AS A PERCENTAGE OF THE FUND'S TOTAL
ASSETS.
- --------------------------------------------------------------------------------
PERMITTED INVESTMENTS
- --------------------------------------------------------------------------------
SECURITIES/INSTRUMENTS: - At least 65% of the Fund's total
domestic common stocks assets will be invested in or
convertible securities exposed to(2) U.S. equity
securities of foreign issuers (traded securities.
principally on U.S. exchanges)
depository receipts
illiquid securities
144A securities
restricted securities
futures and related options on
securities indexes
REITs
exchange-traded and OTC options on
securities and indexes (including
writing covered options)
equity swap contracts
contracts for differences
index futures
repurchase agreements
warrants or rights
investment companies (open and closed end)
- -------------------------
(1) There can be no assurance that the Manager will be successful in
employing these strategies.
(2) The words "exposed to" as used in these guidelines mean that, for
purposes of the relevant requirement or restriction, the total of the
Fund's exposure to the relevant market or security through direct
investments and through derivative instruments will be considered.
44
<PAGE> 65
CASH AND MONEY MARKET INSTRUMENTS - The Fund expects that less
Any short-term assets will be invested in than 5% of its net assets
cash or high quality money market will be exposed to cash and
instruments including securities issued by money market instruments.
the U.S. government and agencies thereof, This limitation does NOT
bankers' acceptances, commercial paper, include cash and money
bank certificates of deposit and repurchase market instruments in margin
agreements accounts or otherwise held
against exposure achieved
through derivative
instruments ("equitized
cash").
- --------------------------------------------------------------------------------
PROHIBITED INVESTMENTS AND PRACTICES
- --------------------------------------------------------------------------------
The Fund will NOT engage in the following practices except as indicated:
PURCHASING SECURITIES ON MARGIN - Except for short-term credits necessary for
clearance of transactions.
BORROWING MONEY - Except that the Fund may temporarily borrow
up to 20% of its net assets from banks for
the payment of redemptions or settlement of
securities transactions, but not as a
leveraged investment strategy.
UNDERWRITING SECURITIES - Except to the extent that the Fund is
deemed an underwriter for securities law
purposes in connection with disposition of
portfolio investments.
MAKING LOANS - Except that purchasing debt obligations,
repurchase agreements and engaging in
securities lending will not be considered
making loans for this purpose. The Fund may
loan securities valued at up to one-third
of its total assets.
PLEDGING, HYPOTHECATING OR - Except that collateral arrangements with
MORTGAGING FUND ASSETS respect to swap agreements, the writing of
options, stock index, interest rate,
currency or other futures contracts,
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 also not deemed to be a
pledge or encumbrance.
SELLING UNCOVERED PUT OR CALL OPTIONS ON SECURITIES OR INDEXES
MAKING SHORT SALES OF SECURITIES
INVESTING IN REAL ESTATE
INVESTING IN NON-FINANCIAL COMMODITY CONTRACTS
PARTICIPATING IN DIRECTED BROKERAGE ARRANGEMENTS
MAKING INVESTMENTS FOR THE PURPOSE OF GAINING CONTROL OF A COMPANY'S MANAGEMENT
- --------------------------------------------------------------------------------
RESTRICTIONS AND LIMITATIONS
- --------------------------------------------------------------------------------
OPTIONS ON SECURITIES - No more than 5% of the Fund's net assets
will be invested in time premiums on
options on particular securities (as
opposed to options on indexes).
OTHER INVESTMENT COMPANIES - The Fund will not own more than 3% of the
outstanding voting securities of any
investment company.
- No more than 5% of the Fund's net assets
will be invested in any single investment
company.
- No more than 10% of the Funds net assets
will be invested in securities of
investment companies in the aggregate.
- The Fund will not own other Funds of GMO
Trust.
ILLIQUID SECURITIES - No more than 15% of the Fund's net assets
will be invested in illiquid securities.
INVESTMENT IN INSURANCE - The Fund will not purchase more than 10% of
COMPANIES the total outstanding voting stock of any
insurance company (including foreign
insurance companies).
45
<PAGE> 66
INVESTMENT IN SECURITIES ISSUED - EQUITY: The Fund will not purchase more
BY BROKERS, DEALERS, than 5% of any class of stock of a
UNDERWRITERS AND INVESTMENT broker, dealer, underwriter or
ADVISERS investment adviser.
- DEBT: The Fund may not purchase more
than 10% of any such company's total
outstanding debt in the aggregate.
- INVESTMENT LIMITS: No more than 5% of
the Fund's total assets will be
invested in the securities of a SINGLE
broker, dealer, underwriter or
investment adviser. the net payment
obligation of swap contracts where one
of these types of companies is the
counterparty also counts for purposes
of this restriction.
This policy does not apply to companies
that derived less than 15% of revenues
from "securities-related businesses"
during the most recent fiscal year.
- --------------------------------------------------------------------------------
DIVERSIFICATION/CONCENTRATION
- --------------------------------------------------------------------------------
DIVERSIFICATION - Except for U.S. government securities,
cash, and money market instruments, the
Fund will not invest in any one
security to an extent greater than 5
percentage points over that security's
weighting in the Fund's benchmark.
- The Fund will not purchase more than
10% of the outstanding securities of
any issuer.
CONCENTRATION - The Fund will not invest more than 25%
of its total assets in securities of
issuers in any one industry.
DERIVATIVE INSTRUMENTS
TYPES OF DERIVATIVES - Futures contracts and related options
on securities indexes
- Long equity swap contracts: where the
Fund pays a fixed rate plus the
negative performance, if any, and
receives the positive performance, if
any, of an index or basket of
securities.
- Short equity swap contracts: where the
Fund receives a fixed rate plus the
negative performance, if any, and pays
the positive performance of an index or
basket of securities C Contracts for
differences: equity swaps that contain
both a long and short equity component.
USES OF DERIVATIVES
HEDGING - TRADITIONAL HEDGING: Short equity
futures, related options and short
equity swap contracts used to hedge
against an equity risk already
generally present in the Fund.(3)
- ANTICIPATORY HEDGING: If the Fund
receives or anticipates significant
cash purchase transactions, the Fund
may hedge market risk (risk of not
being invested in the market) by
purchasing long futures contracts or
entering long equity swap contracts to
obtain market exposure until such time
as direct investments can be made
efficiently. Conversely, if the Fund
receives or anticipates a significant
demand for cash redemptions, the Fund
may sell futures contracts or enter
into short equity swap contracts, to
allow the Fund to dispose of securities
in a more orderly fashion without the
Fund being exposed to leveraged loss
exposure in the interim.
- -------------------------
(3) The Fund may use such hedging to remove or reduce general market
exposure (e.g. an index or broad basket of securities) relative to specific
exposure existing in the Fund (the specific stocks of that market actually
owned by the Fund). The Fund may also seek to remove specific exposure
(e.g. a single stock, small basket or more focused index of securities
expected to do poorly in an otherwise promising market) relative to general
or broad market exposure that exists in the Fund.
46
<PAGE> 67
INVESTMENT - The Fund may use derivative instruments
(particularly long futures contracts,
related options and long equity swap
contracts) in place of investing
directly in securities. This will
include using equity derivatives to
"equitize" cash balances held by the
Fund. The Fund may also use long
derivatives for investment in
conjunction with short hedging
transactions to adjust the weights of
the Fund's underlying equity portfolio
to a level the Manager believes is the
optimal exposure to individual markets,
sectors and equities.
RISK MANAGEMENT - - The Fund may use equity futures,
SYNTHETIC SALES AND PURCHASES related options and equity swap
contracts to adjust the weight of the
Fund to a level the manager believes is
the optimal exposure to individual
markets, sectors and equities.
Sometimes, such transactions are used
as a precursor to actual sales and
purchases. For example, if the Fund
held a large proportion of stocks of a
particular market and the Manager
believed that stocks of another market
would outperform such stocks, the Fund
might use a short futures contract on
an appropriate index (to synthetically
"sell" a portion of the Fund's
portfolio) in combination with a long
futures contract on another index (to
synthetically "buy" exposure to that
index). Long and short equity swap
contracts and contracts for differences
may also be used for these purposes.
Equity derivatives (and corresponding
currency forwards) used to effect
synthetic sales and purchases will
generally be unwound as actual
portfolio securities are sold and
purchased.
LIMITATIONS ON THE USE OF - There is no limit on the use of
DERIVATIVES derivatives for hedging purposes.
- The face value of derivatives used for
investment purposes will be limited to
25% of the Fund's assets. When a
currency forward is used in conjunction
with an equity derivative for
investment purposes, the currency
forward will not be independently
counted for this restriction.
- When long futures contracts and long
equity swaps are used for investment,
an amount of cash or high quality debt
securities equal to the face value of
all such long derivative positions will
be segregated against such exposure.
However, for purposes of this
restriction, if an existing long equity
exposure is reduced or eliminated by a
short derivative position, the
combination of the long and short
position will be considered as cash
available to segregate against a new
long derivative exposure.
- The net long equity exposure of the
Fund, including direct investment in
securities and long derivative
positions, will not exceed 100% of the
Fund's net assets.
- The aggregate absolute face value of
all futures contracts and swap
contracts (without regard to sign and
assuming no offset of long and short
positions, and counting both components
of any contract for differences) will
not exceed 100% of the Fund's assets.
- Except when such instruments are used
for bona-fide hedging, no more than 5%
of the Fund's net assets will be
committed to initial margin on futures
contracts and time premiums on related
options.
- Counterparties used for OTC derivatives
must have a long-term debt rating of A
or higher when the derivative is
entered into. Occasionally, short-term
derivatives will be entered into with
counterparties that have only high
short-term debt ratings.
47
<PAGE> 68
- --------------------------------------------------------------------------------
GMO TAX MANAGED INTERNATIONAL EQUITIES FUND
- --------------------------------------------------------------------------------
TAX-SENSITIVE STRATEGIES THAT MAY BE EMPLOYED(4)
- - Manager may control portfolio turnover in order to defer the realization
and minimize the distributions of capital gains.
- - Manager may, when appropriate, sell securities in order to realize capital
losses. Losses may be used to offset realized capital gains, thus reducing
net capital gains distributions.
- - When making sales of specific securities, the Manager considers strategies,
such as selling securities with the highest cost basis, to minimize capital
gains.
- - In lieu of redeeming in cash, the Manager may meet redemption requests
through in-kind redemptions in whole or in part by a distribution of
appreciated securities held by the Fund, so that the Fund will generally
not be required to distribute the capital gains in those securities to the
remaining shareholders in the Fund. The effect to the redeeming shareholder
is the same for federal income tax purposes as a redemption in cash.
Shareholders receiving the redemption in kind would pay tax on the capital
gains realized, if any, on the Fund shares redeemed.
================================================================================
ANY NUMERICAL OR PERCENTAGE LIMITATION SET FORTH IN THIS DOCUMENT WILL BE
APPLIED ONLY AT THE TIME OF INITIAL INVESTMENT IN A SECURITY OR OTHER
INVESTMENT. THE FUND DOES NOT UNDERTAKE TO ADJUST ITS PORTFOLIO IN THE CASE
WHERE MARKET MOVEMENTS, CASH FLOWS OR OTHER FACTORS CAUSE ANY OF SUCH
LIMITATIONS TO BE EXCEEDED. EXCEPT AS OTHERWISE INDICATED, NUMERICAL AND
PERCENT LIMITATIONS ARE EXPRESSED AS A PERCENTAGE OF THE FUND'S TOTAL
ASSETS.
- At least 65% of the Fund's
EQUITY SECURITIES: total assets will be
common stocks (non-US issuers) invested in or exposed to
convertible bonds non-U.S. securities.
convertible preferred stocks
OTHER EQUITY SECURITIES:
depository receipts: ADRs, GDRs, EDRs
foreign issues traded in the U.S. and
abroad
investment companies (open & closed-end)
Illiquid securities
144A securities
restricted securities
equity futures and related options
exchange-traded and OTC Options on
securities and indexes (including writing
covered options)
equity swap contracts
contracts for differences
repurchase agreements
securities of emerging market countries
warrants or rights
investment companies (open and closed end)
- --------------------------------------------------------------------------------
PERMITTED INVESTMENTS
- --------------------------------------------------------------------------------
- At least 65% of the Fund's
EQUITY SECURITIES: total assets will be
common stocks (non-US issuers) invested in or exposed to
convertible bonds non-U.S. securities.
convertible preferred stocks
- ---------------------
(4) There can be no assurance that the Manager will be successful in
employing these strategies.
48
<PAGE> 69
OTHER EQUITY SECURITIES:
depository receipts: ADRs, GDRs, EDRs
foreign issues traded in the U.S. and abroad
investment companies (open & closed-end)
Illiquid securities
144A securities
restricted securities
equity futures and related options
exchange-traded and OTC Options on
securities and indexes (including
writing covered options)
equity swap contracts
contracts for differences
repurchase agreements
securities of emerging market countries
warrants or rights
investment companies (open and closed end)
FIXED INCOME SECURITIES:
long and medium-term corporate and
government bonds
non-convertible preferred stock
FOREIGN CURRENCY TRANSACTIONS - Fund may invest in spot
currency transactions,
forward foreign currency
contracts, currency swap
contracts, options on
currencies, currency futures
and related options.
CASH AND MONEY MARKET INSTRUMENTS - The Fund expects that less
Any short-term assets will be invested in than 5% of its total assets
cash or high quality money market will be invested in or
instruments including securities issued by exposed to cash and money
the U.S. government and agencies thereof, market instruments. This
bankers' acceptances, commercial paper, limitation does NOT include
Bank certificates of deposit and repurchase cash and money market
agreements instruments in margin
accounts or otherwise held
against exposure achieved
through derivative
instruments ("equitized
cash").
- --------------------------------------------------------------------------------
PROHIBITED INVESTMENTS AND PRACTICES
- --------------------------------------------------------------------------------
The Fund will NOT engage in the following practices except as indicated:
PURCHASING SECURITIES ON MARGIN - Except for short-term credits necessary for
clearance of transactions.
BORROWING MONEY - Except that the Fund may temporarily borrow
up to 20% of its net assets from banks for
the payment of redemptions or settlement of
securities transactions, but not as a
leveraged investment strategy.
UNDERWRITING SECURITIES - Except to the extent that the Fund is
deemed an underwriter for securities law
purposes in connection with disposition of
portfolio investments.
- Except that purchasing debt obligations,
repurchase agreements
- and engaging in securities lending will not
MAKING LOANS be considered making loans for this
purpose. The Fund may loan securities
valued at up to one-third of its total
assets.
PLEDGING, HYPOTHECATING OR - Except that collateral arrangements with
MORTGAGING FUND ASSETS respect to swap agreements, the writing of
options, stock index, interest rate,
currency or other futures
49
<PAGE> 70
contracts, 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 also not deemed to be
a pledge or encumbrance.
INVESTING DIRECTLY IN REAL ESTATE
INVESTING IN NON-FINANCIAL COMMODITY CONTRACTS
PARTICIPATING IN DIRECTED BROKERAGE ARRANGEMENTS
MAKING INVESTMENTS FOR THE PURPOSE OF GAINING CONTROL OF A COMPANY'S MANAGEMENT
MAKING SHORT SALES OF SECURITIES
- --------------------------------------------------------------------------------
RESTRICTIONS AND LIMITATIONS
- --------------------------------------------------------------------------------
OPTIONS ON SECURITIES - No more than 5% of the Fund's net
assets will be invested in time
premiums on options on particular
securities (as opposed to options on
indexes)
OTHER INVESTMENT COMPANIES - The Fund will not own more than 3% of
the outstanding voting securities of
any investment company
- No more than 5% of the Fund's net
assets will be invested in any single
investment company
- No more than 10% of the Fund's net
assets will be invested in securities
of investment companies in the
aggregate
- The Fund will not own other Funds of
GMO Trust
ILLIQUID SECURITIES - No more than 15% of the Fund's net
assets will be invested in illiquid
securities.
INVESTMENT IN INSURANCE - The Fund will not purchase more than
COMPANIES the extent limited by the 1940 Act of
the total outstanding voting stock of
any insurance company (including
foreign insurance companies).
INVESTMENT IN SECURITIES ISSUED - EQUITY: The Fund will not purchase more
BY BROKERS, DEALERS, than 5% of any class of stock of a
UNDERWRITERS AND INVESTMENT broker, dealer, underwriter or
ADVISERS investment adviser.
- DEBT: The Fund may not purchase more
than 10% of any such company's total
outstanding debt in the aggregate.
- INVESTMENT LIMITS: No more than 5% of
the Fund's total assets will be
invested in the securities of a SINGLE
broker, dealer, underwriter or
investment adviser. The net payment
obligation of swap contracts where one
of these types of companies is the
counterparty also counts for purposes
of this restriction.
This policy does not apply to companies
that derived less than 15% of revenues
from "securities-related businesses"
during the most recent fiscal year.
INVESTMENT IN "EMERGING - The Fund may invest up to 15% of its
COUNTRIES" net assets in securities of issuers in
newly industrializing countries in
Asia, Latin America, the Middle East,
Southern Europe, Eastern Europe and
Africa.
DIVERSIFICATION/CONCENTRATION
DIVERSIFICATION - Except for U.S. government securities,
cash, and money market instruments, the
Fund will not invest in any one
security to an extent greater than 5
percentage points over that security's
weighting in the Fund's benchmark.
- The Fund will not purchase more than
10% of the outstanding securities of
any issuer.
- The Fund will not invest more than 25%
of its total assets in securities of
50
<PAGE> 71
CONCENTRATION issuers in any one industry.
- The Fund will have greater than 65% of
its total assets invested in or exposed
to(5) securities principally traded in
the securities market of at least three
countries.
DERIVATIVE INSTRUMENTS (OTHER THAN FOREIGN CURRENCY TRANSACTIONS)
TYPES OF DERIVATIVES - Futures contracts and related options
on securities indexes
- Long equity swap contracts: where the
Fund pays a fixed rate plus the
negative performance, if any, and
receives the positive performance, if
any, of an index or basket of
securities.
- Short equity swap contracts: where the
Fund receives a fixed rate plus the
negative performance, if any, and pays
the positive performance of an index or
basket of securities
- Contracts for differences: equity swaps
that contain both long and short equity
components.
USES OF DERIVATIVES
HEDGING - TRADITIONAL HEDGING: Short equity
futures, related options and short
equity swap contracts used to hedge
against an equity risk already
generally present in the Fund.(6)
- ANTICIPATORY HEDGING: If the Fund
receives or anticipates significant
cash purchase transactions, the Fund
may hedge market risk (risk of not
being invested in the market) by
purchasing long futures contracts or
entering long equity swap contracts to
obtain market exposure until such time
as direct investments can be made
efficiently. Conversely, if the Fund
receives or anticipates a significant
demand for cash redemptions, the Fund
may sell futures contracts or enter
into short equity swap contracts, to
allow the Fund to dispose of securities
in a more orderly fashion without the
Fund being exposed to leveraged loss
exposure in the interim.
INVESTMENT - THE Fund may use derivative instruments
(particularly long futures contracts,
related options and long equity swap
contracts) in place of investing
directly in securities. This will
include using equity derivatives to
"equitize" cash balances held by the
Fund. Because a foreign equity
derivative generally only provides the
return of a foreign market in local
currency terms, the Fund will often
purchase a foreign currency forward in
conjunction with using equity
derivatives to give the effect of
investing directly. The Fund may also
use long derivatives for investment in
conjunction with short hedging
transactions to adjust the weights of
the Fund's underlying equity portfolio
to a level the Manager believes is the
optimal exposure to individual
countries and equities. For example, if
the Manager expects a positive return
forecast for a select group of UK
companies, but a negative return for
the UK market as a whole, then this
Fund may overweight the select group of
equities and reduce exposure to the UK
market by selling UK equity futures or
enter a swap contract that is long a
specific basket of securities and short
the UK market generally.
- --------------------------
(5) The words "exposed to" as used in these guidelines mean that, for
purposes of the relevant requirement or restriction, the total of the
fund's exposure to the relevant market or security through direct
investments and through derivative instruments will be considered.
(6) The Fund may use such hedging to remove or reduce general market
exposure (e.g. an index or broad basket of securities) relative to specific
exposure existing in the Fund (the specific stocks of that market actually
owned by the Fund). The Fund may also seek to remove specific exposure
(e.g. a single stock, small basket or more focused index of securities
expected to do poorly in an otherwise promising market) relative to general
or broad market exposure that exists in the Fund
51
<PAGE> 72
RISK MANAGEMENT - - THE Fund may use equity futures,
SYNTHETIC SALES AND PURCHASES related options and equity swap
contracts to adjust the weight of the
Fund to a level the manager believes is
the optimal exposure to individual
countries and equities. Sometimes, such
transactions are used as a precursor to
actual sales and purchases. For
example, if the Fund held a large
proportion of stocks of a particular
market and the Manager believed that
stocks of another market would
outperform such stocks, the Fund might
use a short futures contract on an
appropriate index (to synthetically
"sell" a portion of the Fund's
portfolio) in combination with a long
futures contract on another index (to
synthetically "buy" exposure to that
index). Long and short equity swap
contracts and contracts for differences
may also be used for these purposes.
Often, a foreign currency forward will
be used in conjunction with the long
derivative position to create the
effect of investing directly. Equity
derivatives (and corresponding currency
forwards) used to effect synthetic
sales and purchases will generally be
unwound as actual portfolio securities
are sold and purchased.
LIMITATIONS ON THE USE OF - There is no limit on the use of
DERIVATIVES derivatives for hedging purposes.
- The face value of derivatives used for
investment purposes will be limited to
25% of the Fund's assets. When a
currency forward is used in conjunction
with an equity derivative for
investment purposes, the currency
forward will not be independently
counted for this restriction.
- When long futures contracts and long
equity swaps are used for investment,
an amount of cash or high quality debt
securities equal to the face value of
all such long derivative positions will
be segregated against such exposure.
However, for purposes of this
restriction, if an existing long equity
exposure is reduced or eliminated by a
short derivative position, the
combination of the long and short
position will be considered as cash
available to segregate against a new
long derivative exposure.
- The net long equity exposure of the
Fund, including direct investment in
securities and long derivative
positions, will not exceed 100% of the
Fund's net assets.
- The aggregate absolute face value of
all futures contracts and swap
contracts (without regard to sign and
assuming no offset of long and short
positions, and counting both components
of any contract for differences) will
not exceed 100% of the Fund's assets.
- Except when such instruments are used
for bona-fide hedging, no more than 5%
of the Fund's net assets will be
committed to initial margin on futures
contracts and time premiums on related
options.
- Counterparties used for OTC derivatives
must have a long-term debt rating of A
or higher when the derivative is
entered into. Occasionally, short-term
derivatives will be entered into with
counterparties that have only high
short-term debt ratings.
FOREIGN CURRENCY TRANSACTIONS
TYPES OF FOREIGN CURRENCY - Buying and selling spot currencies
TRANSACTIONS - Forward foreign currency contracts
- Currency futures contracts and related
options
- Options on currencies
- Currency swap contracts
USES OF FOREIGN CURRENCY
TRANSACTIONS
HEDGING - TRADITIONAL HEDGING: The Fund may
effect foreign currency transactions -
generally short forward or futures
contracts -- to hedge the risk of
foreign currencies represented by its
securities investments back into the
U.S. dollar. The Fund is not required
to hedge any of the currency risk
obtained by investing in securities
denominated in foreign currencies.
- ANTICIPATORY HEDGING: When the Fund
enters into a contract for the purchase
or anticipates the need to purchase a
security denominated in a foreign
currency, it
52
<PAGE> 73
may "lock in" the U.S. dollar price of the
security by buying the foreign currency or
through currency forwards or futures.
- PROXY HEDGING: The Fund may hedge the
exposure of a given foreign currency by
using an instrument relating to a different
currency which the Manager believes is
highly correlated to the currency being
hedged.
INVESTMENT - The Fund may enter into currency forwards
or futures contracts in conjunction with
entering into a futures contract on a
foreign index in order to create synthetic
foreign currency denominated securities
RISK MANAGEMENT - Subject to the limitations described below,
the Fund will permit the Fund to have
foreign currency exposure that is
significantly different than the currency
exposure represented by its portfolio
investments. This may include long exposure
to particular currencies beyond the amount
of the Fund's investment in securities
denominated in that currency.
LIMITATIONS OF FOREIGN CURRENCY - The Fund will typically hedge less than 30%
TRANSACTIONS of the foreign currency exposure
represented by its investments in
foreign-currency denominated securities.
- The Fund's aggregate net foreign currency
exposure, assuming full offset of long and
short positions, will not exceed 100% of
the Fund's net assets denominated in
foreign currencies, though the currency
exposure of the Fund may differ
substantially from the currencies in which
the Fund's securities are denominated.
- The aggregate absolute face value of all
currency forward, currency futures and
currency swap contracts (without regard to
sign and assuming no offset of long and
short positions, and counting both
components of any contract for differences)
will not exceed 50% of the Fund's assets.
- The Fund will not be net short in any
foreign currency, except that, when the
Fund is attempting to hedge all or nearly
all of its exposure to a particular
currency, changes in the market value of
foreign equities may cause the Fund to be
temporarily net short in the currency. Such
temporary net short positions will not
exceed 1% of the Fund's assets.
53
<PAGE> 74
- --------------------------------------------------------------------------------
GMO TAX-MANAGED SMALL COMPANIES FUND
- --------------------------------------------------------------------------------
TAX-SENSITIVE STRATEGIES THAT MAY BE EMPLOYED(7)
- - Manager may control portfolio turnover in order to defer the realization
and minimize the distributions of capital gains.
- - Manager may, when appropriate, sell securities in order to realize capital
losses. Losses may be used at various times to offset realized capital
gains, thus reducing net capital gains distributions.
- - When making sales of specific securities, the Manager considers strategies,
such as selling securities with the highest cost basis, to minimize capital
gains.
- - In lieu of redeeming in cash, the Manager may meet redemption requests
through in-kind redemptions in whole or in part by a distribution of
appreciated securities held by the Fund, so that the Fund will generally
not be required to distribute the capital gains in those securities to the
remaining shareholders in the Fund. The effect to the redeeming shareholder
is the same for federal income tax purposes as a redemption in cash.
Shareholders receiving the redemption in kind would pay tax on the capital
gains realized, if any, on the Fund shares redeemed.
================================================================================
ANY NUMERICAL OR PERCENTAGE LIMITATION SET FORTH IN THIS DOCUMENT WILL BE
APPLIED ONLY AT THE TIME OF INITIAL INVESTMENT IN A SECURITY OR OTHER
INVESTMENT. THE FUND DOES NOT UNDERTAKE TO ADJUST ITS PORTFOLIO IN THE CASE
WHERE MARKET MOVEMENTS, CASH FLOWS OR OTHER FACTORS CAUSE ANY OF SUCH
LIMITATIONS TO BE EXCEEDED. EXCEPT AS OTHERWISE INDICATED, NUMERICAL AND
PERCENTAGE LIMITATIONS ARE EXPRESSED AS A PERCENTAGE OF THE FUND'S TOTAL ASSETS.
- --------------------------------------------------------------------------------
PERMITTED INVESTMENTS
- --------------------------------------------------------------------------------
SECURITIES/INSTRUMENTS: - Under normal market
domestic common stocks conditions, at least 65% of
convertible securities the Fund's total assets will
securities of foreign issuers (traded be invested in or exposed
principally on U.S. Exchanges) to(9) the equity securities
depository receipts of small companies.
investment companies (open & closed end)
illiquid securities - Any short-term assets will
144A Securities be invested in cash or High
restricted securities Quality Money Market
futures and related options on Instruments including
securities indexes securities issued by the
REITs U.S. government and agencies
exchange-traded and OTC options on thereof, bankers'
securities and indexes (including writing acceptances, commercial
covered options) paper, bank certificates of
equity swap contracts deposit and repurchase
contracts for differences agreements. The Fund expects
index futures that less than 5% of its net
repurchase agreements assets will be exposed to
cash and money market instruments cash and money market
warrants or rights instruments. This limitation
does NOT include cash and
money market instruments in
margin accounts or otherwise
held against exposure
achieved through derivative
instruments ("equitized
cash").
- -------------------------------------------------------------------------------
PROHIBITED INVESTMENTS AND PRACTICES
- -------------------------------------------------------------------------------
The Fund will NOT engage in the following practices except as indicated:
- --------------------
(7) There can be no assurance that the Manager will be successful in
employing these strategies.
(9) The words "exposed to" as used in these guidelines mean that, for
purposes of the relevant requirement or restriction, the total of the
Fund's exposure to the relevant market or security through direct
investments and through derivative instruments will be considered.
54
<PAGE> 75
PURCHASING SECURITIES ON MARGIN - Except for short-term credits
necessary for clearance of
transactions.
BORROWING MONEY - Except that the Fund may borrow
up to 20% of its net assets from
banks temporarily for the
payment of redemptions or
settlement of securities
transactions, but not as a
leveraged investment strategy.
UNDERWRITING SECURITIES - Except to the extent that the
Fund is deemed an underwriter
for securities law purposes in
connection with disposition of
portfolio investments.
MAKING LOANS - Except that purchasing debt
obligations, repurchase
agreements and engaging in
securities lending will not be
considered making loans for this
purpose. Fund may loan
securities valued at up to
one-third of its total assets.
PLEDGING, HYPOTHECATING OR - Except that collateral
MORTGAGING FUND ASSETS arrangements with respect to
swap agreements, the writing of
options, stock index, interest
rate, currency or other futures
contracts, 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 also not deemed
to be a pledge or encumbrance.
INVESTING IN REAL ESTATE
INVESTING IN NON-FINANCIAL COMMODITY CONTRACTS
PARTICIPATING IN DIRECTED BROKERAGE ARRANGEMENTS
MAKING INVESTMENTS FOR THE PURPOSE OF GAINING CONTROL OF A COMPANY'S
MANAGEMENT
MAKING SHORT SALES OF SECURITIES
SELLING UNCOVERED PUT OR CALL OPTIONS ON SECURITIES OR INDEXES
- --------------------------------------------------------------------------------
RESTRICTIONS AND LIMITATIONS
- --------------------------------------------------------------------------------
OPTIONS ON SECURITIES - No more than 5% of the Fund's
net assets will be invested in
time premiums on options on
particular securities (as
opposed to options on indexes).
OTHER INVESTMENT COMPANIES - The Fund will not own more than
3% of the outstanding voting
securities of any investment
company.
- No more than 5% of the Fund's
net assets will be invested in
any single investment company.
- No more than 10% of the Fund's
net assets will be invested in
securities of investment
companies in the aggregate.
- The Fund will not own other
Funds of GMO Trust.
ILLIQUID SECURITIES - No more than 15% of the Fund's
net assets will be invested in
illiquid securities.
INVESTMENT IN INSURANCE COMPANIES - The Fund will not purchase more
than 10% of the total
outstanding voting stock of any
insurance company (including
foreign insurance companies).
INVESTMENT IN SECURITIES ISSUED BY - EQUITY: The Fund will not
BROKERS, DEALERS, UNDERWRITERS AND purchase more than 5% of any
INVESTMENT ADVISERS class of stock of a broker,
dealer, underwriter or
investment adviser.
- INVESTMENT LIMITS: No more than
5% of the Fund's total assets
will be invested in the
securities of a SINGLE broker,
dealer, underwriter or
investment adviser. The net
payment obligation of swap
contracts where one of these
types of companies is the
counterparty also counts for
purposes of this restriction.
This policy does not apply to
companies that derived less than
15% of revenues from
"securities-related businesses"
during the most recent fiscal
year.
55
<PAGE> 76
DIVERSIFICATION/CONCENTRATION
DIVERSIFICATION - With respect to at least 50% of the Fund's
total assets, the Fund will not invest
more than 5% of its assets in any one
security, except for U.S. government
securities, cash, and money market
instruments.
CONCENTRATION - The Fund will not invest more than 25% of
its total assets in securities of issuers
in any one industry.
DERIVATIVE INSTRUMENTS
TYPES OF DERIVATIVES - Futures contracts and related options on
securities indexes
- Long equity swap contracts: where the Fund
pays a fixed rate plus the negative
performance, if any, and receives the
positive performance, if any, of an index
or basket of securities.
- Short equity swap contracts: where the
Fund receives a fixed rate plus the
negative performance, if any, and pays the
positive performance of an index or basket
of securities
- Contracts for differences: equity swaps
that contain both a long and short equity
component.
USES OF DERIVATIVES - TRADITIONAL HEDGING: Short equity futures,
related options and short equity swap
contracts used to hedge against an equity
risk already generally present in the
Fund.(10)
HEDGING - ANTICIPATORY HEDGING: If the Fund receives
or anticipates significant cash purchase
transactions, the Fund may hedge market
risk (risk of not being invested in the
market) by purchasing long futures
contracts or entering into long equity
swap contracts to obtain market exposure
until such time as direct investments can
be made efficiently. Conversely, if the
Fund receives or anticipates a significant
demand for cash redemptions, the Fund may
sell futures contracts or enter into short
equity swap contracts to allow the Fund to
dispose of securities in a more orderly
fashion without the Fund being exposed to
leveraged loss exposure in the interim.
INVESTMENT - The Fund may use derivative instruments
(particularly long futures contracts,
related options and long equity swap
contracts) in place of investing directly
in securities. This will include using
equity derivatives to "equitize" cash
balances held by the Fund. The Fund may
also use long derivatives for investment
in conjunction with short hedging
transactions to adjust the weights of the
Fund's underlying equity portfolio to a
level the Manager believes is the optimal
exposure to individual markets, sectors
and equities.
RISK MANAGEMENT - - The Fund may use equity futures, related
SYNTHETIC SALES AND options and equity swap contracts to
PURCHASES adjust the weight of the Fund to a level
the Manager believes is the optimal
exposure to individual markets, sectors
and equities. Sometimes, such transactions
are used as a precursor to actual sales
and purchases. For example, if the Fund
held a large proportion of stocks of a
particular market and the Manager believed
that stocks of another market would
outperform such stocks, the Fund might use
a short futures contract on an appropriate
index (to synthetically "sell" a portion
of the Fund's portfolio) in combination
with a long futures contract on another
index (to synthetically "buy" exposure to
that index). Long and short equity swap
contracts and contracts for differences
may also be used for these purposes.
Equity derivatives (and corresponding
currency forwards) used to effect
synthetic sales and purchases will
generally be unwound as actual portfolio
securities are sold and purchased.
- ------------------------
(10) The Fund may use such hedging to remove or reduce general
market exposure (e.g., an index or broad basket of securities) relative to
specific exposure existing in the Fund (the specific stocks of that market
actually owned by the Fund). The Fund may also seek to remove specific
exposure (e.g., a single stock, small basket or more focused index of
securities expected to do poorly in an otherwise promising market) relative
to general or broad market exposure that exists in the Fund.
56
<PAGE> 77
LIMITATIONS ON THE - There is no limit on the use of
USE OF DERIVATIVES derivatives for hedging purposes.
- The face value of derivatives used for
investment purposes will be limited to 25%
of the Fund's assets. When a currency
forward is used in conjunction with an
equity derivative for investment purposes,
the currency forward will not be
independently counted for this
restriction.
- When long futures contracts and long
equity swaps are used for investment, an
amount of cash or high quality debt
securities equal to the face value of all
such long derivative positions will be
segregated against such exposure. However,
for purposes of this restriction, if an
existing long equity exposure is reduced
or eliminated by a short derivative
position, the combination of the long and
short position will be considered as cash
available to segregate against a new long
derivative exposure.
- The net long equity exposure of the Fund,
including direct investment in securities
and long derivative positions, will not
exceed 100% of the Fund's net assets.
- The aggregate absolute face value of all
futures contracts and swap contracts
(without regard to sign and assuming no
offset of long and short positions, and
counting both components of any contract
for differences) will not exceed 100% of
the Fund's assets.
- Except when such instruments are used for
bona-fide hedging, no more than 5% of the
Fund's net assets will be committed to
initial margin on futures contracts and
time premiums on related options.
- Counterparties used for OTC derivatives
must have a long-term debt rating of A or
higher when the derivative is entered
into. Occasionally, short-term derivatives
will be entered into with counterparties
that have only high short-term debt
ratings.
57
<PAGE> 78
FINANCIAL STATEMENTS
The audited financial statements for the Tax-Managed U.S. Equities Fund and
the Tax-Managed International Equities Fund for the fiscal year ended February
28, 1999 included in the Trust's Annual Reports filed with the Securities and
Exchange Commission on May 10, 1999, 1999 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.
GMO TRUST
SPECIMEN PRICE-MAKE-UP SHEET
Following are computations of the total offering price per share for each
class of shares of the Tax-Managed U.S. Equities Fund and the Tax-Managed
International Equities Fund, in each case based upon their respective net asset
values and shares of beneficial interest outstanding at the close of business on
February 28, 1999.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
TAX-MANAGED U.S. EQUITIES FUND - CLASS III
- ------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
<S> <C>
Net Assets at Value (Equivalent to $10.67 per share based on 760,573 shares of
beneficial interest outstanding) $8,115,517
----------
- ----------------------------------------------------------------------------------------------------------------------
Offering Price ($10.67 x 100/99.86) * $10.68
------
- ----------------------------------------------------------------------------------------------------------------------
TAX-MANAGED INTERNATIONAL EQUITIES FUND-CLASS III
- -------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Net Assets at Value (Equivalent to $9.71 per share based on 1,907,929 shares of $18,529,073
beneficial interest outstanding) -----------
- ----------------------------------------------------------------------------------------------------------------------
Offering Price ($9.71 x 100/99.40)* $9.77
-----
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
- ----------------------------
*Represents maximum offering price charged on certain cash purchases. See
"Purchase of Shares" in the Shareholder's Manual.
58
<PAGE> 79
GMO TRUST
SHAREHOLDER'S MANUAL
SHAREHOLDER'S MANUAL FOR CLASS II, CLASS III AND CLASS IV SHARES
GMO FUNDS
<TABLE>
<CAPTION>
U.S. FUNDS INTERNATIONAL EQUITY FUNDS FIXED INCOME FUNDS ASSET ALLOCATION FUNDS
<S> <C> <C> <C>
U.S. Core Fund International Core Fund Domestic Bond Fund International Equity
Tobacco-Free Core Fund Currency Hedged U.S. Bond/Global Alpha A Allocation Fund
Value Fund International Core Fund Fund World Equity Allocation
Fundamental Value Fund Foreign Fund U.S. Bond/Global Alpha B Fund
Intrinsic Value Fund International Small Fund Global (U.S.+) Equity
Growth Fund Companies Fund International Bond Fund Allocation Fund
Small Cap Value Fund Japan Fund Currency Hedged Global Balanced Allocation
Small Cap Growth Fund Emerging Markets Fund International Bond Fund Fund
REIT Fund Evolving Countries Fund Global Bond Fund U.S. Sector Fund
Tax-Managed U.S. Asia Fund Emerging Country Debt
Equities Fund Global Properties Fund Fund
Tax-Managed Small Tax-Managed International Short-Term Income Fund
Companies Fund Equities Fund Global Hedged Equity Fund
Inflation Indexed Bond
Fund
Emerging Country Debt Share
Fund
</TABLE>
This GMO Trust Shareholder's Manual (the "Manual") contains detailed
information about purchase and redemption options and procedures for each of the
funds listed above (the "Funds"). This Manual also includes information
regarding Class II, Class III and Class IV Shares of the Funds, including the
classes of shares available for each Fund, the eligibility requirements for each
class and the circumstances under which a shareholder's shares of one class of a
Fund will be automatically converted to a different class of shares of that
Fund. This Manual is not a prospectus, and should be used in conjunction with
each relevant Fund's prospectus, as amended from time to time (collectively, the
"Prospectuses"). This Manual, and the information disclosed herein, is
incorporated by reference into the Prospectuses, and is considered part of the
Prospectuses.
You can call GMO Trust (the "Trust") collect at 1-617-346-7646 to find out
more about the Funds.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
How to Buy Shares........................................... 2
Purchase Procedures....................................... 2
How to Redeem Shares........................................ 3
Purchase Premiums and Redemption Fees....................... 4
Multiple Classes............................................ 6
Eligibility for Classes................................... 7
Conversions between Classes............................... 8
Distributions............................................... 8
</TABLE>
JUNE 30, 1999
SHAREHOLDER'S MANUAL AS REVISED OCTOBER 18, 1999
<PAGE> 80
HOW TO BUY SHARES
Shares of each Fund are available only from the Trust and may be purchased
on any day when the New York Stock Exchange is open for business (a "business
day"). Shares may be purchased by sending a purchase order to the Trust. See
"Purchase Procedures" below.
The purchase price of a share of each Fund is (i) the net asset value next
determined after a purchase order is received in good order plus (ii) a premium,
if any, established from time to time by the Trust for the particular Fund and
class to be purchased. All purchase premiums are paid to and retained by the
Fund and are intended to cover the brokerage and other costs associated with
putting the investment to work in the relevant markets. Purchase premiums
generally apply only to cash purchases, subject to certain exceptions described
below. Each class of shares of a Fund has the same rate of purchase premium, if
any. The purchase premiums currently in effect for each Fund are set forth under
"Purchase Premiums and Redemption Fees" on page 4. Purchase premiums are not
sales loads.
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
purchase order. Securities acceptable to the Manager as consideration for Fund
shares will be valued as set forth under "Determination of Net Asset Value"
(generally the last quoted sale price) as of the time of the next determination
of net asset value after such acceptance. All dividends, subscription or other
rights which are reflected in the market price of accepted securities at the
time of valuation become the property of the relevant Fund and must be delivered
to the Trust upon receipt by the investor from the issuer. A gain or loss for
federal income tax purposes may be realized by the investor subject to federal
income taxation upon the exchange, depending upon the investor's basis in the
securities tendered.
The Manager will not approve securities as acceptable consideration for
Fund shares unless (1) the Manager, in its sole discretion, believes the
securities are appropriate investments for the Fund; (2) the investor represents
and agrees that all securities offered to the Fund are not subject to any
restrictions upon their sale by the Fund under the Securities Act of 1933, or
otherwise; and (3) the securities may be acquired under the investment
restrictions applicable to the relevant Fund. Investors interested in making
in-kind purchases should telephone the Trust at (617) 346-7646.
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." 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. Boston time. 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. Boston time is the deadline for
transferring those securities to the account designated by the Trust's 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.
Boston time on or prior to the fourth business day after such assurances are
received.
PURCHASE PROCEDURES:
(a) General: Investors should call the Trust at (617) 346-7646 to obtain a
Purchase Order Form, which contains wire transfer and mailing instructions. The
Trust reserves the right to reject any order for Trust Shares. DO NOT SEND CASH,
CHECKS OR SECURITIES DIRECTLY TO THE TRUST.
Purchases will be made in full and fractional shares of each Fund
calculated to three decimal places. The Trust's Transfer Agent will send a
written confirmation (including a statement of shares owned) to shareholders at
the time of each transaction.
(b) Purchase Order Form: Investors must submit an application to the Trust and
it must be accepted by the Trust before it will be considered in "good order."
The Purchase Order Form may be submitted to the Trust (i) By Mail to GMO Trust
c/o Grantham, Mayo, Van Otterloo & Co. LLC, 40 Rowes Wharf, Boston, MA 02110,
Attention: Shareholder Services, or (ii) By Facsimile to (617) 439-4192,
Attention: Shareholder Services.
(c) Acceptance of Order: A shareholder may confirm acceptance of a mailed or
faxed purchase order by calling the Trust at (617) 346-7646. If a Purchase Order
is mailed to the Trust, it will be acted upon when received.
2
<PAGE> 81
(d) Payment: All Federal funds must be transmitted to Investors Bank & Trust
Company for the account of the specific Fund of GMO Trust. "Federal funds" are
monies credited to Investors Bank & Trust Company's account with the Federal
Reserve Bank of Boston. All checks must be made payable to the relevant Fund or
to GMO Trust. The Trust will not accept any third party checks. The wiring
instructions and mailing address for checks are as follows:
<TABLE>
<S> <C>
WIRING INSTRUCTIONS: MAILING ADDRESS FOR CHECKS:
Investors Bank and Trust, Boston, Massachusetts Investors Bank and Trust
ABA # 011001438 GMO Transfer Agent MFD 23
Attn.: Transfer Agent P.O. Box 9130
GMO Deposit Account 55555-4444 (200 Clarendon Street), 16th Floor
Further credit: GMO Fund/Account Name, Shareholder Name and/or Number Boston, MA 02117-9130
Payable to: GMO Trust or [Name]
Fund
</TABLE>
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.
HOW TO REDEEM SHARES
Shares of each Fund may be redeemed on any business day in cash or in kind.
The redemption price is the net asset value per share next determined after
receipt of the redemption request in "good order" less any applicable redemption
fee. All redemption fees are paid to and retained by the Fund and are intended
to cover the brokerage and other Fund costs associated with redemptions. All
classes of a particular Fund bear the same redemption fee rate, if any. The
redemption fees currently in effect for each Fund are set forth under "Purchase
Premiums and Redemption Fees" on page 4. Redemption fees are not sales loads or
contingent deferred sales charges.
If the Manager determines, in its sole discretion, that it would be
detrimental to the best interest of the remaining shareholders of a Fund to make
payment wholly or partly in cash, the Fund may pay the redemption price in whole
or in part by a distribution in-kind of securities held by the Fund in lieu of
cash. Securities used to redeem Fund shares in-kind will be valued in accordance
with the relevant Fund's procedures for valuation described under "Determination
of Net Asset Value." Securities distributed by a Fund in-kind will be selected
by the Manager in light of the Fund's objective and will not generally represent
a pro rata distribution of each security held in the Fund's portfolio. Any
in-kind redemptions will be of readily marketable securities to the extent
available. Investors may incur brokerage charges on the sale of any such
securities so received in payment of redemptions.
Payment on redemption will be made as promptly as possible and in any event
within seven days after the request for redemption is received by the Trust in
"good order." A redemption request is in "good order" if it includes the exact
name in which shares are registered, the investor's account number and the
number of shares or the dollar amount of shares to be redeemed and if it is
signed exactly in accordance with the form of registration. In addition, for a
redemption request to be in "good order" on a particular day, the investor's
request must be received by the Trust prior to the close of regular trading on
the New York Stock Exchange on that day (generally 4:00 p.m. New York City
Time). Redemption requests received after such deadline will be honored on the
next following business day, and the redemption will be effected based on the
net asset value per share computed on such next following business day (subject
to any applicable redemption fee). Persons acting in a fiduciary capacity, or on
behalf of a corporation, partnership or trust, must specify, in full, the
capacity in which they are acting. The redemption request will be considered
"received" by the Trust only after (i) it is mailed to, and received by, the
Trust at the appropriate address set forth above for purchase orders, or (ii) it
is faxed to the Trust at the appropriate facsimile number set forth above for
purchase orders, and the investor has confirmed receipt of the faxed request by
calling the Trust at (617) 346-7646. 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 or, upon
request, a check can be mailed to the registration address.
When opening an account with the Trust, shareholders will be required to
designate the account(s) to which funds or securities may be transferred upon
redemption. Designation of additional accounts and any change in the accounts
originally designated must be made in writing.
Each Fund may suspend the right of redemption and may postpone payment for
more than seven days when the New York Stock Exchange is closed for other than
weekends or holidays, or if permitted by the rules of the Securities and
Exchange Commission during periods when trading on the Exchange is restricted or
during an emergency which makes it impracticable for the Fund to dispose of its
securities or to fairly determine the value of the net assets of the Fund, or
during any other period permitted by the Securities and Exchange Commission for
the protection of investors. Because certain Funds hold portfolio securities
listed on foreign exchanges which may trade on days on which the New York Stock
Exchange is closed, the net asset value of such Funds' shares may be
significantly affected on days when shareholders have no access to such Funds.
3
<PAGE> 82
PURCHASE PREMIUMS AND REDEMPTION FEES
The following table sets forth the purchase premiums and redemption fees,
if any, for each of the Funds. Purchase premiums and redemption fees are not
sales loads or contingent deferred sales charges, and are paid directly to the
relevant Fund at purchase or redemption of Fund shares. Notes to the table begin
on page 5.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
CASH PURCHASE PREMIUM REDEMPTION FEES
GMO FUND NAME (AS A % OF AMOUNT REDEEMED)(1) (AS A % OF AMOUNT REDEEMED)(1)
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
U.S. EQUITY FUNDS
U.S. Core Fund 0.14%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
Tobacco-Free Core Fund 0.14%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
Value Fund 0.14%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
Fundamental Value Fund 0.15%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
Intrinsic Value Fund 0.14%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
Growth Fund 0.14%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
Small Cap Value Fund 0.50%(2) 0.50%(2)
- ------------------------------------------------------------------------------------------------------------------------------
Small Cap Growth Fund 0.50%(2) 0.50%(2)
- ------------------------------------------------------------------------------------------------------------------------------
REIT Fund 0.50%(2) 0.50%(2)
- ------------------------------------------------------------------------------------------------------------------------------
Tax-Managed U.S. Equities Fund 0.14%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
Tax-Managed Small Companies Fund 0.50%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
INTERNATIONAL EQUITY FUNDS
International Core Fund 0.60%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
Currency Hedged International Core Fund 0.60%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
Foreign Fund None None
- ------------------------------------------------------------------------------------------------------------------------------
International Small Companies Fund 1.00%(2) 0.60%(2)
- ------------------------------------------------------------------------------------------------------------------------------
Japan Fund 0.20%(2) 0.20%(2)
- ------------------------------------------------------------------------------------------------------------------------------
Emerging Markets Fund 1.60%(3) 0.40%(3,4)
- ------------------------------------------------------------------------------------------------------------------------------
Evolving Countries Fund 1.60%(3) 0.40%(3)
- ------------------------------------------------------------------------------------------------------------------------------
Asia Fund 1.20%(3) 0.40%(3)
- ------------------------------------------------------------------------------------------------------------------------------
Global Properties Fund 0.60%(2,5) 0.30%(2,5)
- ------------------------------------------------------------------------------------------------------------------------------
Tax-Managed International Equities Fund 0.60%(2) None
- ------------------------------------------------------------------------------------------------------------------------------
FIXED INCOME FUNDS
Domestic Bond Fund None None
- ------------------------------------------------------------------------------------------------------------------------------
U.S. Bond/Global Alpha A Fund 0.15%(3) None
- ------------------------------------------------------------------------------------------------------------------------------
U.S. Bond/Global Alpha B Fund 0.15%(3) None
- ------------------------------------------------------------------------------------------------------------------------------
International Bond Fund 0.15%(3) None
- ------------------------------------------------------------------------------------------------------------------------------
Currency Hedged International Bond Fund 0.15%(3) None
- ------------------------------------------------------------------------------------------------------------------------------
Global Bond Fund 0.15%(3) None
- ------------------------------------------------------------------------------------------------------------------------------
Emerging Country Debt Fund 0.50%(3) 0.25%(3,9)
- ------------------------------------------------------------------------------------------------------------------------------
Short-Term Income Fund None None
- ------------------------------------------------------------------------------------------------------------------------------
Global Hedged Equity Fund 0.51%(2,6) 1.40%(6,8)
- ------------------------------------------------------------------------------------------------------------------------------
Inflation Indexed Bond Fund 0.10%(3) 0.10%(3)
- ------------------------------------------------------------------------------------------------------------------------------
Emerging Country Debt Share Fund *(11) *(11)
- ------------------------------------------------------------------------------------------------------------------------------
ASSET ALLOCATION FUNDS
International Equity Allocation Fund 0.80%(2,10) 0.11%(2,10)
- ------------------------------------------------------------------------------------------------------------------------------
World Equity Allocation Fund 0.66%(2,10) 0.15%(2,10)
- ------------------------------------------------------------------------------------------------------------------------------
Global (U.S.+) Equity Allocation Fund 0.47%(2,10) 0.15%(2,10)
- ------------------------------------------------------------------------------------------------------------------------------
Global Balanced Allocation Fund 0.35%(2,10) 0.11%(2,10)
- ------------------------------------------------------------------------------------------------------------------------------
U.S. Sector Fund 0.27%(2,6) 0.18%(2,6,7)
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
4
<PAGE> 83
1. Purchase premiums and redemption fees 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. The Manager may reduce these fees in certain limited circumstances
described below.
Normally, no purchase premium is charged with respect to in-kind purchases
of Fund shares. However, the International Core Fund, Currency Hedged
International Core Fund, International Small Companies Fund, Japan Fund,
Tax-Managed International Equities Fund and Global Hedged Equity Fund may
each charge a purchase premium of up to 0.10%, and the Emerging Markets
Fund, Evolving Countries Fund and Asia Fund may each charge a premium of up
to 0.20%, for in-kind purchases involving transfers of large positions in
markets where re-registration and transfer costs are high. Special rules
also apply with respect to in-kind transactions in certain Fixed Income
Funds as described in footnote 3 below.
2. The purchase premium and/or redemption fee for this Fund may generally not
be waived due to offsetting transactions, and may be waived in only rare
circumstances. The premium or fee will only be waived for this Fund (i) if
the purchase or redemption is part of a transfer from or to another Fund
where the Manager is able to transfer securities among the Funds as part of
effecting the transaction, (ii) during periods (expected to exist only
rarely) when the Manager determines that the Fund is either substantially
overweighted or underweighted with respect to its cash position so that a
redemption or purchase will not require a securities transaction, or (iii)
in certain other instances (not including offsetting transactions) where it
is compelling to the Manager that the purchase or redemption will not
result in transaction costs to the Fund. Any waiver with respect to this
Fund must be arranged in advance with the Manager.
3. The stated purchase premium and/or redemption fee for this 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. In addition, except for the Emerging Markets Fund,
Evolving Countries Fund and Asia Fund, the purchase premium or redemption
fee for this Fund will be reduced by 50% if the purchaser makes an in-kind
purchase of Fund shares or if the purchase or redemption is part of a
transfer from or to another Fund where the Manager is able to transfer
securities among the Funds as part of effecting the transaction.
4. Applies only to shares acquired on or after June 1, 1995 (including shares
acquired by reinvestment of dividends or other distribution on or after
such date).
5. It is expected that the purchase premiums and redemption fees for this Fund
will be eliminated once the net assets of the Fund exceed $100 million.
However, even thereafter, the Fund will reserve the right to charge a
purchase premium of up to 0.60% and a redemption fee of up to 0.30% on
purchases or redemptions of amounts that are equal to or greater than 5% of
the Fund's net assets.
6. The Fund invests in various other Funds with different levels of purchase
premiums and/or redemption fees which reflect the trading costs of
different asset classes. Therefore, the Fund's purchase premium and/or
redemption fee has been computed as the weighted average of the purchase
premiums and/or redemption fees of other GMO Funds in which the Fund is
invested and/or which hold securities of the same asset class and/or sector
as securities owned directly by the Fund. The amount of purchase premium
and/or redemption fee for the Fund will be adjusted approximately annually
based on underlying Funds owned by the Fund during the prior year. The
Manager may, but is not obligated to, adjust the purchase premium and/or
redemption fee for the Fund more frequently if the Manager believes in its
discretion that circumstances warrant.
7. Applies only to shares acquired on or after June 30, 1998 (including shares
acquired by reinvestment of dividends or other distributions on or after
such date).
8. If it is not necessary to incur costs relating to the early termination of
hedging transactions to meet redemption requests, the redemption fee will
be reduced to 0.13%.
9. Applies only to shares acquired on or after July 1, 1995 (including shares
acquired by reinvestment of dividends or other distributions on or after
such date).
10. Each of the Asset Allocation Funds invests in various other Funds with
different levels of purchase premiums and redemption fees, which reflect
the trading costs of different asset classes. Therefore, the purchase
premium and redemption fee of each Asset Allocation Fund has been set as
the weighted average of the premiums and fees, respectively, of the
underlying Funds in which the Asset Allocation Fund is invested, based on
actual investments by
5
<PAGE> 84
each Asset Allocation Fund. The amount of purchase premium and redemption
fee for each Asset Allocation Fund is adjusted approximately annually based
on underlying Funds owned by each Asset Allocation Fund during the prior
year. The Manager may, but is not obligated to, adjust the purchase premium
and/or redemption fee for an Asset Allocation Fund more frequently if the
Manager believes in its discretion that circumstances warrant.
11. No purchase premium or redemption fee is charged directly by the Fund. By
virtue of the Fund's investment in the Emerging Country Debt Fund, Fund
shareholders will, however, indirectly bear the Emerging Country Debt
Fund's purchase premium and redemption fee, which are presently up to 0.50%
and 0.25%, respectively.
MULTIPLE CLASSES
Each Fund may offer multiple classes of shares. All Funds offer Class III
Shares and, as described below, certain Funds also offer Class II and/or Class
IV Shares. The Funds may offer other classes of shares not described in this
Manual. The sole economic difference among the various classes of shares
described in this Manual is the level of Shareholder Service Fee that the
classes bear for client and shareholder service, reporting and other support,
reflecting 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 (the "Plan") covering
each class of shares described in this Manual. The following table summarizes
the current eligibility requirements for each class (subject to the exceptions
noted below) and the Shareholder Service Fees each class will pay under the
Plan, expressed as an annual percentage of the average daily net assets
attributable to that class of shares:
CLASS II AND CLASS III SHARES:
- ------------------------------
<TABLE>
<CAPTION>
U.S. CORE FUND, INTERNATIONAL CORE FUND
AND FOREIGN FUND (COLLECTIVELY, MINIMUM TOTAL INVESTMENT/ SHAREHOLDER
THE "CLASS II FUNDS") TOTAL FUND INVESTMENT* SERVICE FEE ("SSF")**
- --------------------------------------- ------------------------- -----------------------
<S> <C> <C>
Class II................................................ $1 million/N/A 0.22%
Class III............................................... $35 million/N/A 0.15%
ASSET ALLOCATION FUNDS (EXCEPT U.S. SECTOR
FUND) AND EMERGING COUNTRY DEBT
SHARE FUND
- ------------------------------------------
Class III............................................... $1 million/N/A 0.00%***
U.S. SECTOR FUND AND GLOBAL
HEDGED EQUITY FUND
- ---------------------------
Class III............................................... $1 million/N/A 0.15%****
ALL OTHER FUNDS (EXCEPT
CLASS II FUNDS AND
ASSET ALLOCATION FUNDS)
- -----------------------
Class III............................................... $1 million/N/A 0.15%
CLASS IV SHARES:
- ----------------
U.S. CORE FUND............................................ $250 million/$125 million 0.105%
INTERNATIONAL CORE FUND................................... $250 million/$125 million 0.09%
FOREIGN FUND.............................................. $250 million/N/A 0.09%
CURRENCY HEDGED INTERNATIONAL CORE FUND................... $250 million/$125 million 0.09%
EMERGING MARKETS FUND..................................... $250 million/$125 million 0.105%
EMERGING COUNTRY DEBT FUND................................ $250 million/$125 million 0.10%
</TABLE>
* The eligibility requirements in the table above are subject to certain
exceptions and special rules for certain plan investors and for certain
clients with continuous client relationships with GMO since May 31, 1996.
These exceptions and special rules are explained under "Eligibility for
Classes" below.
** All classes of shares of a Fund pay the same investment management fee.
*** These Funds will indirectly bear an additional SSF of 0.15% by virtue of
their investments in other Funds of the Trust. Thus, the total SSF borne by
Class III Shares of these Funds is the same as that borne by Class III
Shares of the other Funds. See "Fees and Expenses" in the Prospectuses.
**** The SSF charged to these Funds will be reduced by a corresponding amount
for all SSF's indirectly borne by the relevant Fund by reason of its
investments in Class III Shares of other Funds of the Trust. Thus, the
total SSF borne by Class III Shares of these Funds is the same as that
borne by Class III Shares of the other Funds of the Trust.
6
<PAGE> 85
ELIGIBILITY FOR CLASSES
CLASS II AND CLASS III SHARES:
Class II Shares are currently being offered only for the "Class II Funds"
listed in the table above. Class III Shares are currently being offered for all
Funds. With certain exceptions described below, for a client to be eligible for
Class II or Class III Shares, the client must satisfy the minimum "Total
Investment" (as defined below) requirement set forth in the table.
For clients establishing a relationship with GMO on or after June 1,
1996: A client's Total Investment will be determined by GMO at the time of a
new client's initial investment with GMO, at least annually 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 U.S. 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 U.S. Active Division) since the previous Determination Date (plus the
market value of any account managed by GMO's U.S. 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 U.S. 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 Active
U.S. Division) made since the previous Determination Date. For clients with GMO
accounts 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 31, 1997,
their Total Investment will be determined as described above. Notwithstanding
anything to the contrary in this Manual or the Prospectuses, assets invested in
the Pelican Fund will not be considered when determining a client's Total
Investment. For purposes of this Manual and the Prospectuses, accounts managed
by GMO's U.S. Active Division include certain separate accounts managed by GMO.
Clients with any questions regarding whether certain of their assets are deemed
to be managed by GMO's U.S. Active Division should call GMO at (617) 346-7646.
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.
CLASS IV SHARES:
Class IV Shares are currently being offered only for the Funds listed in
the table on the previous page. Eligibility for Class IV Shares of a Fund is
dependent upon the client meeting either (i) the minimum "Total Fund Investment"
set forth in the table, which includes only a client's total investment in the
particular Fund, or (ii) the minimum "Total Investment" set forth in the table,
calculated as described above for 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 particular 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.
ALL CLASSES:
- - Investments by defined contribution plans (such as 401(k) plans) will
generally be invested in the class of shares of the relevant Fund(s) with the
highest Shareholder Service Fee (including classes of shares that may not be
described in this Manual) offered from time to time by the relevant Fund(s)
regardless of the size of the investment, and will NOT be eligible to convert
to other classes with lower Shareholder Service Fees.
- - There is no minimum additional investment required to purchase additional
shares of a Fund for any class of shares.
- - The Manager will make all determinations as to the aggregation of client
accounts for purposes of determining eligibility.
- - Eligibility requirements for each class of shares are subject to change upon
notice to shareholders.
7
<PAGE> 86
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 each Fund will be automatically
converted to the class of shares of such Fund which is then being offered with
the lowest Shareholder 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 on a date selected by the Manager. Also, if a
client makes an investment in any Fund of the Trust (except for the Pelican
Fund) or puts additional assets under GMO's management (except for accounts
managed by GMO's U.S. 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 end, on a date selected by the Manager.
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 was 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 was 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).
Notwithstanding the foregoing special rules, clients shall always remain
eligible to remain in and/or be converted to any class of shares of the relevant
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 shares of all Funds are
available in all jurisdictions.
DISTRIBUTIONS
The policy of each U.S. Equity Fund (except for the REIT Fund), the
Short-Term Income Fund and the Domestic Bond Fund is to declare and pay
distributions of its dividends and interest quarterly. The policy of each other
Fund is to declare and pay distributions of its dividends, interest and foreign
currency gains semi-annually. Each Fund also intends to distribute net gains
from the sale of securities held for not more than one year ("net short-term
capital gains") and net gains from the sale of securities held for more than one
year ("net long-term capital gains") at least annually.
All dividends and/or distributions will be paid in shares of the relevant Fund,
at net asset value, unless the shareholder elects to receive cash. There is no
purchase premium on reinvested dividends or distributions. Shareholders may make
this election by marking the appropriate box on the application or by writing to
the Trust.
8
