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GMO INTRINSIC VALUE FUND
40 Rowes Wharf, Boston, Massachusetts 02110
The GMO INTRINSIC VALUE FUND (the "INTRINSIC VALUE FUND") (the "FUND")
is one 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
Fund of the Trust.
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 AUGUST 2, 1999
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TABLE OF CONTENTS
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SUMMARY OF FUND OBJECTIVE AND PRINCIPAL INVESTMENT STRATEGIES............ 1
SUMMARY OF PRINCIPAL RISKS............................................... 2
FEES AND EXPENSES........................................................ 5
BENCHMARK AND INDEX...................................................... 6
HOW TO BUY SHARES........................................................ 6
HOW TO REDEEM SHARES..................................................... 7
CLASSES OF SHARES........................................................ 8
DISTRIBUTIONS............................................................ 10
DETERMINATION OF NET ASSET VALUE......................................... 10
TAXES.................................................................... 11
MANAGEMENT OF THE TRUST.................................................. 12
ADDITIONAL INFORMATION................................................Back Cover
SHAREHOLDER INQUIRIES.................................................Back Cover
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SUMMARY OF FUND OBJECTIVE AND
PRINCIPAL INVESTMENT STRATEGIES
This summary describes the Fund's investment objective and principal
investment strategies. The 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 the 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.
In the Fund summary that follows, it is noted that the 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 Fund is managed and/or meant to be measured relative to the Russell
1000 Value Index. While the Fund may be managed or measured relative to a
benchmark or index, the Fund is not managed as an "index fund" or "index-plus
fund," and the actual composition of the Fund's portfolio may differ
substantially from that of its benchmark or index. The benchmark or index
against which the Manager measures its performance may be changed from time to
time. Some general information about the benchmark and index is provided under
"Benchmark and Index" later in this Prospectus.
Except for certain policies that are explicitly described as
fundamental in this Prospectus or in the Statement of Additional Information,
the Fund's investment objective and policies may be changed by the Trustees
without shareholder approval.
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GMO INTRINSIC VALUE FUND
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FUND INCEPTION DATE: 8/2/99
OBJECTIVE AND PRINCIPAL STRATEGIES
INVESTMENT OBJECTIVE: The GMO Intrinsic Value Fund seeks long-term capital
growth through investment in equity securities. The Fund's current benchmark is
the Russell 1000 Value Index.
INVESTMENT UNIVERSE: The Fund invests primarily in equity securities of
companies chosen from the Russell 1000 Index, emphasizing large capitalization
equity securities. The Fund may also use derivatives.
PRINCIPAL INVESTMENTS AND STRATEGIES: The Fund invests primarily in U.S. equity
securities of companies that, in the opinion of the Manager, represent favorable
values relative to their market prices. 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 derivative instruments and related instruments to: (i)
hedge equity exposure; (ii) replace direct investing; (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 assets to equity securities or markets.
METHODOLOGY/PORTFOLIO CONSTRUCTION: The Manager uses quantitative analytical
methods, for example, computer models, to choose approximately 300 stocks from
among the companies listed in the Russell 1000 Index for the Fund's portfolio.
Using a bottom-up approach that normally focuses on individual stock selection,
with less emphasis on industry and sector allocation, the Manager researches and
evaluates individual companies. Stocks of companies with price to book ratios,
prices to sales ratios, price to fair values and cash flow yields that meet the
Manager's criteria as undervalued or cheap are ranked highly. Stocks ranked
highly by more than one criterion are favored for selection. The Manager
believes that a security with a low price in relation to its fair value or
intrinsic value has opportunity for appreciation. The Manager attempts to
control risk by weighing the trade-off between a stock's expected return and its
potential to contribute to the Fund's overall risk profile.
SUMMARY OF PRINCIPAL RISKS
The value of your investment in the Fund changes with the values of the
Fund's investments. Many factors can affect those values, and you could lose
money by investing in this Fund. Factors that may affect the Fund's portfolio as
a whole are called "principal risks." They are summarized in this section. This
summary describes the nature of these risks but is not intended to include every
potential risk. The Fund could be subject to additional principal risks because
the types of investments made by the Fund change over time. The "Investment
Guidelines" set forth in the Statement of Additional Information include more
information about the Fund and its investments. Copies of the Investment
Guidelines and copies of the complete Statement of Additional Information are
available free of charge by contacting the Manager. An investment in the Fund is
not a deposit of a bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency.
* MARKET RISK. The Fund is subject to market risk, which is the risk of
unfavorable market-induced changes in the value of the securities owned by the
Fund. The following summarizes certain general market risks associated with
investments in equity securities.
EQUITY SECURITIES. A principal risk of the 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
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also decline due to factors which 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 that 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 Fund maintains substantial exposure to equities and generally does
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 Fund to unpredictable declines in the value of its 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 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. The Fund will have particularly
significant exposure to these risks because it will invest primarily in
companies chosen from the Russell 1000 Index.
* 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 the Fund may be prevented from selling particular
securities at the price at which the Fund values them. The Fund is subject to
liquidity risk, particularly with respect to its use of derivatives.
* DERIVATIVES RISK. The Fund 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 Fund may use derivatives for many purposes, including for
hedging, and as a substitute for direct investment in securities or other
assets. The Fund may also use derivatives as a way to efficiently adjust its
exposure 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 Fund, 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 the
Fund will engage in these transactions to reduce exposure to other risks when
that would be beneficial.
* 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. The Fund is not "diversified" within
the meaning of the 1940 Act. This means it is permitted to invest in a
relatively small number of issuers and/or foreign currencies with greater
concentration of risk. As a result, credit, market and other risks associated
with the Fund's investment strategies or techniques may be more pronounced.
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* LEVERAGING RISK. The 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 Fund may invest in
derivatives and may enter into reverse repurchase agreements. While the Fund
does not intend to use derivatives to create net exposure to securities,
currencies or other assets in amounts greater than the total assets of the Fund,
the Fund will consider derivative instruments as offsetting one another or other
assets such that only the net difference in 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 Fund may perform as if it were leveraged.
* 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.
The Fund is exposed to credit risk primarily because it may use OTC
derivatives (such as swap contracts) and because it may engage in the lending of
Fund securities or use of repurchase agreements.
* MANAGEMENT RISK. The 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
Fund, 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 Fund is generally not
subject to the risk of market timing because it generally stays fully invested
in the relevant asset class, such as U.S. equity securities.
* SPECIAL YEAR 2000 RISK CONSIDERATIONS. Many of the services provided
to the Fund depend on the proper functioning of computer systems. Many systems
in use today cannot distinguish between the year 1900 and the year 2000. Should
any of the Fund's service systems fail to process information properly, that
could have an adverse impact on the Fund's operations and services provided to
shareholders. GMO, as well as the Fund's administrator, transfer agent,
custodians 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 problem will be corrected in all respects and
that the Fund's 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
The following table describes the fees and expenses you may pay if you buy and
hold shares of the Fund.
<TABLE>
<CAPTION>
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PURCHASE AND REDEMPTION
FEES
(fees paid directly to
Fund at purchase or ANNUAL FUND OPERATING EXPENSES
redemption) (expenses that are deducted from Fund assets)
- ------------ --------------------------- ---------------------------------------------------------------------------------
Cash
Purchase Redemption
Premium Fees TOTAL
(as a % of (as a % of ANNUAL NET
amount amount Management Shareholder Other OPERATING Expense ANNUAL
invested)(1) redeemed) Fee Service Fee(2) Expenses(3) EXPENSES Reimbursement(4) EXPENSES
- ------------ ------------- ------------- ------------ ---------------- ----------- ----------- ---------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Class III
Shares 0.14% None 0.33% 0.15% 0.10% 0.58% 0.10% 0.48%
- ------------ ------------- ------------- ------------ ---------------- ----------- ----------- ---------------- ----------
</TABLE>
NOTES TO FEES AND EXPENSES
(1.) Purchase premiums generally apply only to cash transactions. No
purchase premium is charged with respect to in-kind purchases of Fund
Shares. 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 purchase premium 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 (i) if the purchase is part of a transfer
from or to another Fund of GMO Trust 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 must be arranged in advance
with the Manager.
(2.) The Shareholder Service Fee ("SSF") is paid to GMO for providing client
services and reporting services, and is the sole economic distinction
between the various classes of Fund shares.
(3.) Based on estimated amounts for the Fund's first fiscal year.
(4.) The Manager has contractually agreed to reimburse the 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, interest expense and transfer taxes) would otherwise exceed
0.33% of the Fund's average daily net assets.
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EXAMPLES
The example below illustrates 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 and apply whether or not you redeem your shares at the
end of each period.
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1 Year
(after reimbursement) 3 Years
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Class III Shares $63 $190
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BENCHMARK AND INDEX
The Fund's benchmark is the Russell 1000 Value Index. This Index is
maintained and published by the Frank Russell Company and is composed of the
1,000 largest U.S. companies based on total market capitalization with lower
price-to-book ratios and lower forecasted growth values.
HOW TO BUY SHARES
Shares of the Fund are available only from the Trust and may be
purchased on any day when the New York Stock Exchange is open for business (a
"business day"). Shares may be purchased by sending a purchase order to the
Trust. See "Purchase Procedures" below.
The purchase price of a share of the Fund is (i) the net asset value
next determined after a purchase order is received in good order plus (ii) a
premium, if any, established from time to time by the Trust for the class to be
purchased. 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. The
purchase premium is set forth under "Fees and Expenses." 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 that are reflected in the market price of accepted securities at the time
of valuation become the property of the Fund and must be delivered to the Trust
upon receipt by the investor from the issuer. A gain or loss for federal income
tax purposes may be realized by 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
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interested in making in-kind purchases should telephone the Trust collect 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 or
submitting a check to the transfer agent 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. 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, a check 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 collect 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 the 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 collect at (617) 346-7646. If a
Purchase Order is mailed to the Trust, it will be acted upon when received.
(d) Payment: All checks must be made payable to the Fund or the Trust and mailed
to Investors Bank & Trust Company, 200 Clarendon Street, Boston, Massachusetts
02116 - Attention: GMO Trust. All Federal funds must be transmitted to Investors
Bank & Trust Company for the account of the Fund. "Federal funds" are monies
credited to Investors Bank & Trust Company's account with the Federal Reserve
Bank of Boston.
NOTE: The Trust may attempt to process orders for Fund 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 the Fund may be redeemed on any business day in cash or in
kind. The redemption price is the net asset value per share next determined
after receipt of the redemption request in "good order." The Fund does not
currently charge any redemption fee.
If the Manager determines, in its sole discretion, that it would be
detrimental to the best interest of the
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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 the Fund in-kind will be selected by the Manager in light of the
Fund's objective and will not generally represent a pro rata distribution of
each security held in the Fund's portfolio. Any in-kind redemptions will be of
readily marketable securities to the extent available. Investors may incur
brokerage charges on the sale of any such securities so received in payment of
redemptions.
Payment on redemption will be made as promptly as possible and in any
event within seven days after the request for redemption is received by the
Trust in "good order." A redemption request is in "good order" if it includes
the exact name in which shares are registered, the investor's account number and
the number of shares or the dollar amount of shares to be redeemed and if it is
signed exactly in accordance with the form of registration. In addition, for a
redemption request to be in "good order" on a particular day, the investor's
request must be received by the Trust by 4:15 p.m. Boston time on a business
day. When a redemption request is received after 4:15 p.m. Boston time, the
redemption request will not be considered to be in "good order" and is required
to be resubmitted on the following business day. Persons acting in a fiduciary
capacity, or on behalf of a corporation, partnership or trust, must specify, in
full, the capacity in which they are acting. The redemption request will be
considered "received" by the Trust only after (i) it is mailed to, and received
by, the Trust at the appropriate address set forth above for purchase orders, or
(ii) it is faxed to the Trust at the appropriate facsimile number set forth
above for purchase orders, and the investor has confirmed receipt of the faxed
request by calling the Trust at (617) 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.
The Fund may suspend the right of redemption and may postpone payment
for more than seven days when the New York Stock Exchange is closed for other
than weekends or holidays, or if permitted by the rules of the Securities and
Exchange Commission during periods when trading on the Exchange is restricted or
during an emergency which makes it impracticable for the Fund to dispose of its
securities or to fairly determine the value of the net assets of the Fund, or
during any other period permitted by the Securities and Exchange Commission for
the protection of investors. Because the Fund may 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 the Fund's shares may be
significantly affected on days when shareholders have no access to the Fund.
CLASSES OF SHARES
The Fund has four classes of Shares, Class I, Class II, Class III, and
Class IV Shares, but currently offers Class III Shares only. The sole economic
difference among the various classes of shares is the level of Shareholder
Service Fee that the classes bear for client and shareholder service, reporting
and other support. The existence of multiple classes reflects the fact that, as
the size of a client relationship increases, the cost to service that client
decreases as a percentage of the assets in that account. Thus, the Shareholder
Service Fee is lower for classes where eligibility criteria require greater
total assets under GMO's management.
The Trust has adopted a Shareholder Servicing Plan (the "Plan")
covering each class of shares of the Fund. The following table summarizes the
current eligibility requirements for Class III Shares (subject to the exceptions
noted below) and the Shareholder Service Fees the class will pay under the Plan,
expressed as an annual percentage of the average daily net assets attributable
to Class III shares:
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SHAREHOLDER
INTRINSIC VALUE FUND MINIMUM TOTAL INVESTMENT* SERVICE FEE ("SSF")**
- -------------------- ------------------------- ---------------------
Class III $ 1 million 0.15%
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* 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.
ELIGIBILITY FOR CLASSES
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CLASS III SHARES:
With certain exceptions described below, for a client to be eligible
for 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.
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ALL CLASSES:
* Investments by defined contribution plans (such as 401(k) plans) will
always be invested in the class of shares of the relevant Fund(s) with the
highest Shareholder Service Fee 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.
DISTRIBUTIONS
The policy of the Fund is to declare and pay distributions of its
dividends and interest quarterly. The 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 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.
DETERMINATION OF NET ASSET VALUE
The net asset value of a share is determined for the Fund once on each
day on which the New York Stock Exchange is open, except that the Fund may not
determine its net asset value on days during which no security is tendered for
redemption and no order to purchase or sell such security is received by the
Fund. Net asset value is determined as of 4:15 p.m., New York City Time. The
Fund's net asset value is determined by dividing the total market value of the
Fund's portfolio investments and other assets, less any liabilities, by the
total outstanding shares of the Fund. Portfolio securities listed on a
securities exchange for which market quotations are available are valued at the
last quoted sale price on each business day or, if there is no such reported
sale, at the most recent quoted bid price. 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.
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
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<PAGE> 13
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.
TAXES
The following is a general summary of the principal federal income tax
consequences of investing in the Fund for shareholders who are U.S. citizens,
residents or domestic corporations. Shareholders should consult their own tax
advisors about the precise tax consequences of an investment in the Fund in
light of each shareholder's particular tax situation, including possible
foreign, state, local or other applicable tax laws (including the federal
alternative minimum tax).
* The 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 the 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.
* The Fund's investments in foreign securities may be subject to foreign
withholding taxes on dividends or interest. In that case, the 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, the 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 the 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 the Fund's distributions and may cause the 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.
-11-
<PAGE> 14
MANAGEMENT OF THE TRUST
The Fund is advised and managed by Grantham, Mayo, Van Otterloo & Co.
LLC, 40 Rowes Wharf, Boston, Massachusetts 02110 (the "Manager" or "GMO") which
provides investment advisory services to a substantial number of institutional
and other investors. 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 the Fund's Management Contract, the Manager selects and reviews
the Fund's investments and provides executive and other personnel for the
management of the Trust. Pursuant to the Trust's Agreement and Declaration of
Trust, the Board of Trustees supervises the affairs of the Trust as conducted by
the Manager. In the event that the Manager ceases to be the manager of the Fund,
the right of the Trust to use the identifying name "GMO" may be withdrawn.
The Management Contract provides for payment to the Manager of a
management fee at the stated annual rate set forth under Fees and Expenses. The
management fee is computed and accrued daily, and paid monthly. In addition, the
Manager has contractually agreed to reimburse the Fund and to bear certain Fund
expenses until June 30, 2000 in order to limit the Fund's annual expenses to
specified limits (with certain exclusions). These limits and the terms
applicable to them are described under "Fees and Expenses".
Mr. R. Jeremy Grantham and Mr. Christopher Darnell are primarily
responsible for the day-to-day management of the Fund. 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. Darnell has been engaged by the Manager in portfolio
management since 1984, and currently serves as a Member of the Manager.
Pursuant to a Servicing Agreement with the Trust on behalf of each
class of shares of the Fund, 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.
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<PAGE> 15
ADDITIONAL INFORMATION
Additional information about the Fund's investments will be available
in the Fund's annual and semi-annual reports to shareholders. In the 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 annual and semi-annual reports, the Fund's Statement
of Additional Information dated June 30, 1999, as revised from time to time, 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 the
Fund, has been filed with the Securities and Exchange Commission ("SEC") and is
incorporated by reference into this Prospectus.
Information about the 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 Fund 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.
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> 16
GMO INTRINSIC VALUE FUND
STATEMENT OF ADDITIONAL INFORMATION
August 2, 1999
This Statement of Additional Information is not a prospectus. It relates to the
GMO Intrinsic Value Fund Prospectus dated August 2, 1999, as amended from time
to time (the "Prospectus"), and should be read in conjunction therewith.
Information from the Prospectus is incorporated by reference into this Statement
of Additional Information. The Prospectus may be obtained from GMO Trust, 40
Rowes Wharf, Boston, Massachusetts 02110, or by calling the trust collect at
(617) 346-7646.
<PAGE> 17
TABLE OF CONTENTS
CAPTION PAGE
- ------- ----
INVESTMENT OBJECTIVES AND POLICIES ............................................1
DESCRIPTION AND RISKS OF FUND INVESTMENTS......................................1
INVESTMENT RESTRICTIONS.......................................................17
MANAGEMENT OF THE TRUST.......................................................19
INVESTMENT ADVISORY AND OTHER SERVICES........................................22
PORTFOLIO TRANSACTIONS........................................................23
DESCRIPTION OF THE TRUST AND OWNERSHIP OF SHARES..............................24
VOTING RIGHTS.................................................................25
SHAREHOLDER AND TRUSTEE LIABILITY.............................................26
DISTRIBUTIONS.................................................................27
TAXES .....................................................................27
PERFORMANCE INFORMATION.......................................................31
INVESTMENT GUIDELINES.........................................................32
<PAGE> 18
INVESTMENT OBJECTIVE AND POLICIES
The principal strategies and risks of investing in the GMO Intrinsic
Value Fund (the "Fund") are described in the Prospectus. Unless otherwise
indicated in the Prospectus or this Statement of Additional Information, the
investment objective and policies of the Fund may be changed without shareholder
approval.
DESCRIPTIONS AND RISKS OF FUND INVESTMENTS
The following is a detailed description of the various investment
practices in which the Fund may engage and the risks associated with their use.
The 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 in which practices the Fund may engage.
PORTFOLIO TURNOVER
The after-tax impact of portfolio turnover will be considered when
making investment decisions for the Fund. The Fund's portfolio turnover rate is
expected not to exceed 150%.
In any particular year, market conditions may well result in greater
rates than are presently anticipated. High portfolio turnover involves
correspondingly greater brokerage commissions and other transaction costs, which
will be borne directly by the Fund and may involve realization of capital gains
that would be taxable when distributed to shareholders of the Fund unless such
shareholders are themselves exempt. See "Taxes" and "Distributions" in the
Prospectus 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 ordinarily taxed to shareholders at ordinary income tax
rates.
NON-DIVERSIFIED PORTFOLIO
The Fund is a "non-diversified" fund under the 1940 Act, and as such is
not required to satisfy the "diversified" fund requirement set forth in the 1940
Act. As a non-diversified fund, the Fund is permitted to (but not required to)
invest a higher percentage of its assets in the securities of fewer issuers,
relative to diversified funds. Such concentration could increase the risk of
loss to the Fund should there be a decline in the market value of any one
portfolio security, relative to diversified funds. Investment in a
non-diversified fund may therefore entail greater risks than investment in a
diversified fund. The Fund, however, must meet certain diversification standards
to qualify as a "regulated investment company" under the Internal Revenue Code
of 1986, as amended.
<PAGE> 19
CERTAIN RISKS OF FOREIGN INVESTMENTS
Investment in foreign issuers or securities principally traded overseas
may involve certain special risks due to foreign economic, political and legal
developments, including expropriation or nationalization of assets, imposition
of withholding taxes on dividend or interest payments, and possible difficulty
in obtaining and enforcing judgments against foreign entities. Furthermore,
issuers of foreign securities are subject to different, often less
comprehensive, accounting, reporting and disclosure requirements than domestic
issuers. The securities of some foreign governments and companies and foreign
securities markets are less liquid and at times more volatile than comparable
U.S. securities and securities markets. Foreign brokerage commissions and other
fees are also generally higher than in the United States. The laws of some
foreign countries may limit the Fund's ability to invest in securities of
certain issuers located in these foreign countries. There are also special tax
considerations which apply to securities of foreign issuers and securities
principally 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.
SECURITIES LENDING
The Fund may make secured loans of portfolio securities amounting to
not more than one-third of the Fund's total assets. The risks in lending
portfolio securities, as with other extensions of credit, consist of possible
delay in recovery of the securities or possible loss of rights in the collateral
should the borrower fail financially. However, such loans will be made only to
broker-dealers that are believed by the Manager to be of relatively high credit
standing. Securities loans are made to broker-dealers pursuant to agreements
requiring that loans be continuously secured by collateral in cash or 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. The Fund may also call such loans in order to sell the
securities involved. The Manager has retained lending agents on behalf of the
Fund that are compensated based on a percentage of each Fund's return on the
securities lending activity. The Fund also pays various fees in connection with
such loans including shipping fees and reasonable custodian fees approved by the
Trustees of the Trust or persons acting pursuant to direction of the Board.
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<PAGE> 20
DEPOSITORY RECEIPTS
The Fund may invest in American Depositary Receipts (ADRs), Global
Depository Receipts (GDRs) and European Depository Receipts (EDRs)
(collectively, "Depository Receipts") if issues of such Depository Receipts are
available that are consistent with the Fund's investment objective. Depository
Receipts generally evidence an ownership interest in a corresponding foreign
security on deposit with a financial institution. Transactions in Depository
Receipts usually do not settle in the same currency in which the underlying
securities are denominated or traded. Generally, ADRs, in registered form, are
designed for use in the U.S. securities markets and EDRs, in bearer form, are
designed for use in European securities markets. GDRs may be traded in any
public or private securities markets and may represent securities held by
institutions located anywhere in the world.
CONVERTIBLE SECURITIES
A convertible security is a fixed-income security (a bond or preferred
stock) which may be converted at a stated price within a specified period of
time into a certain quantity of the common stock of the same or a different
issuer. Convertible securities are senior to common stock in a corporation's
capital structure, but are usually subordinated to similar non-convertible
securities. Convertible securities provide, through their conversion feature, an
opportunity to participate in capital appreciation resulting from a market price
advance in a convertible security's underlying common stock. The price of a
convertible security is influenced by the market value of the underlying common
stock and tends to increase as the market value of the underlying stock rises,
whereas it tends to decrease as the market value of the underlying stock
declines. The Manager regards convertible securities as a form of equity
security.
FUTURES AND OPTIONS
The Fund may use futures and options for various purposes. Such transactions may
involve options, futures and related options on futures contracts, and those
instruments may relate to particular equity and fixed income securities, equity
and fixed income indexes, and foreign currencies. The Fund may also enter into a
combination of long and short positions (including spreads and straddles) for a
variety of investment strategies, including protecting against changes in
certain yield relationships.
The use of futures contracts and options on futures contracts involves risk.
Thus, while the Fund may benefit from the use of futures contracts and options
on futures contracts, 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 the Fund's performance.
OPTIONS. As has been noted above, the Fund (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.
3
<PAGE> 21
WRITING COVERED OPTIONS. The Fund may seek to increase its return by writing
covered call or put options on optionable securities or indexes. A call option
written by the Fund on a security gives the holder the right to buy the
underlying security from the Fund at a stated exercise price; a put option gives
the holder the right to sell the underlying security to the Fund at a stated
exercise price. In the case of options on indexes, the options are usually cash
settled based on the difference between the strike price and the value of the
index.
The Fund will receive a premium for writing a put or call option, which
increases the Fund's return in the event the option expires unexercised or is
closed out at a profit. The amount of the premium will reflect, among other
things, the relationship of the market price and volatility of the underlying
security or securities index to the exercise price of the option, the remaining
term of the option, supply and demand and interest rates. By writing a call
option on a security, the Fund limits its opportunity to profit from any
increase in the market value of the underlying security above the exercise price
of the option. By writing a put option on a security, the Fund assumes the risk
that it may be required to purchase the underlying security for an exercise
price higher than its then current market value, resulting in a potential
capital loss unless the security subsequently appreciates in value. In the case
of options on an index, if the Fund writes a call, any profit by the Fund in
respect of portfolio securities expected to correlate with the index will be
limited by an increase in the index above the exercise price of the option. If
the Fund writes a put on an index, the Fund may be required to make a cash
settlement greater than the premium received if the index declines.
A call option on a security is "covered" if the Fund owns the underlying
security or has an absolute and immediate right to acquire that security without
additional cash consideration (or for additional cash consideration held in a
segregated account by its custodian) upon conversion or exchange of other
securities held in its portfolio. A call option 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 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. 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 the Fund will be able to effect a closing purchase or a
closing
4
<PAGE> 22
sale transaction at any particular time. Also, an over-the-counter option may be
closed out only with the other party to the option transaction.
Effecting a closing transaction in the case of a written call option will permit
the Fund to write another call option on the underlying security with either a
different exercise price or expiration date or both, or in the case of a written
put option will permit the Fund to write another put option to the extent that
the exercise price thereof is secured by deposited cash or high grade debt
obligations. Also, effecting a closing transaction will permit the cash or
proceeds from the concurrent sale of any securities subject to the option to be
used for other Fund investments. If the Fund desires to sell a particular
security from its portfolio on which it has written a call option, it will
effect a closing transaction prior to or concurrent with the sale of the
security.
The Fund will realize a profit from a closing transaction if the price of the
transaction is less than the premium received from writing the option or is more
than the premium paid to purchase the option; the Fund will realize a loss from
a closing transaction if the price of the transaction is more than the premium
received from writing the option or is less than the premium paid to purchase
the option. Because increases in the market price of a call option will
generally reflect increases in the market price of the underlying security or
index of securities, any loss resulting from the repurchase of a 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.
The Fund may write options in connection with buy-and-write transactions; that
is, the Fund may purchase a security and then write a call option against that
security. The exercise price of the call the Fund determines to write will
depend upon the expected price movement of the underlying security. The exercise
price of a call option may be below ("in-the-money"), equal to ("at-the-money")
or above ("out-of-the-money") the current value of the underlying security at
the time the option is written. Buy-and-write transactions using in-the-money
call options may be used when it is expected that the price of the underlying
security will remain flat or decline moderately during the option period.
Buy-and-write transactions using at-the-money call options may be used when it
is expected that the price of the underlying security will remain fixed or
advance moderately during the option period. Buy-and-write transactions using
out-of-the-money call options may be used when it is expected that the premiums
received from writing the call option plus the appreciation in the market price
of the underlying security up to the exercise price will be greater than the
appreciation in the price of the underlying security alone. If the call options
are exercised in such transactions, the Fund's maximum gain will be the premium
received by it for writing the option, adjusted upward or downward by the
difference between the Fund's purchase price of the security and the exercise
price. If the options are not exercised and the price of the underlying security
declines, the amount of such decline will be offset in part, or entirely, by the
premium received.
The writing of covered put options is similar in terms of risk/return
characteristics to buy-and-write transactions. If the market price of the
underlying security rises or otherwise is above the exercise price, the put
option will expire worthless and the Fund's gain will be limited to the premium
received. If the market price of the underlying security declines or otherwise
is below the exercise price, the Fund may elect to close the position or take
delivery of the security at the exercise price. In that event, the Fund's return
will be the premium received from the put option minus the cost of closing the
position or, if it chooses to take delivery of the security, the premium
received from the
5
<PAGE> 23
put option minus the amount by which the market price of the security is below
the exercise price. Out-of-the-money, at-the-money and in-the-money put options
may be used by the Fund in market environments analogous to those in which call
options are used in buy-and-write transactions.
The extent to which the Fund will be able to write and purchase call and put
options may be restricted by the Fund's intention to qualify as a regulated
investment company under the Internal Revenue Code.
RISK FACTORS IN OPTIONS TRANSACTIONS. The option writer has no control over when
the underlying securities or futures contract must be sold, in the case of a
call option, or purchased, in the case of a put option, since the writer may be
assigned an exercise notice at any time prior to the termination of the
obligation. If an option expires unexercised, the writer realizes a gain in the
amount of the premium. Such a gain, of course, may, in the case of a covered
call option, be offset by a decline in the market value of the underlying
security or futures contract during the option period. If a call option is
exercised, the writer realizes a gain or loss from the sale of the underlying
security or futures contract. If a put option is exercised, the writer must
fulfill the obligation to purchase the underlying security or futures contract
at the exercise price, which will usually exceed the then market value of the
underlying security or futures contract.
An exchange-traded option may be closed out only on a national securities
exchange ("Exchange") which generally provides a liquid secondary market for an
option of the same series. An over-the-counter option may be closed out only
with the other party to the option transaction. If a liquid secondary market for
an exchange-traded option does not exist, it might not be possible to effect a
closing transaction with respect to a particular option with the result that the
Fund holding the option would have to exercise the option in order to realize
any profit. For example, in the case of a written call option, if the Fund is
unable to effect a closing purchase transaction in a secondary market (in the
case of a listed option) or with the purchaser of the option (in the case of an
over-the-counter option), the Fund will not be able to sell the underlying
security (or futures contract) until the option expires or it delivers the
underlying security (or futures contract) upon exercise. Reasons for the absence
of a liquid secondary market on an Exchange include the following: (i) there may
be insufficient trading interest in certain options; (ii) restrictions may be
imposed by an Exchange on opening transactions or closing transactions or both;
(iii) trading halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options or underlying securities;
(iv) unusual or unforeseen circumstances may interrupt normal operations on an
Exchange; (v) the facilities of an Exchange or the Options Clearing Corporation
may not at all times be adequate to handle current trading volume; or (vi) one
or more Exchanges could, for economic or other reasons, decide or be compelled
at some future date to discontinue the trading of options (or a particular class
or series of options), in which event the secondary market on that Exchange (or
in that class or series of options) would cease to exist, although outstanding
options on that Exchange that had been issued by the Options Clearing
Corporation as a result of trades on that Exchange should continue to be
exercisable in accordance with their terms.
The Exchanges have established limitations governing the maximum number of
options which may be written by an investor or group of investors acting in
concert. It is possible that the Fund, the Manager and other clients of the
Manager may be considered to be such a group. These position limits may restrict
the Fund's ability to purchase or sell options on a particular security.
6
<PAGE> 24
The amount of risk the Fund assumes when it purchases an option is the premium
paid for the option plus related transaction costs. In addition to the
correlation risks discussed below, the purchase of an option also entails the
risk that changes in the value of the underlying security or futures contract
will not be fully reflected in the value of the option purchased.
FUTURES. A financial futures contract sale creates an obligation by the seller
to deliver the type of financial instrument called for in the contract in a
specified delivery month for a stated price. A financial futures contract
purchase creates an obligation by the purchaser to pay for and take delivery of
the type of financial instrument called for in the contract in a specified
delivery month, at a stated price. In some cases, the specific instruments
delivered or taken, respectively, at settlement date are not determined until on
or near that date. The determination is made in accordance with the rules of the
exchange on which the futures contract sale or purchase was made. Some futures
contracts are "cash settled" (rather than "physically settled," as described
above) which means that the purchase price is subtracted from the current market
value of the instrument and the net amount if positive is paid to the purchaser,
and if negative is paid by the purchaser. Futures contracts are traded in the
United States only on commodity exchanges or boards of trade -- known as
"contract markets" -- approved for such trading by the Commodity Futures Trading
Commission ("CFTC"), and must be executed through a futures commission merchant
or brokerage firm which is a member of the relevant contract market. Under U.S.
law, futures contracts on individual equity securities are not permitted
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.
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The ability to establish and close out positions on options on futures will be
subject to the development and maintenance of a liquid secondary market. It is
not certain that this market will develop or be maintained.
INDEX FUTURES. The Fund may purchase futures contracts on various securities
indexes ("Index Futures"). For example, the Fund may purchase Index Futures on
the S&P 500 ("S&P 500 Index Futures") and on such other domestic stock indexes
as the Manager may deem appropriate. The Fund's purchase and sale of Index
Futures is limited to contracts and exchanges which have been approved by the
CFTC.
An Index Future may call for "physical delivery" or be "cash settled." An Index
Future that calls for physical delivery is a contract to buy an integral number
of units of the particular securities index at a specified future date at a
price agreed upon when the contract is made. A unit is the value from time to
time of the relevant index. If the Fund purchases an Index Future that calls for
physical delivery, it is obligated to pay the face amount on the stated date.
However, 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 the Fund enters into one futures contract to
buy 500 units of an index at a specified future date at a contract price of
$1,000 per unit and the index is at $1,010 on that future date, the Fund will
gain $5,000 (500 units x gain of $10).
Index Futures that are "cash settled" provide by their terms for settlement on a
net basis reflecting changes in the value of the underlying index. Thus, the
purchaser of such an Index Future is never obligated to pay the face amount of
the contract. The net payment obligation may in fact be very small in relation
to the face amount.
The Fund may close open positions on the futures exchange on which Index Futures
are then traded at any time up to and including the expiration day. All
positions which remain open at the close of the last business day of the
contract's life are required to settle on the next business day (based upon the
value of the relevant index on the expiration day) 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 the Fund purchases foreign
stock Index Futures.
The price of Index Futures may not correlate perfectly with movement in the
relevant index due to certain market distortions. First, all participants in the
futures market are subject to margin deposit and maintenance requirements.
Rather than meeting additional margin deposit requirements,
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investors may close futures contracts through offsetting transactions which
could distort the normal relationship between the index and futures markets.
Secondly, the deposit requirements in the futures market are less onerous than
margin requirements in the securities market, and as a result the futures market
may attract more speculators than does the securities market. Increased
participation by speculators in the futures market may also cause temporary
price distortions. In addition, trading hours for foreign stock Index Futures
may not correspond perfectly to hours of trading on the foreign exchange to
which a particular foreign stock Index 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. The Fund may use options on futures contracts in lieu of writing or
buying options directly on the underlying securities or purchasing and selling
the underlying futures contracts. For example, to hedge against a possible
decrease in the value of its portfolio securities, the Fund may purchase put
options or write call options on futures contracts rather than selling futures
contracts. Similarly, the Fund may purchase call options or write put options on
futures contracts as a substitute for the purchase of futures contracts to hedge
against a possible increase in the price of securities which the Fund expects to
purchase. Such options generally operate in the same manner as options purchased
or written directly on the underlying investments. See "Foreign Currency
Transactions" below for a description of the Fund's 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 the Fund may be exposed to risk of
loss. In addition, it is not always possible to hedge fully or perfectly against
currency fluctuations affecting the value of the securities denominated in
foreign currencies because the value of such securities also is likely to
fluctuate as a result of independent factors not related to currency
fluctuations. The risk of imperfect correlation generally tends to diminish as
the maturity date of the futures contract approaches.
A hedge will not be fully effective where there is such imperfect correlation.
To compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater amount than the hedged securities if the volatility of
the hedged securities is historically greater than the volatility of the futures
contracts. Conversely, the Fund may purchase or sell fewer contracts if the
volatility of the price of the hedged securities is historically less than that
of the futures contract.
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The Fund may also purchase futures contracts (or options thereon) as an
anticipatory hedge against a possible increase in the price of currency in which
is denominated the securities the Fund anticipates purchasing. In such
instances, it is possible that the currency may instead decline. If the Fund
does not then invest in such securities because of concern as to possible
further market and/or currency decline or for other reasons, the Fund may
realize a loss on the futures contract that is not offset by a reduction in the
price of the securities purchased.
The liquidity of a secondary market in a futures contract may be adversely
affected by "daily price fluctuation limits" established by commodity exchanges
which limit the amount of fluctuation in a futures contract price during a
single trading day. Once the daily limit has been reached in the contract, no
trades may be entered into at a price beyond the limit, thus preventing the
liquidation of open futures positions. Prices have in the past exceeded the
daily limit on a number of consecutive trading days. Short positions in index
futures may be closed out only by entering into a futures contract purchase on
the futures exchange on which the index futures are traded.
The successful use of transactions in futures and related options for hedging
and risk management also depends on the ability of the Manager to forecast
correctly the direction and extent of exchange rate, interest rate and stock
price movements within a given time frame. For example, to the extent interest
rates remain stable during the period in which a futures contract or option is
held by the Fund investing in fixed income securities (or such rates move in a
direction opposite to that anticipated), the Fund may realize a loss on the
futures transaction which is not fully or partially offset by an increase in the
value of its portfolio securities. As a result, the Fund's total return for such
period may be less than if it had not engaged in the hedging transaction.
Unlike trading on domestic commodity exchanges, trading on foreign commodity
exchanges is not regulated by the CFTC and may be subject to greater risks than
trading on domestic exchanges. For example, some foreign exchanges may be
principal markets so that no common clearing facility exists and a trader may
look only to the broker for performance of the contract. In addition, unless the
Fund hedges against fluctuations in the exchange rate between the U.S. dollar
and the currencies in which trading is done on foreign exchanges, any profits
that the Fund might realize in trading could be eliminated by adverse changes in
the exchange rate, or the Fund could incur losses as a result of those changes.
USES OF OPTIONS, FUTURES AND OPTIONS ON FUTURES
RISK MANAGEMENT. When futures and options on futures are used for risk
management, the Fund will generally take long positions (e.g., purchase call
options, futures contracts or options thereon) in order to increase the Fund's
exposure to a particular market, market segment or foreign currency. For
example, if the 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, the Fund is
only required to deposit the initial and variation margin as required by
relevant CFTC regulations and the rules of the contract markets. Because the
Fund will then be obligated to purchase the security or index at a set price on
a future date, the Fund's net asset value will fluctuate with the value of the
security as if it were already included in the Fund's portfolio. Risk management
transactions have the effect of providing a degree of investment leverage,
particularly
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when the Fund does not segregate assets equal to the face amount of the contract
(i.e., in cash settled futures contracts) since the futures contract (and
related options) will increase or decrease in value at a rate which is a
multiple of the rate of increase or decrease in the value of the initial and
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. The
Fund will not, however, use futures and options on futures to obtain greater
volatility than it could obtain through direct investment in securities; that
is, the Fund will not normally engage in risk management to increase the average
volatility (beta) of that Fund's portfolio above 1.00, the level of risk (as
measured by volatility) that would be present if the Fund were fully invested in
the securities comprising the relevant index. However, the Fund may invest in
futures and options on futures without regard to this limitation if the face
value of such investments, when aggregated with the Index Futures, equity swaps
and contracts for differences as described below does not exceed 10% of the
Fund's assets.
HEDGING. To the extent indicated elsewhere, the Fund may also enter into options
and futures contracts and buy and sell options on futures for hedging. For
example, the 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 Fund
may also use futures contracts in anticipatory hedge transactions by taking a
long position in a futures contract with respect to a security, index or foreign
currency that the Fund intends to purchase (or whose value is expected to
correlate closely with the security or currency to be purchased) pending receipt
of cash from other transactions 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 the Fund's portfolio is expected to decline as a
result of an increase in rates, the Fund might purchase put options or write
call options on futures contracts rather than selling futures contracts.
Similarly, for anticipatory hedging, the Fund may purchase call options or write
put options as a substitute for the purchase of futures contracts. See "Foreign
Currency Transactions" below for more information regarding the currency hedging
practices of the Fund.
INVESTMENT PURPOSES. To the extent indicated elsewhere, the Fund may also enter
into futures contracts and buy and sell options thereon for investment. For
example, the Fund may invest in futures when its Manager believes that there are
not enough attractive securities available to maintain the standards of
diversity and liquidity set for the Fund pending investment in such securities
if or when they do become available. Through this use of futures and related
options, the Fund may diversify risk in its portfolio without incurring the
substantial brokerage costs which may be associated with investment in the
securities of multiple issuers. This use may also permit the Fund to avoid
potential market and liquidity problems (e.g., driving up the price of a
security by purchasing additional shares of a portfolio security or owning so
much of a particular issuer's stock that the sale of such stock depresses that
stock's price) which may result from increases in positions already held by the
Fund.
When the Fund purchases futures contracts for investment, it will maintain cash,
U.S. Government Securities or other liquid assets in a segregated account with
its custodian in an amount which,
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together with the initial and variation margin deposited on the futures
contracts, is equal to the face value of the futures contracts at all times
while the futures contracts are held.
Incidental to other transactions in fixed income securities, for investment
purposes the Fund may also combine futures contracts or options on fixed income
securities with cash, cash equivalent investments or other fixed income
securities in order to create "synthetic" bonds which approximate desired risk
and return profiles. This may be done where a "non-synthetic" security having
the desired risk/return profile either is unavailable (e.g., short-term
securities of certain foreign governments) or possesses undesirable
characteristics (e.g., interest payments on the security would be subject to
foreign withholding taxes). The Fund may also purchase forward foreign exchange
contracts in conjunction with U.S. dollar-denominated securities in order to
create a synthetic foreign currency denominated security which approximates
desired risk and return characteristics where the non-synthetic securities
either are not available in foreign markets or possess undesirable
characteristics. For greater detail, see "Foreign Currency Transactions" below.
When the Fund creates a "synthetic" bond with a futures contract, it will
maintain cash, U.S. Government Securities or other 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 the Fund's
portfolio. For example, if the 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, the Fund may use futures to achieve a
similar result with reduced transaction costs. In that case, the Fund might
simultaneously enter into short futures positions on an appropriate index (e.g.,
the S&P Mid Cap 400 Index) (to synthetically "sell" the stocks in the Fund) and
long futures positions on another index (e.g., the S&P 500) (to synthetically
"buy" the larger capitalization stocks). When the expected trend has played out,
the Fund would then close out both futures contract positions. The Fund will
only enter into these combined positions if (1) the short position (adjusted for
historic volatility) operates as a hedge of existing portfolio holdings, (2) the
face amount of the long futures position is less than or equal to the value of
the portfolio securities that the Fund would like to dispose of, (3) the
contract settlement date for the short futures position is approximately the
same as that for the long futures position and (4) the Fund segregates an amount
of cash, U.S. Government Securities and other 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 the Fund uses such combined short and
long positions, in addition to possible declines in the values of its investment
securities, the Fund may also suffer losses associated with a securities index
underlying the long futures position underperforming the securities index
underlying the short futures position. However, the Manager will enter into
these combined positions only if the Manager expects that, overall, the Fund
will perform as if it had sold the securities hedged by the short position and
purchased the securities underlying the long position. The Fund may also use
swaps and options on futures to achieve the same objective.
Limitations on the Use of Options and Futures Portfolio Strategies. As noted
above, the Fund 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, Fund's long futures contract positions (less its
short positions) together with the Fund's cash (i.e., equity or fixed income)
positions will not exceed the Fund's total net assets.
The Fund's ability to engage in the options and futures strategies described
above will depend on the availability of liquid markets in such instruments.
Markets in options and futures with respect to currencies are relatively new and
still developing. It is impossible to predict the amount of trading interest
that may exist in various types of options or futures. Therefore no assurance
can be given that the Fund will be able to utilize these instruments effectively
for the purposes set forth above. Furthermore, the Fund's ability to engage in
options and futures transactions may be limited by tax considerations.
SWAP CONTRACTS AND OTHER TWO-PARTY CONTRACTS
The Fund may use swap contracts and other two-party contracts for the
same or similar purposes as they may use options, futures and related options.
The use of swap contracts and other two-party contracts involves risk.
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. The
Fund will usually enter into swaps on a net basis, i.e., the two returns are
netted out, with the Fund receiving or paying, as the case may be, only the net
amount of the two returns.
EQUITY SWAP CONTRACTS AND CONTRACTS FOR DIFFERENCES. Equity swap
contracts involve the exchange of one party's obligation to pay the loss, if
any, with respect to a notional amount of a particular equity index (e.g., the
S&P 500 Index) plus interest on such notional amount at a designated rate (e.g.,
the London Inter-Bank Offered Rate) in exchange for the other party's obligation
to pay the gain, if any, with respect to the notional amount of such index.
If the Fund enters into a long equity swap contract, the Fund's net
asset value will fluctuate as a result of changes in the value of the equity
index on which the equity swap is based as if it had purchased the notional
amount of securities comprising the index. The Fund will not use long equity
swap contracts to obtain greater volatility than it could obtain through direct
investment in securities; that is, the Fund will not normally enter 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 stocks comprising the
Fund's benchmark index. However, the Fund may invest in long equity swap
contracts without regard to this limitation if the notional amount of such
equity swap contracts, when aggregated with the Index Futures as described above
and the contracts for differences as described below, does not exceed 10% of the
Fund's net assets.
Contracts for differences are swap arrangements in which the Fund may
agree with a counterparty that its return (or loss) will be based on the
relative performance of two different groups
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or "baskets" of securities. As to one of the baskets, the Fund's return is based
on theoretical long futures positions in the securities comprising that basket
(with an aggregate face value equal to the notional amount of the contract for
differences) and as to the other basket, the Fund's return is based on
theoretical short futures positions in the securities comprising the basket. The
Fund may also use actual long and short futures positions to achieve the same
market exposure(s) as contracts for differences. The Fund will only enter into
contracts for differences where payment obligations of the two legs of the
contract are netted and thus based on changes in the relative value of the
baskets of securities rather than on the aggregate change in the value of the
two legs. The Fund will only enter into contracts for differences (and analogous
futures positions) when the Manager believes that the basket of securities
constituting the long leg will outperform the basket constituting the short leg.
However, it is possible that the short basket will outperform the long basket
resulting in a loss to the Fund, even in circumstances where the securities in
both the long and short baskets appreciate in value.
Except for instances in which the Fund elects to obtain leverage up to
the 10% limitation mentioned above, the Fund will maintain cash, U.S. Government
Securities or other 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.
The Fund may enter into swaps and contracts for differences for
hedging, investment and risk management. When using swaps for hedging, the Fund
may enter into an interest rate, currency or equity swap, as the case may be, on
either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities. For risk management or investment
purposes the Fund may also enter into a contract for differences in which the
notional amount of the theoretical long position is greater than the notional
amount of the theoretical short position. The Fund will not normally enter into
a contract for differences to increase the volatility (beta) of the Fund's
portfolio above 1.00. However, the Fund may invest in contracts for differences
without regard to this limitation if the aggregate amount by which the
theoretical long positions of such contracts exceed the theoretical short
positions of such contracts, when aggregated with the Index Futures and equity
swaps contracts as described above, does not exceed 10% of the Fund's net
assets.
REPURCHASE AGREEMENTS
The 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 the Fund to earn a return on temporarily available cash at no market risk,
although there is a risk that the seller may default in its obligation to pay
the agreed-upon sum on the redelivery date. Such a default may subject the Fund
to expenses, delays and risks of loss including: (a) possible declines in the
value of the underlying security during the period while the Fund seeks to
enforce its rights thereto, (b) possible reduced levels of income and lack of
access to income during this period and (c) inability to enforce rights and the
expenses involved in attempted enforcement.
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TEMPORARY HIGH QUALITY CASH ITEMS
To the extent noted under "Investment Guidelines," the Fund may
temporarily invest a portion of its assets in cash or cash items pending other
investments or in connection with the maintenance of a segregated account. These
cash items must be of high quality and may include a number of money market
instruments such as securities issued by the United States government and
agencies thereof, bankers' acceptances, commercial paper, and bank certificates
of deposit. By investing in high quality money market securities the Fund may
seek to minimize credit risk with respect to such investments.
U.S. GOVERNMENT SECURITIES
U.S. Government Securities include securities issued or guaranteed by
the U.S. government or its authorities, agencies or instrumentalities. U.S.
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.
Like other fixed income securities, U.S. Government Securities are
subject to market risk and their market values fluctuate as interest rates
change. Thus, for example, the value of an investment in the Fund which holds
U.S. Government Securities may fall during times of rising interest rates.
Yields on U.S. Government Securities tend to be lower than those of corporate
securities of comparable maturities.
In addition to investing directly in U.S. Government Securities, the
Fund may purchase certificates of accrual or similar instruments evidencing
undivided ownership interests in interest payments or principal payments, or
both, in U.S. Government Securities. These certificates of accrual and similar
instruments may be more volatile than other government securities.
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
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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 the Fund may invest include so-called
"inverse floating obligations" or "residual interest bonds" on which the
interest rates typically decline as short-term market interest rates increase
and increase as short-term market rates decline. Such securities have the effect
of providing a degree of investment leverage, since they will generally increase
or decrease in value in response to changes in market interest rates at a rate
which is a multiple of the rate at which fixed-rate long-term securities
increase or decrease in response to such changes. As a result, the market values
of such securities will generally be more volatile than the market values of
fixed rate securities.
The Fund's investment in indexed securities may also create taxable
income in excess of the cash such investments generate. See "Taxes" in the
Prospectus.
FIRM COMMITMENTS
A firm commitment agreement is an agreement with a bank or
broker-dealer for the purchase of securities at an agreed-upon price on a
specified future date. The Fund may enter into firm commitment agreements with
such banks and broker-dealers with respect to any of the instruments eligible
for purchase by the Fund. The Fund will only enter into firm commitment
arrangements with banks and broker-dealers which the Manager determines present
minimal credit risks. The Fund will maintain in a segregated account with its
custodian cash, U.S. Government Securities or other liquid assets in an amount
equal to the Fund's obligations under firm commitment agreements.
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLL AGREEMENTS
The Fund may enter into reverse repurchase agreements and dollar roll
agreements with banks and brokers to enhance return. Reverse repurchase
agreements involve sales by the Fund of portfolio assets concurrently with an
agreement by the Fund to repurchase the same assets at a later date at a fixed
price. During the reverse repurchase agreement period, the Fund continues to
receive principal and interest payments on these securities and also has the
opportunity to earn a return on the collateral furnished by the counterparty to
secure its obligation to redeliver the securities.
Dollar rolls are transactions in which the Fund sells securities for
delivery in the current month and simultaneously contracts to repurchase
substantially similar (same type and coupon) securities on a specified future
date. During the roll period, the Fund forgoes principal and interest paid on
the securities. The Fund is compensated by the difference between the current
sales price
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<PAGE> 34
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.
The 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 the Fund may decline below the price of the securities the Fund has
sold but is obligated to repurchase under the agreement. In the event the buyer
of securities under a reverse repurchase agreement or dollar roll files for
bankruptcy or becomes insolvent, the Fund's use of the proceeds of the agreement
may be restricted pending a determination by the other party or its trustee or
receiver whether to enforce the Fund's obligation to repurchase the securities.
Reverse repurchase agreements and dollar rolls are not considered borrowings by
the Fund for purposes of the Fund's fundamental investment restriction with
respect to borrowings.
ILLIQUID SECURITIES
The Fund may purchase "illiquid securities," i.e., securities which may
not be sold or disposed of in the ordinary course of business within seven days
at approximately the value at which the Fund has valued the investment, which
include securities whose disposition is restricted by securities laws, so long
as no more than 15% of net assets would be invested in such illiquid securities.
The Fund currently intends to invest in accordance with the SEC staff view that
repurchase agreements maturing in more than seven days are illiquid securities.
The SEC staff has stated informally that it is of the view that over-the-counter
options and securities serving as cover for over-the-counter options are
illiquid securities. While the Trust does not agree with this view, it will
operate in accordance with any relevant formal guidelines adopted by the SEC.
In addition, the SEC staff considers equity swap contracts, caps,
floors and collars to be illiquid securities. Consequently, while the staff
maintains this position, the Fund will not enter into an equity swap contract or
a reverse equity swap contract or purchase a cap, floor or collar if, as a
result of the investment, the total value (i.e., marked-to-market value) of such
investments (without regard to their notional amount) together with that of all
other illiquid securities which the Fund owns would exceed 15% of the Fund's
total assets.
INVESTMENT RESTRICTIONS
FUNDAMENTAL RESTRICTIONS:
Without a vote of the majority of the outstanding voting securities of
the Fund, the Trust will not take any of the following actions with respect to
the Fund as indicated:
(1) Borrow money except under the following circumstances: (i) The Fund
may borrow money from banks so long as after such a transaction, the total
assets (including the amount borrowed) less liabilities other than debt
obligations, represent at least 300% of outstanding debt obligations; (ii) The
Fund may also borrow amounts equal to an additional 5% of its total assets
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<PAGE> 35
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; and (iii) The Fund may enter into transactions that are
technically borrowings under the 1940 Act because they involve the sale of a
security coupled with an agreement to repurchase that security (e.g., reverse
repurchase agreements, dollar rolls and other similar investment techniques)
without regard to the asset coverage restriction described in (i) above, so long
as and to the extent that the Fund establishes a segregated account with its
custodian in which it maintains cash and/or liquid securities equal in value to
its obligations in respect of these transactions.
(2) Purchase securities on margin, except such short-term credits as
may be necessary for the clearance of purchases and sales of securities. (For
this purpose, the deposit or payment of initial or variation margin in
connection with futures contracts or related options transactions is not
considered the purchase of a security on margin.)
(3) Make short sales of securities or maintain a short position for the
Fund's account unless at all times when a short position is open the Fund owns
an equal amount of such securities or owns securities which, without payment of
any further consideration, are convertible into or exchangeable for securities
of the same issue as, and equal in amount to, the securities sold short.
(4) Underwrite securities issued by other persons except to the extent
that, in connection with the disposition of its portfolio investments, it may be
deemed to be an underwriter under federal securities laws.
(5) Purchase or sell real estate, although it may purchase securities
of issuers which deal in real estate, including securities of real estate
investment trusts, and may purchase securities which are secured by interests in
real estate.
(6) Make loans, except by purchase of debt obligations or by entering
into repurchase agreements or through the lending of the Fund's portfolio
securities. Loans of portfolio securities may be made with respect to up to 100%
of the Fund's total assets.
(7) Concentrate more than 25% of the value of its total assets in any
one industry.
(8) Purchase or sell commodities or commodity contracts, except that
the Fund may purchase and sell financial futures contracts and options thereon.
(9) Issue senior securities, as defined in the 1940 Act and as
amplified by rules, regulations and pronouncements of the SEC. The SEC has
concluded that even though reverse repurchase agreements, firm commitment
agreements and standby commitment agreements fall within the functional meaning
of the term "evidence of indebtedness", the issue of compliance with Section 18
of the 1940 Act will not be raised with the SEC by the Division of Investment
Management if the Fund covers such securities by maintaining certain "segregated
accounts." Similarly, so long as such segregated accounts are maintained, the
issue of compliance with Section 18 will not be raised with respect to any of
the following: any swap contract or contract for differences; any pledge or
encumbrance of assets permitted by non-fundamental policy (4) below; any
borrowing permitted by restriction 1 above; any collateral arrangements with
respect to initial and variational margin
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<PAGE> 36
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 the 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.
(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 the Fund's total assets (taken at cost). (For the purposes
of this restriction, collateral arrangements with respect to swap agreements,
the writing of options, stock index, interest rate, currency or other futures,
options on futures contracts and collateral arrangements with respect to initial
and variation margin are not deemed to be a pledge or other encumbrance of
assets. The deposit of securities or cash or cash equivalents in escrow in
connection with the writing of covered call or put options, respectively is not
deemed to be a pledge or encumbrance.)
Except as indicated above in Fundamental Restriction No. 1, all
percentage limitations on investments set forth herein and in the Prospectus
will apply at the time of the making of an investment and shall not be
considered violated unless an excess or deficiency occurs or exists immediately
after and as a result of such investment.
The phrase "shareholder approval," as used in the Prospectus, and the
phrase "vote of a majority of the outstanding voting securities," as used herein
with respect to the Fund, means the affirmative vote of the lesser of (1) more
than 50% of the outstanding shares of the Fund, or (2) 67% or more of the shares
of the Fund present at a meeting if more than 50% of the outstanding shares are
represented at the meeting in person or by proxy. Except for policies that are
explicitly described as fundamental in the Prospectus or this Statement of
Additional Information, the investment policies of the 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
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<PAGE> 37
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 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 -
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<PAGE> 38
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.
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).
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.
Except as stated above, the principal occupations of the officers and
Trustees for the last five years have been with the employers as shown above,
although in some cases they have held different positions with such employers.
Other than as set forth in the table below, no Trustee or officer of
the Trust receives any direct compensation from the Trust or any series thereof:
NAME OF PERSON, TOTAL ANNUAL COMPENSATION
POSITION FROM THE TRUST
-------- --------------
Harvey R. Margolis, Trustee $70,000
Jay O. Light, Trustee $70,000
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<PAGE> 39
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 a Management Contract (the "Management Contract") between the
Trust and the Manager, subject to such policies as the Trustees of the Trust may
determine, the Manager will furnish continuously an investment program for the
Fund and will make investment decisions on behalf of the Fund and place all
orders for the purchase and sale of portfolio securities. Subject to the control
of the Trustees, the Manager also manages, supervises and conducts the other
affairs and business of the Trust, furnishes office space and equipment,
provides bookkeeping and certain clerical services and pays all salaries, fees
and expenses of officers and Trustees of the Trust who are affiliated with the
Manager. As indicated under "Portfolio Transactions--Brokerage and Research
Services," the Trust's portfolio transactions may be placed with broker-dealers
which furnish the Manager, at no cost, certain research, statistical and
quotation services of value to the Manager in advising the Trust or its other
clients.
As is disclosed in the Prospectus, the Manager has contractually agreed
to reimburse the Fund with respect to certain Fund expenses through 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 a specified percentage of the Fund's daily
net assets.
The Management Contract provides that the Manager shall not be subject
to any liability in connection with the performance of its services thereunder
in the absence of willful misfeasance, bad faith, gross negligence or reckless
disregard of its obligations and duties.
The Management Contract was approved by the Trustees of the Trust
(including a majority of the Trustees who are not "interested persons" of the
Manager) and by the Fund's sole shareholder in connection with the organization
of the Trust and the establishment of the Fund. The Management Contract will
continue in effect for a period more than two years from the date of its
execution only so long as its continuance is approved at least annually by (i)
vote, cast in person at a meeting called for that purpose, of a majority of
those Trustees who are not "interested persons" of the Manager or the Trust, and
by (ii) the majority vote of either the full Board of Trustees or the vote of a
majority of the outstanding shares of the Fund. 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, the Management Contract
may be terminated on not more than 60 days' written notice by the Manager to the
Trust.
CUSTODIAL ARRANGEMENTS. Investors Bank & Trust Company ("IBT"), 200
Clarendon Street, Boston, Massachusetts 02116, serves as the Trust's custodian
on behalf of the Fund. As such, IBT
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<PAGE> 40
holds in safekeeping certificated securities and cash belonging to the Fund and,
in such capacity, is the registered owner of securities in book-entry form
belonging to the Fund. Upon instruction, IBT receives and delivers cash and
securities of the Fund in connection with Fund transactions and collects all
dividends and other distributions made with respect to Fund portfolio
securities. IBT also maintains certain accounts and records of the Trust and
calculates the total net asset value, total net income and net asset value per
share of the Fund on a daily basis.
SHAREHOLDER SERVICE ARRANGEMENTS. As disclosed in the Prospectus,
pursuant to the terms of a single Servicing Agreement with each fund of the
Trust, GMO provides direct client service, maintenance and reporting to
shareholders of the Fund. The Servicing Agreement was approved by the Trustees
of the Trust (including a majority of the Trustees who are not "interested
persons" of the Manager or the Trust). The Servicing Agreement will continue in
effect for a period more than one year from the date of its execution only so
long as its continuance is approved at least annually by (i) vote, cast in
person at a meeting called for the purpose, of a majority of those Trustees who
are not "interested persons" of the Manager or the Trust, and by (ii) the
majority vote of the full Board of Trustees. The Servicing Agreement
automatically terminates on assignment (except as specifically provided in the
Servicing Agreement) and is terminable by either party upon not more than 60
days' written notice to the other party.
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 the Fund's federal and state income
tax returns, consults with the Trust as to matters of accounting and federal and
state income taxation and provides assistance in connection with the preparation
of various Securities and Exchange Commission filings.
PORTFOLIO TRANSACTIONS
The purchase and sale of portfolio securities for the Fund and for the
other investment advisory clients of the Manager are made by the Manager with a
view to achieving their respective investment objectives. For example, a
particular security may be bought or sold for certain clients of the Manager
even though it could have been bought or sold for other clients at the same
time. Likewise, a particular security may be bought for one or more clients when
one or more other clients are selling the security. In some instances,
therefore, one client may sell indirectly a particular security to another
client. It also happens that two or more clients may simultaneously buy or sell
the same security, in which event purchases or sales are effected on a pro rata,
rotating or other equitable basis so as to avoid any one account being preferred
over any other account.
Transactions involving the issuance of Fund shares for securities or
assets other than cash will be limited to a bona fide reorganization or
statutory merger and to other acquisitions of portfolio securities that meet all
of the following conditions: (a) such securities meet the investment objectives
and policies of the Fund; (b) such securities are acquired for investment and
not for resale; (c) such securities are liquid securities which are not
restricted as to transfer either by law or liquidity of market; and (d) such
securities have a value which is readily ascertainable as evidenced by a listing
on the American Stock Exchange, the New York Stock Exchange, NASDAQ or a
recognized foreign exchange.
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<PAGE> 41
BROKERAGE AND RESEARCH SERVICES. In placing orders for the portfolio
transactions of the Fund, the Manager will seek the best price and execution
available, except to the extent it may be permitted to pay higher brokerage
commissions for brokerage and research services as described below. The
determination of what may constitute best price and execution by a broker-dealer
in effecting a securities transaction involves a number of considerations,
including, without limitation, the overall net economic result to the Fund
(involving price paid or received and any commissions and other costs paid), the
efficiency with which the transaction is effected, the ability to effect the
transaction at all where a large block is involved, availability of the broker
to stand ready to execute possibly difficult transactions in the future and the
financial strength and stability of the broker. Because of such factors, a
broker-dealer effecting a transaction may be paid a commission higher than that
charged by another broker-dealer. Most of the foregoing are judgmental
considerations.
Over-the-counter transactions often involve dealers acting for their
own account. It is the Manager's policy to place over-the-counter market orders
for the 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 the Fund,
the Manager will receive such services from brokers who are expected to handle a
substantial amount of the Fund's portfolio transactions. Research services may
include a wide variety of analyses, reviews and reports on such matters as
economic and political developments, industries, companies, securities and
portfolio strategy. The Manager uses such research in servicing other clients as
well as the Fund.
As permitted by Section 28(e) of the Securities Exchange Act of 1934
and subject to such policies as the Trustees of the Trust may determine, the
Manager may pay an unaffiliated broker or dealer that provides "brokerage and
research services" (as defined in the Act) to the Manager an amount of
commission for effecting a portfolio investment transaction in excess of the
amount of commission another broker or dealer would have charged for effecting
that transaction.
DESCRIPTION OF THE TRUST AND OWNERSHIP OF SHARES
The Trust is organized as a Massachusetts business trust under the laws
of Massachusetts by an Agreement and Declaration of Trust ("Declaration of
Trust") dated June 24, 1985. A copy of the Declaration of Trust is on file with
the Secretary of The Commonwealth of Massachusetts. The fiscal year for the Fund
ends on February 28/29.
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 the Intrinsic Value Fund described in this Statement
of Additional Information, and for each of U.S. Core Fund; 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;
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<PAGE> 42
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;
Tax-Managed U.S. Equities Fund; Tax-Managed International Equities Fund;
Tax-Managed U.S. Small Cap Fund; and Asia Fund. Interests in each portfolio
(Fund) are represented by shares of the corresponding series. Each share of each
series represents an equal proportionate interest, together with each other
share, in the corresponding Fund. The shares of such series do not have any
preemptive rights. Upon liquidation of a Fund, shareholders of the corresponding
series are entitled to share pro rata in the net assets of the Fund available
for distribution to shareholders. The Declaration of Trust also permits the
Trustees to charge shareholders directly for custodial and transfer agency
expenses, but there is no present intention to make such charges.
The Declaration of Trust also permits the Trustees, without shareholder
approval, to subdivide any series of shares into various sub-series or classes
of shares with such dividend preferences and other rights as the Trustees may
designate. This power is intended to allow the Trustees to provide for an
equitable allocation of the impact of any future regulatory requirements which
might affect various classes of shareholders differently. The Trustees have
currently authorized the establishment and designation of up to eight classes of
shares for each series of the Trust (except for the Pelican Fund): Class I
Shares, Class II Shares, Class III Shares, Class IV Shares, Class V Shares,
Class VI Shares, Class VII Shares and Class VIII Shares.
The Trustees may also, without shareholder approval, establish one or
more additional separate portfolios for investments in the Trust or merge two or
more existing portfolios. 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.
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
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
25
<PAGE> 43
limitation, the adoption of or change in the investment objectives, policies or
restrictions of the other Fund and the approval of the investment advisory
contracts of the other Fund. Shareholders of a particular class of shares do not
have separate class voting rights except with respect to matters that affect
only that class of shares and as otherwise required by law.
There will normally be no meetings of shareholders for the purpose of
electing Trustees except that in accordance with the 1940 Act (i) the Trust will
hold a shareholders' meeting for the election of Trustees at such time as less
than a majority of the Trustees holding office have been elected by
shareholders, and (ii) if, as a result of a vacancy in the Board of Trustees,
less than two-thirds of the Trustees holding office have been elected by the
shareholders, that vacancy may only be filled by a vote of the shareholders. In
addition, Trustees may be removed from office by a written consent signed by the
holders of two-thirds of the outstanding shares and filed with the Trust's
custodian or by a vote of the holders of two-thirds of the outstanding shares at
a meeting duly called for the purpose, which meeting shall be held upon the
written request of the holders of not less than 10% of the outstanding shares.
Upon written request by the holders of at least 1% of the outstanding shares
stating that such shareholders wish to communicate with the other shareholders
for the purpose of obtaining the signatures necessary to demand a meeting to
consider removal of a Trustee, the Trust has undertaken to provide a list of
shareholders or to disseminate appropriate materials (at the expense of the
requesting shareholders). Except as set forth above, the Trustees shall continue
to hold office and may appoint successor Trustees. Voting rights are not
cumulative.
No amendment may be made to the Declaration of Trust without the
affirmative vote of a majority of the outstanding shares of the Trust except (i)
to change the Trust's name or to cure technical problems in the Declaration of
Trust and (ii) to establish, designate or modify new and existing series or
sub-series of Trust shares or other provisions relating to Trust shares in
response to applicable laws or regulations.
SHAREHOLDER AND TRUSTEE LIABILITY
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the Trust.
However, the Declaration of Trust disclaims shareholder liability for acts or
obligations of the Trust and requires that notice of such disclaimer be given in
each agreement, obligation, or instrument entered into or executed by the Trust
or the Trustees. The Declaration of Trust provides for indemnification out of
all the property of the relevant Fund for all loss and expense of any
shareholder of that Fund held personally liable for the obligations of the
Trust. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is considered remote since it is limited to 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
26
<PAGE> 44
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.
DISTRIBUTIONS
The Prospectus describes the distribution policies of the Fund under
the heading "Distributions".
TAXES
TAX STATUS AND TAXATION OF THE FUND
The Fund is treated as a separate taxable entity for federal income tax
purposes. The Fund intends to qualify each year as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"). In order to qualify for the special tax treatment accorded regulated
investment companies and their shareholders, the 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;
(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 the 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 the 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 the 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
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<PAGE> 45
paid to shareholders by the 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. The 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 the Fund's shares are generally subject
to federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed.
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 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 the Fund in January of a year
generally is deemed to have been received by shareholders on December 31 of the
preceding year, if the distribution was declared and payable to shareholders of
record on a date in October, November or December of that preceding year. The
Trust will provide federal tax information annually, including information about
dividends and distributions paid during the preceding year to taxable investors
and others requesting such information.
If the 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.
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For corporate shareholders, the dividends-received deduction will
generally apply (subject to a holding period requirement imposed by the Code) to
the Fund's dividends paid from investment income to the extent derived from
dividends received from U.S. corporations. However, any distributions received
by the Fund from REITs will not qualify for the corporate dividends-received
deduction. The Fund's investments in REIT equity securities may require the 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). The 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 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 or employer identification number of the record owner of the account.
WITHHOLDING ON DISTRIBUTIONS TO FOREIGN INVESTORS
Dividend distributions (including distributions derived from short-term
capital gains) are in general subject to a U.S. withholding tax of 30% when paid
to a nonresident alien individual, foreign estate or trust, a foreign
corporation, or a foreign partnership ("foreign shareholder"). Persons who are
resident in a country, such as the U.K., that has an income tax treaty with the
U.S. may be eligible for a reduced withholding rate (upon filing of appropriate
forms), and are urged to consult their tax advisors regarding the applicability
and effect of such a treaty. Distributions of net realized long-term capital
gains paid by the Fund to a foreign shareholder, and any gain realized upon the
sale of Fund shares by such a shareholder, will ordinarily not be subject to
U.S. taxation, unless the recipient or seller is a nonresident alien individual
who is present in the United States for more than 182 days during the taxable
year. However, such distributions and sale proceeds may be subject to backup
withholding, unless the foreign investor certifies his non-U.S. residency
status. 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 the Fund is "effectively
connected" with a U.S. trade or business carried on by such shareholder will in
general be subject to U.S. federal income tax on the income derived from the
Fund at the graduated rates applicable to U.S. citizens, residents or domestic
corporations, whether received in cash or reinvested in shares, and, in the case
of a foreign corporation, may also be subject to a branch profits tax. Again,
foreign shareholders who are resident in a country with an income tax treaty
with the United States may obtain different tax results, and are urged to
consult their tax advisors.
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TAX IMPLICATIONS OF CERTAIN INVESTMENTS
Certain of the Fund's investments, including assets "marked to the
market" for federal income tax purposes, debt obligations issued or purchased at
a discount and potentially so-called "index securities" (including inflation
indexed bonds), will create taxable income in excess of the cash they generate.
In such cases, the Fund may be required to sell assets (including when it is not
advantageous to do so) to generate the cash necessary to distribute as dividends
to its shareholders all of its income and gains and therefore to eliminate any
tax liability at the Fund level.
The Fund's transactions in options, futures contracts, hedging
transactions, forward contracts, straddles and foreign currencies may accelerate
income, defer losses, cause adjustments in the holding periods of the Fund's
securities and convert short-term capital gains or losses into long-term capital
gains or losses. These transactions 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 the 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 the 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
The Fund may experience particular difficulty qualifying as a regulated
investment company in the case of highly unusual market movements, in the case
of high redemption levels and/or during the first year of its operations. If the
Fund does not qualify for taxation as a regulated investment
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<PAGE> 48
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
The Fund may from time to time include its total return in
advertisements or in information furnished to present or prospective
shareholders.
Quotations of average annual total return for the Fund will be
expressed in terms of the average annual compounded rate of return of a
hypothetical investment in the Fund or class over periods of one, three, five,
and ten years (or for such shorter or longer periods as shares of the Fund have
been offered), calculated pursuant to the following formula: P (1 + T)n = ERV
(where P = a hypothetical initial payment of $10,000, T = the average annual
total return, n = the number of years, and ERV = the ending redeemable value of
a hypothetical $1,000 payment made at the beginning of the period). Except as
noted below, all total return figures reflect the deduction of a proportional
share of Fund expenses on an annual basis, and assume that (i) the maximum
purchase premium is deducted from the initial $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 Fund may also, with respect to
certain periods of less than one year, provide total return information for that
period that is unannualized. Any such information would be accompanied by
standardized total return information.
The Fund may also from time to time advertise net return and gross
return data for each month and calendar quarter since the Fund's inception.
Monthly and quarterly return data is calculated by linking daily performance for
the Fund (current net asset value divided by prior net asset value), and assumes
reinvestment of all dividends and gains. Monthly and quarterly performance data
does not reflect payment of any applicable purchase premiums or redemption fees.
All quotations of monthly and quarterly returns would be accompanied by
standardized total return information.
Quotations of the Fund's gross return do not reflect any reduction for
any Fund fees or expenses unless otherwise noted; if the gross return data
reflected the estimated fees and expenses of the Fund, the returns would be
lower than those shown. Quotations of gross return for the Fund for a particular
month or quarter will be calculated in accordance with the following formula:
Gross Return =
Net Return + (Total Annual Operating Expense Ratio) (# of days in relevant
period/365)
Information relating to the Fund's return for a particular month or calendar
quarter is provided to permit evaluation of the Fund's performance and
volatility in different market conditions, and should not be considered in
isolation.
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From time to time, in advertisements, in sales literature, or in
reports to shareholders, the Fund may compare its respective performance to that
of other mutual funds with similar investment objective and to stock or other
relevant indices. For example, the Fund may compare its total return to rankings
prepared by Lipper Analytical Services, Inc., Morningstar, Inc. or any other
independent service that monitors mutual fund performance; the Russell 1000
Value Index, an index of unmanaged groups of common stock; or the Dow Jones
Industrial Average, a recognized unmanaged index of common stocks of 30
industrial companies listed on the New York Stock Exchange.
Performance rankings 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 of 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.
INVESTMENT GUIDELINES
- --------------------------------------------------------------------------------
GMO INTRINSIC VALUE FUND
PERFORMANCE BENCHMARK: Russell 1000 Value Index
GENERAL OBJECTIVE: Seeks long-term capital growth through investment in equity
securities.
- --------------------------------------------------------------------------------
GMO Intrinsic Value Fund (the "Fund") is a series of GMO Trust, a registered
open-end investment company.
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
<TABLE>
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EQUITY SECURITIES: * At least 65% of the Fund's total assets will be
domestic common stocks invested in or exposed to(1) domestic common stocks
convertible securities
OTHER EQUITY SECURITIES:
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
warrants or rights
securities of foreign issuers (traded on U.S. exchanges)
CASH AND MONEY MARKET INSTRUMENTS * The Fund will not normally have greater than 5% of
Any short-term assets will be invested in cash or high its net assets exposed to cash and money market
quality money market instruments including securities instruments. This limitation does NOT include cash and
issued by the U.S. government and agencies thereof, money market instruments in margin accounts or otherwise
bankers' acceptances, commercial paper, held against exposure achieved through derivative
bank certificates of deposit and repurchase agreements. agreements. instruments ("equitized cash").
</TABLE>
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(1) 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.
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GMO Intrinsic Value Fund
Page 2
PROHIBITED INVESTMENTS AND PRACTICES
The Fund will NOT engage in the following practices except as indicated:
<TABLE>
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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 of 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 respect to swap agreements,
MORTGAGING FUND ASSETS 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.
</TABLE>
SELLING UNCOVERED PUT OR CALL OPTIONS ON SECURITIES OR INDEXES
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
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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).
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 purchase more than 5% of any class of
BROKERS, DEALERS, UNDERWRITERS AND stock of a broker, dealer, underwriter or investment adviser.
INVESTMENT ADVISERS
* 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.
</TABLE>
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GMO Intrinsic Value Fund
Page 3
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CONCENTRATION
CONCENTRATION * The Fund will not invest more than 25% of its 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
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.(2)
* 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. 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 options and equity swap
SYNTHETIC SALES AND PURCHASES 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
</TABLE>
- -----------------
(2) 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.
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GMO Intrinsic Value Fund
Page 4
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<S> <C>
synthetic sales and purchases will generally be unwound as
actual portfolio securities are sold and purchased.
LIMITATIONS ON THE USE OF DERIVATIVES * There is no limit on the use of derivatives for hedging purposes.
* The face value of derivatives used for Investment Purposes will be
limited to 25% of the Fund's assets.
* 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.
</TABLE>
35
