THE PBHG FUNDS, INC.
PBHG CLASS SHARES
PROSPECTUS DATED MAY 1, 1997
The PBHG Funds, Inc. (the 'Fund') is a mutual fund that offers a convenient and
economical means of investing in professionally managed portfolios of
securities. This Prospectus offers PBHG Class Shares of each of the following
portfolios (each a 'Portfolio' and, together, the 'Portfolios'):
o PBHG SMALL CAP VALUE FUND
o PBHG MID-CAP VALUE FUND
This Prospectus sets forth concisely the information about the Fund and the
Portfolios that a prospective investor should know before investing. Investors
are advised to read this Prospectus and retain it for future reference. A
Statement of Additional Information dated May 1, 1997 has been filed with the
Securities and Exchange Commission and is available upon request and without
charge by calling 1-800-433-0051. The Statement of Additional Information is
incorporated into this Prospectus by reference. This Prospectus is also
available on the Fund's Web site at http://www.pbhgfunds.com. The Securities and
Exchange Commission maintains a Web site (http://www.sec.gov) that contains the
Statement of Additional Information, material incorporated by reference and
other information regarding registrants that file electronically with the
Securities and Exchange Commission.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
MUTUAL FUND SHARES ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED BY, ANY
DEPOSITORY INSTITUTION. SHARES ARE NOT INSURED BY THE FDIC, THE FEDERAL RESERVE
BOARD, OR ANY OTHER AGENCY, AND ARE SUBJECT TO INVESTMENT RISK, INCLUDING THE
POSSIBLE LOSS OF PRINCIPAL.
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SUMMARY
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The PBHG Funds, Inc. (the 'Fund') is an open-end management investment
company which provides a convenient way to invest in professionally managed
diversified portfolios of securities. This summary provides basic information
about the PBHG Small Cap Value Fund ('Small Cap Value Fund') and PBHG Mid-Cap
Value Fund ('Mid-Cap Value Fund') (each a 'Portfolio' and, together, the
'Portfolios'). This summary is qualified in its entirety by reference to the
more detailed information provided elsewhere in this Prospectus and in the
Statement of Additional Information.
WHAT ARE THE INVESTMENT OBJECTIVES OF THE PORTFOLIOS? The Small Cap Value
Fund seeks to achieve above-average total return over a market cycle of three to
five years, consistent with reasonable risk, by investing primarily in a
diversified portfolio of common stocks with market capitalizations in the range
of companies represented in the Russell 2000 Index, which are considered to be
relatively undervalued based on certain proprietary measures of value. The
Mid-Cap Value Fund seeks to achieve above-average total return over a market
cycle of three to five years, consistent with reasonable risk, by investing in
common stocks and other equity securities of companies with market
capitalizations in the range of companies represented in the Standard & Poor's
MidCap 400 Index ('S&P 400'), which are considered to be relatively undervalued
based on certain proprietary measures of value. There can be no assurance that
either Portfolio will achieve its investment objective.
WHAT ARE THE PRINCIPAL RISKS INVOLVED WITH AN INVESTMENT IN THE
PORTFOLIOS? Each Portfolio invests in securities that fluctuate in value, and
investors should expect each Portfolio's net asset value per share to fluctuate.
Each Portfolio may invest in stocks and convertible securities that may be
traded in the over-the-counter market. Some of these securities may not be as
liquid as exchange-listed stocks. In addition, because the Portfolios invest
extensively in the securities of small or medium capitalization companies, they
may experience greater price volatility than an investment company that invests
primarily in more established, larger capitalized companies. Each of the
Portfolios may invest in equity securities of non-U.S. issuers, which are
subject to certain risks not typically associated with domestic securities. Such
risks include changes in currency rates and in exchange control regulations,
costs associated with conversions between various currencies, limited publicly
available information regarding foreign issuers, lack of uniformity in
accounting, auditing and financial standards and requirements, greater
securities market volatility, less liquidity, less government supervision of
securities markets, changes in taxes on income on securities, and possible
seizure, nationalization or expropriation of the foreign issuer or foreign
deposits. Each of the Portfolios also may enter into futures contracts, which
are subject to special risks. Such risks include the potential of imperfect
correlation between the change the in value of a futures contract purchased or
sold and the market value of the securities held by a Portfolio and the risk
that such Portfolio may not be able to close out a particular futures contract
because of a lack of a liquid secondary market in such futures contract. See
'Investment Objectives and Policies,' 'Risk Factors' and 'Glossary of Permitted
Investments.'
TABLE OF CONTENTS
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<TABLE>
<S> <C>
Summary............................................ 2
Expense Summary.................................... 4
The Fund and the Portfolios........................ 5
Investment Objectives and Policies................. 5
General Investment Policies and Strategies......... 7
Risk Factors....................................... 8
Investment Limitations............................. 8
How to Purchase Fund Shares........................ 9
Shareholder Services............................... 11
How to Redeem Fund Shares.......................... 12
Determination of Net Asset Value................... 14
Performance Advertising............................ 14
Taxes.............................................. 14
General Information................................ 15
Glossary of Permitted Investments.................. 18
</TABLE>
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WHO ARE THE ADVISER AND SUB-ADVISER? Pilgrim Baxter & Associates, Ltd.
('Adviser') serves as the investment adviser to each Portfolio. Newbold's Asset
Management, Inc. ('Sub-Adviser') serves as the investment sub-adviser to each
Portfolio. Pilgrim Baxter & Associates, Ltd. and Newbold's Asset Management,
Inc. are collectively referred to herein as 'Advisers.' See 'Expense Summary,'
'The Adviser' and 'The Sub-Adviser.'
WHO ARE THE ADMINISTRATOR AND SUB-ADMINISTRATOR? PBHG Fund Services, an
affiliate of the Adviser, serves as the administrator of the Fund, and SEI Fund
Resources, an affiliate of the Fund's distributor, serves as sub-administrator
of the Fund. See 'The Administrator and Sub-Administrator.'
WHO ARE THE TRANSFER AGENT AND SUB-TRANSFER AGENTS? DST Systems, Inc.
serves as the transfer agent, dividend disbursing agent and shareholder
servicing agent of the Fund. The Fund may also pay amounts to certain third
parties that provide sub-transfer agency and other administrative services
relating to the Fund to persons who beneficially own interests in the Fund. See
'The Transfer Agent and Sub-Transfer Agents.'
WHO IS THE DISTRIBUTOR? SEI Financial Services Company provides the Fund
with distribution services. See 'The Distributor.'
IS THERE A SALES LOAD? No, PBHG Class Shares of the Portfolio are offered
on a no-load basis.
IS THERE A MINIMUM INITIAL INVESTMENT? The Small Cap Value Fund and the
Mid-Cap Value Fund have a minimum initial investment of $2,500 for regular
accounts and $2,000 for IRAs.
HOW DO I PURCHASE AND REDEEM SHARES? Purchases and redemptions may be made
through the Transfer Agent on any day on which the New York Stock Exchange is
open for business ('Business Day'). A purchase order will be effective as of the
Business Day received by the Transfer Agent if the Transfer Agent receives
sufficient information to execute the order and receives payment by check or
readily available funds prior to 4:00 p.m., Eastern time. Redemption orders
placed with the Transfer Agent prior to 4:00 p.m., Eastern time for each
Portfolio on any Business Day will be effective that day. The purchase and
redemption price for shares is the net asset value per share determined as of
the end of the day the order is effective. Purchases and redemptions also may be
made through certain broker-dealers and other financial institutions. The Fund
also offers a Systematic Investment Plan and a Systematic Withdrawal Plan. See
'Shareholder Services.'
3
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EXPENSE SUMMARY
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The purpose of the following table is to help you understand the various costs
and expenses that you, as a shareholder, will bear directly or indirectly in
connection with an investment in PBHG Class Shares of the Portfolios.
SHAREHOLDER TRANSACTION EXPENSES
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<TABLE>
<CAPTION>
SMALL CAP MID-CAP
VALUE VALUE
FUND FUND
<S> <C> <C>
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Sales Load Imposed on Purchases None None
Sales Load Imposed on Reinvested Dividends None None
Deferred Sales Load None None
Redemption Fees (1) None None
Exchange Fees None None
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(1) A wire redemption charge, currently $10.00, is deducted from the amount of a
Federal Reserve wire redemption payment made at the request of a
shareholder. A charge of $12.00 may be imposed annually on accounts that
fall below the minimum account size ($2,500 for the Small Cap Value Fund and
Mid-Cap Value Fund) as a result of shareholder redemptions.
ANNUAL OPERATING EXPENSES
(as a percentage of average net assets after applicable expense reimbursements
or fee waivers)
<TABLE>
<CAPTION>
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SMALL CAP MID-CAP
VALUE VALUE
FUND FUND
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<S> <C> <C>
Advisory Fees 1.00% 0.85%
12b-1 Fees None None
Other Expenses 0.50% 0.65%
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Total Operating Expenses 1.50% 1.50%
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</TABLE>
The Adviser has agreed to waive or limit its Advisory Fees or assume Other
Expenses in an amount that operates to limit annual operating expenses of each
Portfolio to no more than 1.50% of the average daily net assets of each
Portfolio. Such waiver of Advisory Fees or assumptions of Other Expenses by the
Adviser is subject to a possible reimbursement by each Portfolio in future years
if such reimbursement can be achieved within the foregoing annual expense limit.
It is not expected that the Adviser will need to waive or limit its Advisory
Fees or to assume Other Expenses of either Portfolio.
EXAMPLE
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<CAPTION>
PORTFOLIO 1 YEAR 3 YEARS
<S> <C> <C> <C>
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An investor in the Portfolio would pay the Small Cap Value Fund $ 15 $47
following expenses on a $1,000 investment
assuming (1) 5% annual return, and (2) Mid-Cap Value Fund $ 15 $47
redemption at the end of each time period.
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</TABLE>
This example is based upon estimated Other Expenses of each Portfolio, as
set forth in the 'Annual Operating Expenses' table above. THE EXAMPLE SHOULD NOT
BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY
BE GREATER OR LESS THAN THOSE SHOWN. The purposes of this table is to assist the
investor in understanding the various costs and expenses that may be directly or
indirectly borne by investors in each Portfolio. See 'The Adviser,' 'The
Sub-Adviser' and 'The Administrator and Sub-Administrator.'
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THE FUND AND THE PORTFOLIOS
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The Fund is an open-end management investment company that currently offers
shares in fourteen separate series. This Prospectus relates solely to the PBHG
Class Shares for the Small Cap Value Fund and the Mid-Cap Value Fund. Each share
of each Portfolio represents an undivided interest in that Portfolio. The Fund's
shares are currently divided into two classes of shares (PBHG Class and Trust
Class) having such preferences and special or relative rights and privileges as
the Board of Directors determines. Only the Fund's PBHG Class Shares are offered
by this Prospectus. Trust Class Shares are generally subject to the same
expenses as the PBHG Class Shares but also bear a Rule 12b-1 shareholder
servicing fee of 0.25% of the average daily net assets attributable to its
shares. The Trust Class Shares are not currently available for these Portfolios.
Additional information pertaining to the Fund may be obtained in writing from
the Fund's transfer agent, DST Systems, Inc., P.O. Box 419534, Kansas City,
Missouri 64141-6534, or by calling 1-800-433-0051.
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INVESTMENT OBJECTIVES AND POLICIES
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SMALL CAP VALUE FUND
The Small Cap Value Fund seeks to achieve above-average total return over a
market cycle of three to five years, consistent with reasonable risk, by
investing primarily in a diversified portfolio of common stocks of small
companies with market capitalizations in the range of companies represented in
the Russell 2000 Index, which are considered to be relatively undervalued based
on certain proprietary measures of value.
The current market capitalization of companies in the Russell 2000 Index is
typically between $57 million and $610 million. It is expected that securities
purchased by the Portfolio will typically exhibit lower price/earnings and
price/book value ratios than the average of those in the Russell 2000 Index.
Under normal circumstances, the Portfolio will be structured taking into account
the economic sector weights of the Russell 2000 Index, with the Portfolio's
sector weightings normally within 5% of the sector weightings of that Index.
In selecting investments for the Portfolio, the Advisers emphasize fundamental
investment value and consider the following factors, among others, in
identifying and analyzing a security's fundamental value: the relationship of a
company's potential earnings power to its current stock price; current dividend
income and the potential for current dividends; low price/earnings ratio
relative to other similar companies; strong competitive advantages, including a
recognized brand or trade name or niche market position; sufficient resources
for expansion; capability of management; and favorable overall business
prospects. The Portfolio may invest in common stocks of companies that are
considered to be financially sound and attractive investments based on their
operating history, but which may be experiencing temporary earnings declines due
to adverse economic conditions that may be company or industry specific or due
to unfavorable publicity. The Portfolio may invest in such companies when the
Adviser and Sub-Adviser believe that those companies will react positively to
changing economic conditions or that such companies have taken or are expected
to take actions designed to improve their financial fundamentals or to otherwise
increase the market price of their securities. The utilization of a valuation
approach may result in investment selections that may be out-of-favor or counter
to those of other investors. However, such an approach may also produce
significant capital appreciation.
In addition to the Portfolio's primary investment (i.e., under normal market
conditions, at least 65% of its total assets in common stocks of undervalued
small capitalization companies), the Portfolio may also invest in other equity
securities (i.e., preferred stocks, warrants and securities convertible into or
exchangeable for common stocks) of such small capitalization issuers. The
Portfolio may also utilize futures contracts (i.e., purchase and sell futures
contracts) to the extent that (i) aggregate initial margin deposits to establish
positions other than 'bona fide hedging' positions do not exceed 5% of the
Portfolio's net assets and (ii) the total market value of securities underlying
all futures contracts does not exceed 50% of the value of the Portfolio's total
assets. In addition, the Portfolio may invest up to 15% of its net assets in
restricted or illiquid securities. This limitation does not include any Rule
144A security that has been determined to be liquid pursuant to procedures
established by the Board. The Portfolio may use high-quality money market
investments or short-term bonds to reduce downside volatility during uncertain
or declining market conditions and, for temporary defensive purposes, may invest
in money market securities
5
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or short-term bonds without limitation. See 'General Investment Policies and
Strategies -- Temporary Defensive Positions' below for a fuller description.
The securities in which the Portfolio invests normally will be traded in the
United States or Canada on a registered securities exchange or an established
over-the-counter market. The Portfolio may invest up to 15% of its total assets
in securities of foreign issuers, including American Depository Receipts
('ADRs') and other similar instruments. In addition, the Portfolio may purchase
securities on a when-issued or delayed delivery basis.
See 'Risk Factors' and 'Glossary of Permitted Investments' in this Prospectus
for a fuller description of the Portfolio's permitted investments and their
risks.
MID-CAP VALUE FUND
The Mid-Cap Value Fund seeks to achieve above-average total return over a market
cycle of three to five years, consistent with reasonable risk, by investing in
common stocks and other equity securities of companies with market
capitalizations in the range of companies represented in the S&P 400, which are
considered to be relatively undervalued based on certain proprietary measures of
value.
The current market capitalization of companies in the S&P 400 is typically
between $200 million to over $5 billion. It is expected that securities
purchased by the Portfolio will typically exhibit lower price/earnings value
ratios than the average of those in the S&P 400. Under normal circumstances, the
Portfolio will be structured taking into account the economic sector weights of
the S&P 400 with the Portfolio's sector weightings normally within 5% of the
sector weightings of that Index.
In selecting investments for the Portfolio, the Advisers emphasize fundamental
investment value and consider the following factors, among others, in
identifying and analyzing a security's fundamental value and capital
appreciation potential: the relationship of a company's potential earnings power
to its current stock price; current dividend income and the potential for
dividend growth; low price/earnings ratio relative to other similar companies;
strong competitive advantages, including a recognized brand or trade name or
niche market position; sufficient resources for expansion; capability of
management; and favorable overall business prospects. The Portfolio may invest
in securities of companies that are considered to be financially sound and
attractive investments based on their operating history, but which may be
experiencing temporary earnings declines due to adverse economic conditions that
may be company or industry specific or due to unfavorable publicity. The
Portfolio may invest in such companies when the Adviser and Sub-Adviser believe
that those companies will react positively to changing economic conditions or
that such companies have taken or are expected to take actions designed to
improve their financial fundamentals or to otherwise increase the market price
of their securities. The utilization of a valuation approach may result in
investment selections that may be out-of-favor or counter to those of other
investors. However, such an approach may also produce significant capital
appreciation.
Under normal market conditions, the Portfolio will invest at least 65% of its
total assets in equity securities (i.e., common stocks, preferred stocks,
warrants and securities convertible into or exchangeable for common stocks) of
undervalued medium capitalization issuers. The equity securities in which the
Portfolio invests normally will be traded in the United States or Canada on a
registered securities exchange or an established over-the-counter market. The
Portfolio may invest up to 15% of its total assets in securities of foreign
issuers, including ADRs and other similar instruments. The Portfolio may also
utilize futures contracts (i.e., purchase and sell futures contracts) to the
extent that (i) aggregate initial margin deposits to establish positions other
than 'bona fide hedging' positions do not exceed 5% of the Portfolio's net
assets and (ii) the total market value of securities underlying all futures
contracts does not exceed 50% of the value of the Portfolio's total assets. In
addition, the Portfolio may invest up to 15% of its net assets in restricted or
illiquid securities. This limitation does not include any Rule 144A security
that has been determined to be liquid pursuant to procedures established by the
Board. The Portfolio may use high-quality money market investments or short-term
bonds to reduce downside volatility during uncertain or declining market
conditions and, for temporary defensive purposes, may invest in money market
securities or short-term bonds without limitation. See 'General Investment
Policies and Strategies -- Temporary Defensive Positions' below for a fuller
description. In addition, the Portfolio may purchase securities on a when-issued
or delayed delivery basis.
6
<PAGE>
See 'Risk Factors' and 'Glossary of Permitted Investments' in this Prospectus
for a fuller description of the Portfolio's permitted investments and their
risks.
There can be no assurance that any Portfolio will be able to achieve its
investment objective.
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GENERAL INVESTMENT POLICIES AND STRATEGIES
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INVESTMENT PROCESS
The investment process is both quantitative and fundamental. In seeking to
identify attractive investment opportunities for the Portfolios, the Sub-Adviser
first creates a universe of companies each of whose current share price is low
in relation to its real worth or future prospects. Using custom designed
research models and proprietary software, which incorporate certain key elements
of value investing (such as consistency of dividend payment, balance sheet
strength and, low stock price relative to its assets, earnings, cash flow and
business franchise), the Sub-Adviser screens more than 8,000 possible companies
and creates an initial universe of statistically attractive value companies.
Following the creation of this universe of possible investments, the Sub-Adviser
uses its strong fundamental research capabilities to carefully identify
securities that are currently out of favor but which have the potential to
achieve significant appreciation as the marketplace recognizes their fundamental
value. Once constructed, portfolios are continually monitored for change. The
Sub-Adviser follows a disciplined valuation approach that requires it to sell
any portfolio security that becomes overvalued relative to the market. Sales of
portfolio securities are primarily triggered by the relative change in a
company's price/earnings ratio. Adverse changes in other key value elements are,
of course, factors that would also trigger a sale. Of course, there can be no
assurance that use of these techniques will be successful.
PORTFOLIO TURNOVER
Portfolio turnover will tend to rise during periods of economic turbulence and
decline during periods of stable growth. A higher turnover rate (100% or more)
increases transaction costs (e.g., brokerage commissions) and increases realized
gains and losses. It is expected that under normal market conditions, the annual
portfolio turnover rates for each Portfolio will not exceed 400%. High rates of
portfolio turnover necessarily result in correspondingly greater brokerage and
portfolio trading costs, which are paid by the Portfolio. Trading in
fixed-income securities does not generally involve the payment of brokerage
commissions, but does involve indirect transaction costs. In addition to
portfolio trading costs, higher rates of portfolio turnover may result in the
realization of capital gains. To the extent net short-term capital gains are
realized, any distributions resulting from such gains are considered ordinary
income for federal income tax purposes. In addition, high rates of portfolio
turnover may adversely affect each Portfolio's status as a 'regulated investment
company' ('RIC') under Section 851 of the Internal Revenue Code of 1986, as
amended ('Code').
TEMPORARY DEFENSIVE POSITIONS
Under normal market conditions, each Portfolio expects to be fully invested in
its primary investments, as described above. However, for temporary defensive
purposes, when the Advisers determine that market conditions warrant, each
Portfolio may invest up to 100% of its assets in cash and money market
instruments (consisting of securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities; certificates of deposit, time
deposits and bankers' acceptances issued by banks or savings and loan
associations having net assets of at least $500 million as stated on their most
recently published financial statements; commercial paper rated in one of the
two highest rating categories by at least one nationally recognized statistical
rating organization; repurchase agreements involving such securities; and, to
the extent permitted by applicable law and each Portfolio's investment
restrictions, shares of other investment companies investing solely in money
market securities. To the extent a Portfolio is invested in temporary defensive
instruments, it will not be pursuing its investment objective. See 'Glossary of
Permitted Investments' and the Statement of Additional Information for further
information about such investments.
7
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RISK FACTORS
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SMALL AND MEDIUM CAPITALIZATION STOCKS
Investments in common stocks in general are subject to market risks that may
cause their prices to fluctuate over time. Therefore, an investment in each
Portfolio may be more suitable for long-term investors who can bear the risk of
these fluctuations. The Small Cap Value Fund invests primarily in securities
issued by small and medium capitalization companies and the Mid-Cap Value Fund
invests primarily in securities issued by mid-capitalization companies. While
the Advisers intend to invest in small and medium capitalization companies that
have strong balance sheets and favorable business prospects, any investment in
small and medium capitalization companies involves greater risk and price
volatility than that customarily associated with investments in larger, more
established companies. This increased risk may be due to the greater business
risks of their small or medium size, limited markets and financial resources,
narrow product lines and frequent lack of management depth. The securities of
small and medium capitalization companies are often traded in the
over-the-counter market, and might not be traded in volumes typical of
securities traded on a national securities exchange. Thus, the securities of
small and medium capitalization companies are likely to be less liquid, and
subject to more abrupt or erratic market movements, than securities of larger,
more established companies.
OVER-THE-COUNTER MARKET
Each Portfolio may invest in over-the-counter stocks. In contrast to the
securities exchanges, the over-the-counter market is not a centralized facility
which limits trading activity to securities of companies which initially satisfy
certain defined standards. Generally, the volume of trading in an unlisted or
over-the-counter common stock is less than the volume of trading in a listed
stock. This means that the depth of market liquidity of some stocks in which
each Portfolio invests may not be as great as that of other securities and if a
Portfolio were to dispose of such a stock, it might have to offer the shares at
a discount from recent prices, or sell the shares in small lots over an extended
period of time.
FOREIGN SECURITIES
Investing in the securities of foreign issuers involves special risks and
considerations not typically associated with investing in U.S. companies. These
risks and considerations include differences in accounting, auditing and
financial reporting standards, generally higher commission rates on foreign
portfolio transactions, the possibility of expropriation or confiscatory
taxation, adverse changes in investment or exchange control regulations,
political instability which could affect U.S. investment in foreign countries
and potential restrictions on the flow of international capital and currencies.
Foreign issuers may also be subject to less government regulation than U.S.
companies. Moreover, the dividends and interest payable on foreign securities
may be subject to foreign withholding taxes, thus reducing the net amount of
income available for distribution to a Portfolio's shareholders. Further,
foreign securities often trade with less frequency and volume than domestic
securities and, therefore, may exhibit greater price volatility. Changes in
foreign exchange rates will affect, favorably or unfavorably, the value of those
securities which are denominated or quoted in currencies other than the U.S.
dollar.
FUTURES CONTRACTS
The primary risks associated with the use of futures contracts are (i) imperfect
correlations between the change in market value of the securities held by a
Portfolio and the prices of futures contracts purchased or sold by a Portfolio;
and (ii) possible lack of a liquid secondary market for a futures contract and
the resulting inability to close a futures position, which could have an adverse
impact on a Portfolio's ability to execute futures and options strategies.
For additional information regarding permitted investments for each Portfolio
and their risks, see 'Glossary of Permitted Investments' and the Statement of
Additional Information.
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INVESTMENT LIMITATIONS
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The investment objectives of each Portfolio, the investment limitations set
forth below and certain investment limitations contained in the Statement of
Additional Information are fundamental policies of each Portfolio. A Portfolio's
fundamental policies cannot be changed without
8
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the consent of the holders of a majority of the Portfolio's outstanding shares.
Each Portfolio, as a fundamental policy, may not:
1. Purchase securities of any issuer (except securities issued or guaranteed by
the United States, its agencies or instrumentalities and repurchase agreements
involving such securities) if, as a result, more than 5% of the total assets of
the Portfolio would be invested in the securities of such issuer. This
restriction applies to 75% of each Portfolio's total assets.
2. Purchase any securities which would cause 25% or more of the total assets of
a Portfolio to be invested in the securities of one or more issuers conducting
their principal business activities in the same industry, provided that this
limitation does not apply to investments in obligations issued or guaranteed by
the U.S. Government or its agencies and instrumentalities and repurchase
agreements involving such securities. For purposes of this limitation, (i)
utility companies will be divided according to their services, for example, gas
distribution, gas transmission, electric and telephone will each be considered a
separate industry, and (ii) financial service companies will be classified
according to the end users of their services, for example, automobile finance,
bank finance and diversified finance will each be considered a separate
industry. For purposes of this limitation, supranational organizations are
deemed to be issuers conducting their principal business activities in the same
industry.
3. Borrow money except for temporary or emergency purposes and then only in an
amount not exceeding 33 1/3% of the value of each Portfolio's total assets. This
borrowing provision is included solely to facilitate the orderly sale of
portfolio securities to accommodate substantial redemption requests if they
should occur and is not for investment purposes. All borrowings in excess of 5%
of the Portfolio's total assets will be repaid before making investments.
The foregoing percentages will apply at the time of the purchase of a security.
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HOW TO PURCHASE FUND SHARES
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You may purchase shares of each Portfolio directly through DST Systems, Inc.
('DST' or the 'Transfer Agent'). Purchases of shares of each Portfolio may be
made on any Business Day. Shares of each Portfolio are offered only to residents
of states in which such shares are eligible for purchase.
You may place orders by mail, wire or telephone if you have elected the
Telephone Purchase Authorization option on your Account Application. If market
conditions are extraordinarily active, or if severe weather or other emergencies
exist, and you experience difficulties placing orders by telephone, you may wish
to consider placing your order by other means, such as mail or overnight
delivery.
You may also purchase shares of each Portfolio through certain broker-dealers or
other financial institutions that are authorized to sell you shares of the
Portfolios. Such financial institutions may charge you a fee for this service in
addition to each Portfolio's public offering price.
Neither the Fund nor the Transfer Agent will be responsible for any loss,
liability, cost or expenses for acting upon wire instruction or upon telephone
instructions that it reasonably believes to be genuine. The Fund and the
Transfer Agent will each employ reasonable procedures to confirm that
instructions communicated by telephone are genuine including requiring a form of
personal identification prior to acting upon instructions received by telephone
and recording telephone instructions.
Each Portfolio reserves the right to reject any purchase order or to suspend or
modify the continuous offering of its shares. For example, the investment
opportunities for small or medium capitalization companies may from time to time
be more limited than those in other sectors of the stock market. Therefore, in
order to retain adequate investment flexibility, the Adviser and Sub-Adviser may
from time to time recommend to the Board of Directors of the Fund that a
Portfolio, which invests extensively in such companies, indefinitely discontinue
the sale of its shares to new investors (other than directors, officers and
employees of the Adviser, Sub-Adviser and its affiliated companies). In such
event, the Board of Directors would determine whether such discontinuance is in
the best interests of the applicable Portfolio and its shareholders.
MINIMUM INITIAL INVESTMENT
The minimum initial investment for the Small Cap Value Fund and Mid-Cap Value
Fund is $2,500 for regular accounts and $2,000 for IRAs. There is no minimum for
subsequent purchases except for those (1) using the Systematic Investment Plan
or (2) electing to purchase
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additional shares by telephone. The Distributor may waive the minimum at its
discretion. No minimum applies to subsequent purchases effected by dividend
reinvestment. As described below, subsequent purchases through the Fund's
Systematic Investment Plan and by Telephone Purchase Authorization must be at
least $25 and $1,000, respectively.
INITIAL PURCHASES BY MAIL
An account may be opened by mailing a check or other negotiable bank draft
payable to -- The PBHG Funds, Inc., for $2,500 or more for regular accounts and
$2,000 for IRAs, together with a completed Account Application to: THE PBHG
FUNDS, INC. C/O DST SYSTEMS, INC., P.O. BOX 419534, KANSAS CITY, MISSOURI
64141-6534. The Fund will not accept third-party checks, i.e., a check not
payable to The PBHG Funds, Inc. or a Portfolio for initial or subsequent
investments.
ADDITIONAL PURCHASES BY PHONE (TELEPHONE PURCHASE AUTHORIZATION)
You may purchase additional shares by telephoning the Transfer Agent at
1-800-433-0051. The minimum telephone purchase is $1,000, and the maximum is
five times the net asset value of shares held by the shareholder on the day
preceding such telephone purchase for which payment has been received. The
telephone purchase will be made at the offering price next computed after the
receipt of the call by the Transfer Agent. Payment for the telephone purchase
must be received by the Transfer Agent within seven days. If payment is not
received within seven days, you will be liable for all losses incurred as a
result of the cancellation of such purchase.
INITIAL PURCHASE BY WIRE
If you have an account with a commercial bank that is a member of the Federal
Reserve System, you may purchase shares of the Portfolios by requesting your
bank to transmit funds by wire transfer. Before making an initial investment by
wire, you must first telephone 1-800-433-0051 to receive an Account Application
and account number. The Account Application must be received prior to receipt of
the wire. Your name, account number, taxpayer identification number or Social
Security Number, and address must be specified in the wire. All wires must be
received by 4:00 p.m. Eastern time to be effective on that day. In addition, an
original Account Application should be promptly forwarded to: DST Systems, Inc.,
P.O. Box 419534, Kansas City, Missouri 64141-6534. All wires must be sent as
follows: United Missouri Bank of Kansas City, N.A.; ABA #10-10-00695; for
Account Number 98705-23469; Further Credit: [Name of Portfolio and account
number].
ADDITIONAL PURCHASES BY WIRE
Additional investments may be made at any time through the wire procedures
described above, which must include your name and account number. Your bank may
impose a fee for investments by wire.
PURCHASES BY ACH
If you have made this election, shares of each Portfolio may be purchased via
Automated Clearing House ('ACH'). Investors purchasing via ACH should complete
the bank information section on the Account Application and attach a voided
check or deposit slip to the Account Application. This option must be
established on your account at least 15 days prior to you initiating an ACH
transaction.
GENERAL INFORMATION REGARDING PURCHASES
A purchase order will be effective as of the day received by the Transfer Agent
if the Transfer Agent receives sufficient information to execute the order and
receives payment before 4:00 p.m., Eastern time for a Portfolio. Payment may be
made by check or readily available funds. The purchase price of shares of a
Portfolio is the net asset value per share next determined after a purchase
order is effective. Purchases will be made in full and fractional shares of a
Portfolio calculated to three decimal places. The Fund will not issue
certificates representing shares of the Portfolios.
In order for your purchase order to be effective on the day you place your order
with your broker-dealer or other financial institution, such broker-dealer or
financial institution must (i) receive your order before 4:00 p.m. Eastern time
for each Portfolio and (ii) promptly transmit the order to the Transfer Agent.
See 'Determination of Net Asset Value' below. The broker-dealer or financial
institution is responsible for promptly transmitting purchase orders to the
Transfer Agent so that you may receive the same day's net asset value.
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If a check received for the purchase of shares does not clear, the purchase will
be canceled, and you could be liable for any losses or fees incurred. The Fund
reserves the right to reject a purchase order when the Fund determines that it
is not in the best interests of the Fund or its shareholders to accept such an
order.
- ------------------------------------------------------
SHAREHOLDER SERVICES
- ------------------------------------------------------
SHAREHOLDER INQUIRIES AND SERVICES OFFERED
If you have any questions about the Portfolios or the shareholder services
described below, please call the Fund at 1-800-433-0051. WRITTEN INQUIRIES
SHOULD BE SENT TO DST SYSTEMS, INC., P.O. BOX 419534, KANSAS CITY, MISSOURI
64141-6534. The Fund reserves the right to amend the shareholder services
described below or to change the terms or conditions relating to such services
upon 60 days' notice to shareholders. You may, however, discontinue any service
you select, provided that with respect to the Systematic Investment and
Systematic Withdrawal Plans described below, the Transfer Agent receives your
notification to discontinue such service(s) at least ten days before the next
scheduled investment or withdrawal date.
SYSTEMATIC INVESTMENT AND SYSTEMATIC
WITHDRAWAL PLANS
For your convenience, the Fund provides plans that enable you to add to your
investment or withdraw from your account(s) with a minimum of paperwork. You can
utilize these plans by simply completing the appropriate section of the Account
Application.
(1) SYSTEMATIC INVESTMENT PLAN. The Systematic Investment Plan is a convenient
way for you to purchase shares in the Portfolios at regular monthly or quarterly
intervals selected by you. The Systematic Investment Plan enables you to achieve
dollar-cost averaging with respect to investments in the Portfolios despite
their fluctuating net asset values through regular purchases of a fixed dollar
amount of shares in the Portfolios. Dollar-cost averaging brings discipline to
your investing. Dollar-cost averaging results in more shares being purchased
when a Portfolio's net asset value is relatively low and fewer shares being
purchased when a Portfolio's net asset value is relatively high, thereby helping
to decrease the average price of your shares.
Through the Systematic Investment Plan, shares are purchased by transferring
monies (minimum of $25 per transaction per Portfolio) from your designated
checking or savings account. Your systematic investment in the Portfolio(s)
designated by you will be processed on a regular basis at your option beginning
on or about either the first or fifteenth day of the month or quarter you
select. This Systematic Investment Plan must be established on your account at
least 15 days prior to the intended date of your first systematic investment.
(2) SYSTEMATIC WITHDRAWAL PLAN. The Systematic Withdrawal Plan provides a
convenient way for you to receive current income while maintaining your
investments in any Portfolio. The Systematic Withdrawal Plan permits you to have
payments of $50 or more automatically transferred from your account(s) in any
Portfolio to your designated checking or savings account on a monthly,
quarterly, or semi-annual basis. This Systematic Withdrawal Plan also provides
the option of having a check mailed to the address of record for your account.
In order to start this Plan, you must have a minimum balance of $5,000 in any
account utilizing this feature. Your systematic withdrawals will be processed on
a regular basis beginning on or about either the first or fifteenth day of the
month, quarter or semi-annual period you select.
EXCHANGE PRIVILEGES
Once payment for your shares has been received (i.e., an account has been
established), you may exchange some or all of your shares for shares of other
series of the Fund currently available for investment by new investors. However,
if you own shares of any series of the Fund other than the PBHG Cash Reserves
Fund, you are limited to four (4) exchanges annually from such series to the
PBHG Cash Reserves Fund. Exchanges are made at net asset value. The Fund
reserves the right to change the terms and conditions of the exchange privilege
discussed herein, or to terminate the exchange privilege, upon sixty (60) days'
notice. Exchanges will be made only after proper instructions in writing or by
telephone (an 'Exchange Request') are received for an established account by the
Transfer Agent.
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TAX-SHELTERED RETIREMENT PLANS
A variety of retirement plans, including IRAs, SEP-IRAs, 401(a) Keogh and
Corporate money purchase pension and profit sharing plans, and 401(k) and 403(b)
plans are available to investors in the Fund.
(1) INDIVIDUAL RETIREMENT ACCOUNTS ('IRAS'). You may save for your retirement
and shelter your investment income from current taxes by either: (a)
establishing a new IRA; or (b) 'rolling-over' to the Fund monies from other IRA
accounts or lump sum distributions from a qualified retirement plan. If you are
between 18 and 70 1/2 years of age, you can use an IRA to invest up to $2,000
per year of your earned income in any of the Portfolios. You may also invest up
to $2,000 per year in a spousal IRA if your spouse has no earned income. There
is a $10.00 annual maintenance fee charged to IRA investors. If you maintain IRA
accounts in more than one portfolio of the Fund, you will only be charged one
fee. This fee can be prepaid or will be debited from your account if not
received by the announced deadline.
(2) SEP-IRAS. If you are a self-employed person, you can establish a Simplified
Employee Pension Plan ('SEP-IRA'). A SEP-IRA is designed to provide persons with
self-employed income (and their eligible employees) with many of the same tax
advantages as a Keogh, but with fewer administrative requirements.
(3) 401(A) KEOGH AND CORPORATE RETIREMENT PLANS. Both a prototype money
purchase pension plan and a profit sharing plan, which may be used alone or in
combination, are available for self-employed individuals and their partners, and
corporations to provide tax-sheltered retirement benefits for individuals and
employees.
(4) 401(K) PLANS. Through the establishment of a 401(k) plan by a corporation
of any size, employees can invest a portion of their wages in the Portfolios on
a tax-deferred basis in order to help them meet their retirement needs.
(5) 403(B) PLANS. Section 403(b) plans are custodial accounts which are
available to employees of most non-profit organizations and public schools.
OTHER SPECIAL ACCOUNTS
The Fund also offers the following special accounts to meet your needs:
(1) UNIFORM GIFT TO MINORS/UNIFORM TRANSFERS TO MINORS. By establishing a
Uniform Gift to Minors Account/Uniform Transfers to Minors with the Fund you can
build a fund for your children's education or a nest egg for their future and,
at the same time, potentially reduce your own income taxes.
(2) CUSTODIAL AND FIDUCIARY ACCOUNTS. The Fund provides a convenient means of
establishing custodial and fiduciary accounts for investors with fiduciary
responsibilities.
For further information regarding any of the above retirement plans and
accounts, please call toll free at 1-800-433-0051. Retirement investors may,
however, wish to consult with their own tax counsel or adviser.
- ------------------------------------------------------
HOW TO REDEEM FUND SHARES
- ------------------------------------------------------
Redemption orders received by the Transfer Agent prior to 4:00 p.m., Eastern
time for each Portfolio on any Business Day will be effective that day. The
redemption price of shares is the net asset value per share of a Portfolio next
determined after the redemption order is effective. Payment on redemption will
be made as promptly as possible and, in any event, within seven days after the
redemption order is received, provided, however, that redemption proceeds for
shares purchased by check (including certified or cashier's checks) will be
forwarded only upon collection of payment for such shares; collection of payment
may take up to 15 days.
You may also redeem shares of each Portfolio through certain broker-dealers and
other financial institutions at which you maintain an account. Such financial
institutions may charge you a fee for this service.
In order for your redemption order for any Portfolio to be effective on the day
you place your redemption order with your broker-dealer or other financial
institution, such broker-dealer or financial institution must (i) receive your
order before 4:00 p.m. Eastern Time for each Portfolio and (ii) promptly
transmit the order to the Transfer Agent. See 'Determination of Net Asset Value'
above. The financial institution is responsible for promptly transmitting
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redemption orders to the Transfer Agent so that your shares are redeemed at the
same day's net asset value per share.
You may receive redemption payments in the form of a check or by Federal Reserve
wire or ACH transfer.
BY MAIL
There is no charge for having a check for redemption proceeds mailed.
BY TELEPHONE
Redemption orders may be placed by telephone provided that this option has been
elected. Shares held in IRA accounts are not eligible for this option and must
be redeemed by written request. Neither the Fund nor the Transfer Agent will be
responsible for any loss, liability, cost or expense for acting upon wire
instructions or upon telephone instructions that it reasonably believes to be
genuine. The Fund and the Transfer Agent will each employ reasonable procedures
to confirm that instructions communicated by telephone are genuine, including
requiring a form of personal identification prior to acting upon instructions
received by telephone and recording telephone instructions. If reasonable
procedures are not employed, the Fund and the Transfer Agent may be liable for
any losses due to unauthorized or fraudulent telephone transactions.
If market conditions are extraordinarily active, or other extraordinary
circumstances exist and you experience difficulties placing redemption orders by
telephone, you may wish to consider placing your order by other means, such as
mail or overnight delivery.
BY WIRE
The Transfer Agent will deduct a wire charge, currently $10.00, from the amount
of a Federal Reserve wire redemption payment made at the request of a
shareholder. Shareholders cannot receive proceeds from redemptions of shares of
a Portfolio by Federal Reserve wire on federal holidays restricting wire
transfers.
BY ACH
The Fund does not charge for ACH transactions; however, such transactions will
not be posted to your bank account until the second Business Day following the
transaction. In order to process a redemption by ACH, banking information must
be established on your account at least 15 days prior to initiating an ACH
transaction. A voided check or deposit slip must accompany requests to establish
this option.
SIGNATURE GUARANTEES
A signature guarantee is a widely accepted way to protect you by verifying the
signature on certain redemption requests. The Fund requires signature guarantees
to be provided in the following circumstances: (1) written requests for
redemptions in excess of $50,000; (2) all written requests to wire redemption
proceeds; and (3) redemption requests that provide that the redemption proceeds
should be sent to an address other than the address of record or to a person
other than the registered shareholder(s) for the account. Signature guarantees
can be obtained from any of the following institutions: a national or state
bank, a trust company, a federal savings and loan association, or a
broker-dealer that is a member of a national securities exchange. The Fund does
not accept guarantees from notaries public or organizations that do not provide
reimbursement in the case of fraud.
MINIMUM ACCOUNT SIZE
Due to the relatively high cost of maintaining smaller accounts, the Fund may
impose an annual $12.00 below minimum account charge and reserves the right to
redeem shares in any non-retirement account if, as the result of redemptions,
the value of any account drops below $2,500 for each Portfolio. You will be
allowed at least sixty (60) days, after notice by the Fund, to make an
additional investment to bring your account value up to at least the applicable
minimum account size before the annual $12.00 below minimum account fee is
charged and/or the redemption of a non-retirement account is processed. The
applicable minimum account charge will be imposed annually on any such account
until the account is brought up to the applicable minimum account size.
The right of redemption may be suspended or the date of payment of redemption
proceeds postponed during certain periods as set forth more fully in the
Statement of Additional Information.
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- ------------------------------------------------------
DETERMINATION OF NET ASSET VALUE
- ------------------------------------------------------
The net asset value per share of each Portfolio is determined by dividing the
total market value of the Portfolio's investments and other assets, less any
liabilities, by the total outstanding shares of the Portfolio. Net asset value
per share is determined daily as of the close of trading on the New York Stock
Exchange (normally 4:00 p.m., Eastern time) on any Business Day. The net asset
value per share of each Portfolio is listed under PBHG in the mutual fund
section of most major daily newspapers, including the Wall Street Journal.
- ------------------------------------------------------
PERFORMANCE ADVERTISING
- ------------------------------------------------------
From time to time, each Portfolio may advertise its yield and total return.
These figures will be based on historical earnings and are not intended to
indicate future performance. No representation can be made regarding actual
future yields or returns. For each Portfolio, yield refers to the annualized
income generated by an investment in the Portfolio over a specified 30-day
period. The yield is calculated by assuming that the same amount of income
generated by the investment during that period is generated in each 30-day
period over one year and is shown as a percentage of the investment.
The total return of each Portfolio refers to the average compounded rate of
return on a hypothetical investment for designated time periods (including but
not limited to the period from which the Portfolio commenced operations through
the specified date), assuming that the entire investment is redeemed at the end
of each period and assuming the reinvestment of all dividend and capital gain
distributions.
Each Portfolio may periodically compare its performance to that of other mutual
funds tracked by mutual fund rating services (such as Lipper Analytical
Services, Inc.) or by financial and business publications and periodicals, broad
groups of comparable mutual funds, unmanaged indices which may assume investment
of dividends but generally do not reflect deductions for administrative and
management costs and other investment alternatives. Each Portfolio may quote
services such as Morningstar, Inc., a service that ranks mutual funds on the
basis of risk-adjusted performance, and Ibbotson Associates of Chicago,
Illinois, which provides historical returns of the capital markets in the U.S.
Each Portfolio may use long-term performance of these capital markets to
demonstrate general long-term risk versus reward scenarios and could include the
value of a hypothetical investment in any of the capital markets. Each Portfolio
may also quote financial and business publications and periodicals as they
relate to fund management, investment philosophy, and investment techniques.
Each Portfolio may quote various measures of volatility and benchmark
correlation in advertisements and may compare these measures to those of other
funds. Measures of volatility attempt to compare historical share price
fluctuations or total returns to a benchmark while measures of benchmark
correlation indicate how valid a comparative benchmark might be. Measures of
volatility and correlation are calculated using averages of historical data and
cannot be calculated precisely.
The performance of the Fund's Trust Class shares may be lower than that of the
Fund's PBHG Class Shares because of the additional Rule 12b-1 shareholder
servicing expenses charged to Trust Class Shares.
- ------------------------------------------------------
TAXES
- ------------------------------------------------------
The following summary of federal income tax consequences is based on current tax
laws and regulations, which may be changed by legislative, judicial or
administrative action. No attempt has been made to present a detailed
explanation of the federal, state or local income tax treatment of the
Portfolios or their shareholders. Accordingly, you are urged to consult your tax
advisor regarding specific questions as to federal, state and local income
taxes. See the Statement of Additional Information for further information.
TAX STATUS OF THE PORTFOLIOS
Each Portfolio is treated as a separate entity for federal income tax purposes
and is not combined with the Fund's other series. Each Portfolio intends to
qualify or to continue to qualify for the special tax treatment afforded a RIC
under Subchapter M of the Code. So long as each Portfolio qualifies for this
special tax treatment, it will be relieved of federal income tax on that part of
its net investment income and net capital gain (the excess of net long-term
capital gain over net short-term capital loss) which it distributes to
shareholders.
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<PAGE>
TAX STATUS OF DISTRIBUTIONS
Each Portfolio will distribute all of its net investment income (including, for
this purpose, net short-term capital gain) to shareholders. Dividends from net
investment income will be taxable to shareholders as ordinary income whether
received in cash or in additional shares. Dividends from net investment income
will qualify for the dividends-received deduction for corporate shareholders
only to the extent such distributions are derived from dividends paid by
domestic corporations. It can be expected that only certain dividends of a
Portfolio will qualify for that deduction. Any net capital gains will be
distributed annually and will be taxed to shareholders as long-term capital
gains, regardless of how long the shareholder has held shares and regardless of
whether the distributions are received in cash or in additional shares. Each
Portfolio will make annual reports to its shareholders of the federal income tax
status of all distributions, including the amount of dividends eligible for the
dividends-received deduction.
Certain securities purchased by the Portfolios (such as U.S. Treasury STRIPS,
defined in 'Glossary of Permitted Investments' below) are sold with original
issue discount and thus do not make periodic cash interest payments. Each
Portfolio will be required to include as part of its current net investment
income the accrued discount on such obligations for purposes of the distribution
requirement even though the Portfolio has not received any interest payments on
such obligations during that period. Because each Portfolio distributes all of
its net investment income to its shareholders, the Portfolio may have to sell
portfolio securities to distribute such accrued income, which may occur at a
time when the Advisers would not have chosen to sell such securities and which
may result in a taxable gain or loss.
Income received on direct U.S. obligations is exempt from income tax at the
state level when received directly by a Portfolio and may be exempt, depending
on the state, when received by a shareholder as income dividends from a
Portfolio provided certain state-specific conditions are satisfied. Not all
states permit such income dividends to be tax exempt and some require that a
certain minimum percentage of an investment company's income be derived from
state tax-exempt interest. Each Portfolio will inform its shareholders annually
of the percentage of income and distributions derived from direct U.S.
obligations. You should consult your tax advisor to determine whether any
portion of the income dividends received from a Portfolio is considered tax
exempt in your particular state.
Dividends declared by a Portfolio in October, November or December of any year
and payable to shareholders of record on a date in one of those months will be
deemed to have been paid by the Portfolio and received by the shareholders on
December 31 of that year, if paid by the Portfolio at any time during the
following January.
Each Portfolio intends to make sufficient distributions prior to the end of each
calendar year to avoid liability for the federal excise tax applicable to
regulated investment companies.
TAX TREATMENT OF TRANSACTIONS
Each sale, exchange or redemption of a Portfolio's shares is a taxable event to
the shareholder.
Income derived by a Portfolio from securities of foreign issuers may be subject
to foreign withholding taxes.
- ------------------------------------------------------
GENERAL INFORMATION
- ------------------------------------------------------
THE FUND
The Fund, an open-end management investment company, was originally incorporated
in Delaware in 1985 under the name PBHG Growth Fund, Inc. Effective July 31,
1992, the Fund was reorganized as a Maryland corporation pursuant to an
Agreement and Articles of Merger that was approved by Fund shareholders on July
21, 1992. On September 8, 1993, the Fund's shareholders voted to change the name
of the Fund to The Advisors' Inner Circle Fund II, Inc. On May 2, 1994, the
Fund's shareholders voted to change the name of the Fund to The PBHG Funds, Inc.
All consideration received by the Fund for shares of any Portfolio and all
assets of such Portfolio belong to that Portfolio and would be subject to
liabilities related thereto. The Fund reserves the right to create and issue
shares of additional series.
Each Portfolio of the Fund pays its respective expenses relating to its
operation, including fees of its service providers, audit and legal expenses,
expenses of preparing prospectuses, proxy solicitation material and reports to
shareholders, costs of custodial services and registering its shares under
federal and state securities laws, pricing and insurance expenses and pays
additional expenses including
15
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litigation and other extraordinary expenses, brokerage costs, interest charges,
taxes and organization expenses.
THE ADVISER
Pilgrim Baxter & Associates, Ltd. is a professional investment management firm
and registered investment adviser that, along with its predecessors, has been in
business since 1982. The controlling shareholder of the Adviser is United Asset
Management Corporation ('UAM'), a New York Stock Exchange listed holding company
principally engaged, through affiliated firms, in providing institutional
investment management services and acquiring institutional investment management
firms. UAM's corporate headquarters are located at One International Place,
Boston, Massachusetts 02110. The Adviser currently has discretionary management
authority with respect to over $12 billion in assets. In addition to advising
the Portfolios, the Adviser provides advisory services to the Fund's other
portfolios and to pension and profit-sharing plans, charitable institutions,
corporations, individual investors, trusts and estates, and other investment
companies. The principal business address of the Adviser is 1255 Drummers Lane,
Suite 300, Wayne, Pennsylvania 19087.
The Adviser serves as the investment adviser to each of the Portfolios under an
investment advisory agreement with the Fund (the 'Advisory Agreement'). Under
the Advisory Agreement, the Adviser either continuously reviews, supervises and
administers the investment program of each Portfolio, which includes managing
and selecting investments, or oversees the investment management of a Portfolio
by that Portfolio's sub-adviser, subject to the supervision of, and policies
established by, the Board of Directors of the Fund.
For its services, the Adviser is entitled to a fee, which is calculated daily
and paid monthly, at an annual rate of 1.00% of the average daily net assets of
the Small Cap Value Fund and 0.85% of the average daily assets of Mid-Cap Value
Fund. The advisory fee paid by each Portfolio is higher than those paid by most
investment companies, although the Adviser believes the fee to be comparable to
that paid by investment companies with similar investment objectives and
policies.
THE SUB-ADVISER
Newbold's Asset Management, Inc., 950 Haverford Road, Bryn Mawr, Pennsylvania,
is a registered investment adviser that was formed in 1940. Like the Adviser,
the controlling shareholder of the Sub-Adviser is UAM. The Sub-Adviser currently
has discretionary management authority with respect to over $4 billion in
assets. In addition to advising the Portfolios, the Sub-Adviser provides
advisory services to pension and profit-sharing plans, charitable institutions,
trusts, estates and other investment companies.
The Sub-Adviser serves as the investment sub-adviser for each Portfolio pursuant
to a sub-advisory agreement with the Fund and the Adviser ('Sub-Advisory
Agreement'). Under the Sub-Advisory Agreement, the Sub-Adviser manages the
investments of each of the Portfolios, selects investments and places all orders
for purchases and sales of the Portfolio's securities, subject to the general
supervision of the Board of Directors of the Fund and the Adviser.
For the services provided and expenses incurred pursuant to the Sub-Advisory
Agreement for the Small Cap Value Fund and the Mid-Cap Value Fund, the
Sub-Adviser is entitled to receive from the Adviser a fee with respect to each
Portfolio which is computed daily and paid monthly at an annual rate of 0.65% of
the average daily net assets of the Small Cap Value Fund and 0.50% of the
average daily net assets of the Mid-Cap Value Fund.
PORTFOLIO MANAGER
Gary D. Haubold, CFA, has managed the PBHG Small Cap Value Fund and PBHG Mid-Cap
Value Fund since their inception. Mr. Haubold joined the Sub-Adviser in January
1997. Prior to joining the Sub-Adviser, Mr. Haubold was employed by Miller
Anderson & Sherrerd ('MAS') from 1993 until January 6, 1997. At MAS, Mr. Haubold
served as the co-manager of the Small Cap Value Portfolio of the MAS Fund from
December 31, 1994 through January 6, 1997 and as the co-manager of the Mid-Cap
Value Portfolio of the MAS Fund from its inception on December 30, 1994 through
January 6, 1997. Mr. Haubold was the person primarily responsible for the
day-to-day management and investment selections of those two mutual funds during
the periods noted. Prior to joining MAS, Mr. Haubold was Senior Vice President
of Wood, Struthers & Winthrop.
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EXPENSE LIMITATION AGREEMENTS
In the interest of limiting the expenses of each Portfolio, the Adviser has
entered into an expense limitation agreement with the Fund ('Expense Limitation
Agreement'), with respect to each Portfolio, pursuant to which the Adviser has
agreed to waive or limit its fees and to assume other expenses of each Portfolio
to the extent necessary to limit the total annual operating expenses (expressed
as a percentage of each Portfolio's average daily net assets) to 1.50%.
Reimbursement by each Portfolio of the advisory fees waived or limited and other
expenses paid by the Adviser pursuant to the Expense Limitation Agreement may be
made at a later date when each Portfolio has reached a sufficient asset size to
permit reimbursement to be made without causing the total annual expense rate of
the Portfolio to exceed 1.50%. Consequently, no reimbursement by a Portfolio
will be made unless: (i) the Portfolio's assets exceed $75 million; (ii) the
Portfolio's total annual expense ratio is less than 1.50%; and (iii) the payment
of such reimbursement was approved by the Board of Directors on a quarterly
basis.
THE ADMINISTRATOR AND SUB-ADMINISTRATOR
PBHG Fund Services (the 'Administrator') provides the Fund with administrative
services, including regulatory reporting and all necessary office space,
equipment, personnel and facilities. For these administrative services, the
Administrator is entitled to a fee, which is calculated daily and paid monthly,
at an annual rate of 0.15% of the average daily net assets of the Fund. The
principal place of business of the Administrator is 1255 Drummers Lane, Suite
300, Wayne, Pennsylvania 19087.
SEI Fund Resources (the 'Sub-Administrator'), an indirect wholly-owned
subsidiary of SEI Corporation ('SEI') and an affiliate of the Fund's
distributor, assists the Administrator in providing administrative services to
the Fund. For acting in this capacity, the Administrator pays the
Sub-Administrator a fee at the annual rate of 0.07% of the average daily net
assets of each Portfolio with respect to $2.5 billion of the total average daily
net assets of the Fund, and a fee at the annual rate of 0.025% of the average
daily net assets of each Portfolio with respect to the total average daily net
assets of the Fund in excess of $2.5 billion.
THE TRANSFER AGENT AND SUB-TRANSFER AGENTS
DST Systems, Inc., P.O. Box 419534, Kansas City, Missouri 64141-6534 serves as
the transfer agent, dividend disbursing agent and shareholder servicing agent
for the Fund under a transfer agency agreement with the Fund.
From time to time, the Fund may pay amounts to third parties that provide
sub-transfer agency and other administrative services relating to the Fund to
persons who beneficially own interests in the Fund, such as participants in
401(k) plans. These services may include, among other things, sub-accounting
services, answering inquiries relating to the Fund, delivering on behalf of the
Fund proxy statements, annual reports, updated Prospectuses, other
communications regarding the Fund, and related services as the Fund or the
beneficial owners may reasonably request. In such cases, the Fund will not
compensate such third parties at a rate that is greater than the rate the Fund
is currently paying the Transfer Agent for providing these services to
shareholders investing directly in the Fund.
THE DISTRIBUTOR
SEI Financial Services Company (the 'Distributor'), One Freedom Valley Road,
Oaks, Pennsylvania 19456, a wholly-owned subsidiary of SEI, provides the Fund
with distribution services. No compensation is paid to the Distributor for
distribution services for the PBHG Class Shares of the Portfolios.
DIRECTORS OF THE FUND
The management and affairs of the Fund are supervised by the Board of Directors
under the laws of the State of Maryland. The Directors have approved agreements
under which, as described above, certain companies provide essential management
services to the Fund.
VOTING RIGHTS
Each share held entitles the shareholder of record to one vote. Shareholders of
each Portfolio will vote separately on matters relating solely to it, such as
approval of advisory agreements and changes in fundamental policies, and matters
affecting some but not all series of the Fund will be voted on only by
shareholders of the affected series. Shareholders of all series of the Fund will
vote together on matters affecting the Fund generally, such as the election of
Directors or selection of independent accountants.
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Shareholders of the PBHG Class of the Fund will vote separately on matters
relating solely to the PBHG Class and not on matters relating solely to the
Trust Class of the Fund. As a Maryland corporation, the Fund is not required to
hold annual meetings of shareholders but shareholder approval will be sought for
certain changes in the operation of the Fund and for the election of directors
under certain circumstances. In addition, a director may be removed by the
remaining directors or by shareholders at a special meeting called upon written
request of shareholders owning at least 10% of the outstanding shares of the
Fund. In the event that such a meeting is requested, the Fund will provide
appropriate assistance and information to the shareholders requesting the
meeting.
REPORTING
The Fund issues unaudited financial information semi-annually, and audited
financial statements annually for each Portfolio. The Fund also furnishes
periodic reports and, as necessary, proxy statements to shareholders of record.
SHAREHOLDER INQUIRIES
You may direct inquiries to the Fund by writing to The PBHG Funds, Inc., P.O.
Box 419534, Kansas City, Missouri 64141-6534, or by calling 1-800-433-0051.
DIVIDENDS AND DISTRIBUTIONS
Substantially all of the net investment income (exclusive of capital gains) of a
Portfolio is distributed in the form of annual dividends. If any capital gain is
realized, substantially all of it will be distributed by the Portfolio at least
annually.
Shareholders automatically receive all dividends and capital gain distributions
in additional shares at the net asset value determined on the next Business Day
after the record date, unless the shareholder has elected to take such payment
in cash. Shareholders may change their election by providing written notice to
the Transfer Agent at least fifteen (15) days prior to the distribution.
Shareholders may receive payments for cash distributions in the form of a check
or by Federal Reserve wire or ACH transfer.
Dividends and distributions of the Portfolios are paid on a per share basis. The
value of each share will be reduced by the amount of the payment. If shares are
purchased shortly before the record date for a dividend or distribution of
capital gains, a shareholder will pay the full price for the shares and receive
some portion of the price back as a taxable dividend or distribution.
COUNSEL AND INDEPENDENT ACCOUNTANTS
Katten Muchin & Zavis serves as counsel to the Fund. Coopers & Lybrand, LLP
serves as the independent accountants of the Fund.
CUSTODIAN
CoreStates Bank, N.A. ('Custodian'), Broad and Chestnut Streets, P.O. Box 7618,
Philadelphia, Pennsylvania 19101, serves as the custodian for the Portfolios.
The Custodian holds cash, securities and other assets of the Fund as required by
the Investment Company Act of 1940, as amended (the '1940 Act').
MISCELLANEOUS
As of the date of this Prospectus, SEI Financial Services Company, One Freedom
Valley Road, Oaks, Pennsylvania 19456, as the Portfolios' initial shareholder,
owned of record or beneficially, all of the outstanding PBHG Class Shares of
each Portfolio, and may be deemed to be a controlling person of each Portfolio
for purposes of the 1940 Act.
- ------------------------------------------------------
GLOSSARY OF PERMITTED INVESTMENTS
- ------------------------------------------------------
The following is a description of permitted investments for certain of the
Portfolios:
AMERICAN DEPOSITORY RECEIPTS and GLOBAL DEPOSITORY RECEIPTS ('GDRs') -- ADRs are
securities, typically issued by a U.S. financial institution (a 'depository'),
that evidence ownership interests in a security or a pool of securities issued
by a foreign issuer and deposited with the depository. GDRs, which are sometimes
referred to as Continental Depository Receipts ('CDRs'), are securities,
typically issued by a non-U.S. financial institution, that evidence ownership
interests in a security or a pool of securities issued by either a U.S. or
foreign issuer. ADRs, GDRs and CDRs may be available for investment through
'sponsored' or 'unsponsored' facilities. A sponsored facility is established
jointly by the issuer of the security underlying the receipt and a depository,
whereas an unsponsored facility may be established by a depository
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without participation by the issuer of the receipt's underlying security.
Holders of an unsponsored depository receipt generally bear all the costs of the
unsponsored facility. The depository of an unsponsored facility frequently is
under no obligation to distribute shareholder communications received from the
issuer of the deposited security or to pass through to the holders of the
receipts voting rights with respect to the deposited securities.
BANKERS' ACCEPTANCE -- A bill of exchange or time draft drawn on and accepted by
a commercial bank. It is used by corporations to finance the shipment and
storage of goods and to furnish dollar exchange. Maturities are generally six
months or less.
CERTIFICATE OF DEPOSIT -- A negotiable interest bearing instrument with a
specific maturity. Certificates of deposit are issued by banks and savings and
loan institutions in exchange for the deposit of funds and normally can be
traded in the secondary market prior to maturity. Certificates of deposit
generally carry penalties for early withdrawal.
COMMERCIAL PAPER -- The term used to designate unsecured short-term promissory
notes issued by corporations and other entities. Maturities on these issues
typically vary from a few days to nine months.
CONVERTIBLE SECURITIES -- Securities such as rights, bonds, notes and preferred
stocks which are convertible into or exchangeable for common stocks. Convertible
securities have characteristics similar to both fixed income and equity
securities. Because of the conversion feature, the market value of convertible
securities tends to move together with the market value of the underlying common
stock. As a result, a Portfolio's selection of convertible securities is based,
to a great extent, on the potential for capital appreciation that may exist in
the underlying stock. The value of convertible securities is also affected by
prevailing interest rates, the credit quality of the issuer, and any call
provisions.
DERIVATIVES -- Derivatives are securities that derive their value from other
securities. The following, among others, may be considered to be derivative
securities: futures, convertible securities and 'stripped' U.S. Treasury
securities (e.g., STRIPS). See elsewhere in this 'Glossary of Permitted
Investments' for discussions of these various instruments, and see 'Investment
Objectives and Policies' for more information about the investment policies and
limitations applicable to their use.
FUTURES CONTRACTS -- Futures contracts are derivatives. Futures contracts
provide for the sale by one party and purchase by another party of a specified
amount of a specific security, securities index or currency at a specified
future time and price. Each Portfolio will maintain assets sufficient to meet
its obligations under such futures contracts in a segregated margin account with
the custodian bank or will otherwise comply with the SEC's position on asset
coverage. The prices of futures contracts are volatile and are influenced by,
among other things, actual and anticipated changes in the market and interest
rates.
ILLIQUID SECURITIES -- Securities that cannot be disposed of in the ordinary
course of business within seven (7) days at approximately the price at which the
Portfolio has valued the security.
REPURCHASE AGREEMENTS -- Agreements by which a person obtains a security and
simultaneously commits to return it to the seller at an agreed upon price
(including principal and interest) on an agreed upon date within a number of
days from the date of purchase. The Custodian or its agents will hold the
security as collateral for the repurchase agreement. Collateral must be
maintained at a value at least equal to 102% of the purchase price. Each
Portfolio bears a risk of loss in the event the other party defaults on its
obligations and the Portfolio is delayed or prevented from its right to dispose
of the collateral securities or if the Portfolio realizes a loss on the sale of
the collateral securities. The Advisers will enter into repurchase agreements on
behalf of a Portfolio only with financial institutions deemed to present minimal
risk of bankruptcy during the term of the agreement based on guidelines
established and periodically reviewed by the Directors. Repurchase agreements
are considered loans under the 1940 Act, as well as for federal and state income
tax purposes.
RESTRICTED SECURITIES -- Securities that may not be sold freely to the public
absent registration under the Securities Act of 1933, as amended ('1933 Act'),
or an exemption from registration. A Portfolio may invest in restricted
securities that the Advisers determine are not illiquid, based on guidelines and
procedures developed and established by the Board of Directors of the Fund. The
Board of Directors will periodically review such procedures and guidelines and
will monitor the Advisers' implementation of such
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procedures and guidelines. Under these procedures and guidelines, the Advisers
will consider the frequency of trades and quotes for the security, the number of
dealers in, and potential purchasers for, the securities, dealer undertakings to
make a market in the security, and the nature of the security and of the
marketplace trades. A Portfolio may purchase restricted securities sold in
reliance upon the exemption from registration provided by Rule 144A under the
1933 Act. Restricted securities may be difficult to value because market
quotations may not be readily available. Because of the restrictions on the
resale of restricted securities, they may pose liquidity problems for the
Portfolios.
TIME DEPOSIT -- A non-negotiable receipt issued by a bank in exchange for the
deposit of funds. Like a certificate of deposit, it earns a specified rate of
interest over a definite period of time; however, it cannot be traded in the
secondary market. Time deposits with a withdrawal penalty are considered to be
illiquid securities.
U.S. GOVERNMENT AGENCY OBLIGATIONS -- Certain Federal agencies such as the
Government National Mortgage Association ('GNMA') have been established as
instrumentalities of the United States Government to supervise and finance
certain types of activities. Securities issued by these agencies, while not
direct obligations of the United States Government, are either backed by the
full faith and credit of the United States (e.g., GNMA securities) or supported
by the issuing agencies' right to borrow from the Treasury. The securities
issued by other agencies are supported only by the credit of the instrumentality
(e.g., Tennessee Valley Authority securities).
U.S. GOVERNMENT SECURITIES -- Bills, notes and bonds issued by the U.S.
Government and backed by the full faith and credit of the United States.
U.S. TREASURY OBLIGATIONS -- Bills, notes and bonds issued by the U.S. Treasury,
and separately traded interest and principal component parts of such obligations
that are transferable through the Federal book-entry system known as Separately
Traded Registered Interest and Principal Securities ('STRIPS'). STRIPS are
usually structured with two classes that receive different proportions of the
interest and principal distributions on a pool of mortgage assets. One type of
STRIPS will have one class receiving some of the interest and most of the
principal from the mortgage assets, while the other class will receive all of
the principal ('principal-only' or 'PO class'). The yield to maturity on IO
classes and PO classes is extremely sensitive to the rate of principal payments
(including prepayments) on the related underlying mortgage assets, and a rapid
rate of principal payments may have a material adverse effect on the portfolio
yield to maturity. If the underlying mortgage assets experience greater than
anticipated prepayments of principal, a Portfolio may fail to fully recoup its
initial investment in these securities, even if the security is in one of the
highest rating categories.
WHEN-ISSUED AND DELAYED-DELIVERY SECURITIES -- When-issued and delayed-delivery
securities are securities subject to settlement on a future date. For fixed
income securities, the interest rate realized on when-issued or delayed-delivery
securities is fixed as of the purchase date and no interest accrues to a
Portfolio before settlement. These securities are subject to market fluctuation
due to changes in market interest rates and will have the effect of leveraging a
Portfolio's assets. Portfolios are permitted to invest in the forward
commitments or when-issued securities where such purchases are for investment
and not for leveraging purposes. One or more segregated accounts will be
established with the Custodian, and the Portfolios will maintain liquid assets
in such accounts in an amount at least equal in value to each Portfolio's
commitments to purchase when-issued securities.
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THE PBHG FUNDS, INC.
PBHG SMALL CAP VALUE FUND
PBHG MID-CAP VALUE FUND
INVESTMENT ADVISER:
PILGRIM BAXTER & ASSOCIATES, LTD.
This Statement of Additional Information is not a prospectus and relates only to
the PBHG Small Cap Value Fund and the PBHG Mid-Cap Value Fund (individually a
"Portfolio" and, together, the "Portfolios"). It is intended to provide
additional information regarding the activities and operations of The PBHG
Funds, Inc. (the "Fund" or "Registrant") and each Portfolio, and should be read
in conjunction with the Portfolios' Prospectus dated May 1, 1997. The Prospectus
for the Portfolios may be obtained without charge by calling 1-800-431-0051.
TABLE OF CONTENTS
THE FUND.............................................................S - 2
DESCRIPTION OF PERMITTED INVESTMENTS.................................S - 2
INVESTMENT LIMITATIONS...............................................S - 10
THE ADVISER .........................................................S - 12
THE SUB-ADVISER......................................................S - 13
THE ADMINISTRATOR AND SUB-ADMINISTRATOR..............................S - 14
THE DISTRIBUTOR .....................................................S - 15
DIRECTORS AND OFFICERS OF THE FUND...................................S - 15
COMPUTATION OF YIELD ................................................S - 18
CALCULATION OF TOTAL RETURN..........................................S - 18
PURCHASE AND REDEMPTION OF SHARES....................................S - 18
DETERMINATION OF NET ASSET VALUE.....................................S - 19
TAXES................................................................S - 19
PORTFOLIO TRANSACTIONS...............................................S - 21
DESCRIPTION OF SHARES................................................S - 22
May 1, 1997
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THE FUND
This Statement of Additional Information relates only to the Fund's PBHG Small
Cap Value Fund and PBHG Mid-Cap Value Fund (individually a "Portfolio" and,
together, the "Portfolios"). Each Portfolio is a separate series of The PBHG
Funds, Inc., which was originally incorporated in Delaware on August 2, 1985,
under the name PBHG Growth Fund, Inc., and commenced business shortly thereafter
as an open-end diversified management investment company under the Investment
Company Act of 1940, as amended (the "1940 Act"). On July 21, 1992, shareholders
of the Fund approved an Agreement and Articles of Merger pursuant to which the
Fund was reorganized and merged into a new Maryland corporation, also named PBHG
Growth Fund, Inc. On September 8, 1993, the shareholders of the Fund voted to
change the name of the Fund to The Advisors' Inner Circle Fund II, Inc. On May
2, 1994, the shareholders voted to change the Fund's name to The PBHG Funds,
Inc. The Fund currently offers shares of twelve other portfolios, i.e., PBHG
Growth Fund, PBHG Emerging Growth Fund, PBHG Large Cap Growth Fund, PBHG Select
Equity Fund, PBHG International Fund, PBHG Cash Reserves Fund, PBHG Technology &
Communications Fund, PBHG Core Growth Fund, PBHG Limited Fund, PBHG Large Cap 20
Fund, PBHG Large Cap Value Fund, and PBHG Strategic Small Company Fund through
means of separate prospectuses and statements of additional information. Each
Portfolio is a separate mutual fund, and each share of each Portfolio represents
an equal proportionate interest in each Portfolio. See "Description of Shares."
No investment in shares of a Portfolio should be made without first reading the
Portfolio's Prospectus. Pilgrim Baxter & Associates, Ltd. ("Adviser") serves as
the investment adviser to the Portfolio. Newbold's Asset Management, Inc.
("Sub-Adviser") serves as the investment sub-adviser to each Portfolio. The
Adviser and the Sub-Adviser are collectively referred herein as the "Advisers."
Capitalized terms not defined herein are defined in the Portfolios' Prospectus.
DESCRIPTION OF PERMITTED INVESTMENTS
Illiquid Investments
Illiquid investments are investments that cannot be sold or disposed of in the
ordinary course of business within seven (7) days at approximately the prices at
which they are valued. Under the supervision of the Fund's Board of Directors,
the Advisers determine the liquidity of each Portfolio's investments and,
through reports from the Advisers, the Board monitors investments in illiquid
instruments. In determining the liquidity of a Portfolio's investments, Advisers
may consider various factors including: (1) the frequency of trades and
quotations; (2) the number of dealers and prospective purchasers in the
marketplace; (3) dealer undertakings to make a market, (4) the nature of the
security (including any demand or tender features); and (5) the nature of the
market place for trades (including the ability to assign or offset a Portfolio's
rights and obligations relating to the investment). Investments currently
considered by a Portfolio to be illiquid include repurchase agreements not
entitling the holder to payment of principal and interest within seven (7) days
and over the-counter options. Also, the Advisers may determine some
government-stripped fixed-rate mortgage backed securities are illiquid. In the
absence of market quotations, illiquid investments are priced at fair value as
determined in good faith by
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a committee appointed by the Fund's Board of Directors. If, through a change in
values, net assets or other circumstances, a Portfolio was in a position where
more than 15% of its net assets were invested in illiquid securities, it would
seek to take appropriate steps to protect liquidity.
Investment Company Shares
Each Portfolio may invest in shares of money market mutual funds, to the extent
set forth under "Investment Limitations" below. Since such funds pay management
fees and other expenses, shareholders of each of the Portfolios would indirectly
pay both Portfolio's expenses and the expenses of underlying funds with respect
to Portfolio assets invested therein. Applicable regulations prohibit a
Portfolio from acquiring the securities of other investment companies that are
not "part of the same group of investment companies" if, as a result of such
acquisition, the Portfolio owns more than 3% of the total voting stock of the
company; more than 5% of the Portfolio's total assets are invested in securities
of any one investment company; or more than 10% of the total assets of the
Portfolio are invested in securities (other than treasury stock) issued by all
investment companies. Each Portfolio has no current intention, in the
foreseeable future, of investing more than 5% in investment company securities.
Futures Contracts
Futures Transactions. A futures contract is a bilateral agreement to buy or sell
a security (or deliver a cash settlement price, in the case of a contract
relating to an index or otherwise not calling for physical delivery at the end
of trading in the contracts) for a set price in the future. Futures contracts
are designated by boards of trade which have been designated "contracts markets"
by the Commodities Futures Trading Commission ("CFTC").
No purchase price is paid or received when the contract is entered into.
Instead, a Portfolio upon entering into a futures contract (and to maintain that
Portfolio's open positions in futures contracts) would be required to deposit
with its custodian in a segregated account in the name of the futures broker an
amount of cash, or other assets, known as "initial margin." The margin required
for a particular futures contract is set by the exchange on which the contract
is traded, and may be significantly modified from time to time by the exchange
during the term of the contract. Futures contracts are customarily purchased and
sold on margin that may range upward from less than 5% of the value of the
contract being traded. By using futures contracts as a risk management
technique, given the greater liquidity in the futures market than in the cash
market, it may be possible to accomplish certain results more quickly and with
lower transaction costs.
If the price of an open futures contract changes (by increase in the case of a
sale or by decrease in the case of a purchase) so that the loss on the futures
contract reaches a point at which the margin on deposit does not satisfy margin
requirements, the broker will require an increase in the margin. However, if the
value of a position increases because of favorable price changes in the futures
contract so that the margin deposit exceeds the required margin, the broker will
pay the excess to the Portfolio. These subsequent payments called "variation
margin," to and
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from the futures broker, are made on a daily basis as the price of the
underlying assets fluctuate making the long and short positions in the futures
contract more or less valuable, a process known as "marking to the market." A
Portfolio expects to earn interest income on its initial and variation margin
deposits.
A Portfolio will incur brokerage fees when it purchases and sells futures
contracts. Positions taken in the futures markets are not normally held until
delivery or cash settlement is required, but are instead liquidated through
offsetting transactions which may result in a gain or a loss. While futures
positions taken by a Portfolio will usually be liquidated in this manner, a
Portfolio may instead make or take delivery of underlying securities whenever it
appears economically advantageous to that Portfolio to do so. A clearing
organization associated with the exchange on which futures are traded assumes
responsibility for closing out transactions and guarantees that as between the
clearing members of an exchange, the sale and purchase obligations will be
performed with regard to all positions that remain open at the termination of
the contract.
Securities Index Futures Contracts. Purchases or sales of securities index
futures contracts may be used in an attempt to protect each of the Portfolio's
current or intended investments from broad fluctuations in securities prices. A
securities index futures contract does not require the physical delivery of
securities, but merely provides for profits and losses resulting from changes in
the market value of the contract to be credited or debited at the close of each
trading day to the respective accounts of the parties to the contract. On the
contract's expiration date a final cash settlement occurs and the futures
positions are simply closed out. Changes in the market value of a particular
index futures contract reflect changes in the specified index of securities on
which the future is based.
By establishing an appropriate "short" position in index futures, a Portfolio
may also seek to protect the value of its portfolio against an overall decline
in the market for such securities. Alternatively, in anticipation of a generally
rising market, a Portfolio can seek to avoid losing the benefit of apparently
low current prices by establishing a "long" position in securities index futures
and later liquidating that position as particular securities are in fact
acquired. To the extent that these hedging strategies are successful, a
Portfolio will be affected to a lesser degree by adverse overall market price
movements than would otherwise be the case.
Limitations on Purchase and Sale of Futures Contracts. A Portfolio will not
purchase or sell futures contracts unless either (1) the futures contracts are
purchased for "bona fide hedging" purposes (as that term is defined under the
CFTC regulations) or (2) if purchased for other purposes, the sum of the amounts
of initial margin deposits on a Portfolio's existing futures contracts and
premiums required to establish non-hedging positions would not exceed 5% of the
liquidation value of that Portfolio's total assets. In instances involving the
purchase of futures contracts by a Portfolio, an amount of cash or other liquid
assets, equal to the cost of such futures contracts (less any related margin
deposits), will be deposited in a segregated account with its custodian, thereby
insuring that the use of such futures contracts is unleveraged. In instances
involving the sale of futures contracts by a Portfolio, the securities
underlying such futures contracts or options will at all times be maintained by
that Portfolio or, in the case of index futures contracts, the Portfolio will
own securities the price changes of which are, in the
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opinion of its Adviser expected to replicate substantially the movement of the
index upon which the futures contract is based.
For information concerning the risks associated with utilizing futures
contracts, please see "Risks of Transactions in Futures Contracts Options"
below.
Repurchase Agreements
Repurchase agreements are agreements by which a person (e.g., a Portfolio)
obtains a security and simultaneously commits to return the security to the
seller (a member bank of the Federal Reserve System or primary securities dealer
as recognized by the Federal Reserve Bank of New York) at an agreed upon price
(including principal and interest) on an agreed upon date within a number of
days (usually not more than seven) from the date of purchase. The resale price
reflects the purchase price plus an agreed upon market rate of interest which is
unrelated to the coupon rate or maturity of the underlying security. A
repurchase agreement involves the obligation of the seller to pay the agreed
upon price, which obligation is in effect secured by the value of the underlying
security.
Repurchase agreements are considered to be loans by a Portfolio for purposes of
its investment limitations. The repurchase agreements entered into by the
Portfolios will provide that the underlying security at all times shall have a
value at least equal to 102% of the resale price stated in the agreement (the
Advisers monitor compliance with this requirement). Under all repurchase
agreements entered into by a Portfolio, the Fund's custodian or its agent must
take possession of the underlying collateral. However, if the seller defaults,
the Portfolio could realize a loss on the sale of the underlying security to the
extent that the proceeds of the sale, including accrued interest, are less than
the resale price provided in the agreement including interest. In addition, even
though the Bankruptcy Code provides protection for most repurchase agreements,
if the seller should be involved in bankruptcy or insolvency proceedings, the
Portfolio may incur delay and costs in selling the underlying security or may
suffer a loss of principal and interest if the Portfolio is treated as an
unsecured creditor of the seller and is required to return the underlying
security to the seller's estate.
Restricted Securities
Restricted securities generally can be sold in privately negotiated
transactions, pursuant to an exemption from registration under the Securities
Act of 1933, as amended, or in a registered public offering. Where registration
is required, a Portfolio may be obligated to pay all or part of the registration
expense and a considerable period may elapse between the time it decides to seek
registration and the time a Portfolio may be permitted to sell a security under
an effective registration statement. If, during such a period, adverse market
conditions were to develop, a Portfolio might obtain a less favorable price than
prevailed when it decided to seek registration of the security. Moreover,
investing in Rule 144A securities (i.e., securities that qualify for resale
under Rule 144A under the Securities Act of 1933) would have the effect of
increasing the level of a Portfolio's illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities.
S - 5
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Options
Each of the Portfolios has no current intention, in the foreseeable future of
utilizing options. However, the types of options transactions that a Portfolio
is permitted to utilize are discussed below.
Writing Call Options. A call option is a contract which gives the purchaser of
the option (in return for a premium paid) the right to buy, and the writer of
the option (in return for a premium received) the obligation to sell, the
underlying security at the exercise price at any time prior to the expiration of
the option, regardless of the market price of the security during the option
period. A call option on a security is covered, for example, when the writer of
the call option owns the security on which the option is written (or on a
security convertible into such a security without additional consideration)
throughout the option period.
A Portfolio will write covered call options both to reduce the risks associated
with certain of its investments and to increase total investment return through
the receipt of premiums. In return for the premium income, a Portfolio will give
up the opportunity to profit from an increase in the market price of the
underlying security above the exercise price so long as its obligations under
the contract continue, except insofar as the premium represents a profit.
Moreover, in writing the call option, a Portfolio will retain the risk of loss
should the price of the security decline. The premium is intended to offset that
loss in whole or in part. Unlike the situation in which a Portfolio owns
securities not subject to a call option, a Portfolio, in writing call options,
must assume that the call may be exercised at any time prior to the expiration
of its obligation as a writer, and that in such circumstances the net proceeds
realized from the sale of the underlying securities pursuant to the call may be
substantially below the prevailing market price.
A Portfolio may terminate its obligation under an option it has written by
buying an identical option. Such a transaction is called a "closing purchase
transaction." A Portfolio will realize a gain or loss from a closing purchase
transaction if the amount paid to purchase a call option is less or more than
the amount received from the sale of the corresponding call option. Also,
because increases in the market price of a call option will generally reflect
increases in the market price of the underlying security, any loss resulting
from the exercise or closing out of a call option is likely to be offset in
whole or part by unrealized appreciation of the underlying security owned by the
Portfolio. When an underlying security is sold from a Portfolio's securities
portfolio, that Portfolio will effect a closing purchase transaction so as to
close out any existing covered call option on that underlying security.
Writing Put Options. The writer of a put option becomes obligated to purchase
the underlying security at a specified price during the option period if the
buyer elects to exercise the option before its expiration date. A Portfolio when
it writes a put option will be required to "cover" it, for example, by
depositing and maintaining in a segregated account with its custodian cash, or
other liquid obligations having a value equal to or greater than the exercise
price of the option.
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A Portfolio may write put options either to earn additional income in the form
of option premiums (anticipating that the price of the underlying security will
remain stable or rise during the option period and the option will therefore not
be exercised) or to acquire the underlying security at a net cost below the
current value (e.g., the option is exercised because of a decline in the price
of the underlying security, but the amount paid by such Portfolio, offset by the
option premium, is less than the current price). The risk of either strategy is
that the price of the underlying security may decline by an amount greater than
the premium received. The premium which a Portfolio receives from writing a put
option will reflect, among other things, the current market price of the
underlying security, the relationship of the exercise price to that market
price, the historical price volatility of the underlying security, the option
period, supply and demand and interest rates.
A Portfolio may effect a closing purchase transaction to realize a profit on an
outstanding put option or to prevent an outstanding put option from being
exercised.
Purchasing Put and Call Options. A Portfolio may purchase put options on
securities to protect its holdings against a substantial decline in market
value. The purchase of put options on securities will enable a Portfolio to
preserve, at least partially, unrealized gains in an appreciated security in its
portfolio without actually selling the security. In addition, a Portfolio will
continue to receive interest or dividend income on the security. A Portfolio may
also purchase call options on securities to protect against substantial
increases in prices of securities that the Portfolio intend to purchase pending
its ability to invest in an orderly manner in those securities. A Portfolio may
sell put or call options it has previously purchased, which could result in a
net gain or loss depending on whether the amount received on the sale is more or
less than the premium and other transaction cost paid on the put or call option
which was bought.
Securities Index Options. A Portfolio may write covered put and call options and
purchase call and put options on securities indexes for the purpose of hedging
against the risk of unfavorable price movements adversely affecting the value of
the Portfolio's securities or securities it intends to purchase. A Portfolio
will only write "covered" options. A call option on a securities index is
considered covered, for example, if, so long as the Portfolio is obligated as
the writer of the call, it holds securities the price changes of which are, in
the opinion of the Adviser, expected to replicate substantially the movement of
the index or indexes upon which the options written by the Portfolio are based.
A put on a securities index written by a Portfolio will be considered covered
if, so long as it is obligated as the writer of the put, the Portfolio
segregates with its custodian cash or other liquid obligations having a value
equal to or greater than the exercise price of the option. Unlike a stock
option, which gives the holder the right to purchase or sell a specified stock
at a specified price, an option on a securities index gives the holder the right
to receive a cash "exercise settlement amount" equal to (i) the difference
between the exercise price of the option and the value of the underlying stock
index on the exercise date, multiplied by (ii) a fixed "index multiplier."
A securities index fluctuates with changes in the market value of the securities
so included. For example, some securities index options are based on a broad
market index such as the S&P 500 or the NYSE Composite Index, or a narrower
market index such as the S&P 100. Indexes may
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<PAGE>
also be based on an industry or market segment such as the AMEX Oil and Gas
Index or the Computer and Business Equipment Index.
Over-the-Counter Options. A Portfolio may enter into contracts with primary
dealers with whom it may write over-the-counter options. Such contracts will
provide that the Portfolio has the absolute right to repurchase an option it
writes at any time at a repurchase price which represents the fair market value,
as determined in good faith through negotiation between the parties, but which
in no event will exceed a price determined pursuant to a formula contained in
the contract. Although the specific details of the formula may vary between
contracts with different primary dealers, the formula will generally be based on
a multiple of the premium received by a Portfolio for writing the option, plus
the amount, if any, of the option's intrinsic value (i.e., the amount the option
is "in-the-money"). The formula will also include a factor to account for the
difference between the price of the security and the strike price of the option
if the option is written "out-of-the-money." Such Portfolio has established
standards of creditworthiness for these primary dealers, although the Portfolio
may still be subject to the risk that firms participating in such transactions
will fail to meet their obligations. In instances in which a Portfolio has
entered into agreements with respect to the over-the-counter options it has
written, and such agreements would enable the Portfolio to have an absolute
right to repurchase at a pre-established formula price the over-the-counter
option written by it, the Portfolio would treat as illiquid only securities
equal in amount to the formula price described above less the amount by which
the option is "in-the-money," i.e., the amount by which the price of the option
exceeds the exercise price.
For information concerning the risks associated with utilizing options and
futures contracts, please see "Risks of Transactions in Futures Contracts and
Options" below.
Risks of Transactions in Futures Contracts and Options
Futures. The prices of futures contracts are volatile and are influenced, among
other things, by actual and anticipated changes in the market and interest
rates, which in turn are affected by fiscal and monetary policies and national
and international political and economic events.
Most United States futures exchanges limit the amount of fluctuation permitted
in futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
futures contract, no trades may be made on that day at a price beyond that
limit. The daily limit governs only price movement during a particular trading
day and therefore does not limit potential losses, because the limit may prevent
the liquidation of unfavorable positions. Futures contract prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of futures positions
and subjecting some futures traders to substantial losses.
Because of the low margin deposits required, futures trading involves an
extremely high degree of leverage. As a result, a relatively small price
movement in a futures contract may result in
S - 8
<PAGE>
immediate and substantial loss, as well as gain, to the investor. For example,
if at the time of purchase, 10% of the value of the futures contract is
deposited as margin, a subsequent 10% decrease in the value of the futures
contract would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then closed out. A 15%
decrease would result in a loss equal to 150% of the original margin deposit, if
the futures contract were closed out. Thus, a purchase or sale of a futures
contract may result in losses in excess of the amount invested in the futures
contract.
A decision of whether, when, and how to hedge involves skill and judgment, and
even a well-conceived hedge may be unsuccessful to some degree because of
unexpected market behavior, market trends or interest rate trends. There are
several risks in connection with the use by a Portfolio of futures contracts as
a hedging device. One risk arises because of the imperfect correlation between
movements in the prices of the futures contracts and movements in the prices of
the underlying instruments which are the subject of the hedge. The Advisers
will, however, attempt to reduce this risk by entering into futures contracts
whose movements, in its judgment, will have a significant correlation with
movements in the prices of the Portfolio's underlying instruments sought to be
hedged.
Successful use of futures contracts by a Portfolio for hedging purposes is also
subject to the Portfolio's ability to correctly predict movements in the
direction of the market. It is possible that, when a Portfolio has sold futures
to hedge its portfolio against a decline in the market, the index, indices, or
instruments underlying futures might advance and the value of the underlying
instruments held in that Portfolio's portfolio might decline. If this were to
occur, the Portfolio would lose money on the futures and also would experience a
decline in value in its underlying instruments.
Positions in futures contracts may be closed out only on an exchange or a board
of trade which provides the market for such futures. Although a Portfolio
intends to purchase or sell futures only on exchanges or boards of trade where
there appears to be an active market, there is no guarantee that such will exist
for any particular contract or at any particular time. If there is not a liquid
market at a particular time, it may not be possible to close a futures position
at such time, and, in the event of adverse price movements, the Portfolio would
continue to be required to make daily cash payments of variation margin.
However, in the event futures positions are used to hedge portfolio securities,
the securities will not be sold until the futures positions can be liquidated.
In such circumstances, an increase in the price of securities, if any, may
partially or completely offset losses on the futures contracts.
Options. A closing purchase transaction for exchange-traded options may be made
only on a national securities exchange (exchange). There is no assurance that a
liquid secondary market on an exchange will exist for any particular option, or
at any particular time, and for some options, such as over-the-counter options,
no secondary market on an exchange may exist. If a Portfolio is unable to effect
a closing purchase transaction, that Portfolio will not sell the underlying
security until the option expires or the Portfolio delivers the underlying
security upon exercise.
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<PAGE>
Options traded in the over-the-counter market may not be as actively traded as
those on an exchange. Accordingly, it may be more difficult to value such
options. In addition, it may be difficult to enter into closing transactions
with respect to options traded over-the-counter. The Portfolio will engage in
such transactions only with firms of sufficient credit so as to minimize these
risks. Such options and the securities used as "cover" for such options may be
considered illiquid securities.
The effectiveness of hedging through the purchase of securities index options
will depend upon the extent to which price movements in the portion of the
securities portfolio being hedged correlate with price movements in the selected
securities index. Perfect correlation is not possible because the securities
held or to be acquired by a Portfolio will not exactly match the composition of
the securities indexes on which options are written. In the purchase of
securities index options the principal risk is that the premium and transaction
costs paid by a Portfolio in purchasing an option will be lost if the changes
(increase in the case of a call, decrease in the case of a put) in the level of
the index do not exceed the cost of the option.
INVESTMENT LIMITATIONS
Fundamental Policies
Each Portfolio has adopted certain investment restrictions which, in addition to
those restrictions in the Prospectus, are fundamental and may not be changed
without approval by a majority vote of the respective Portfolio's shareholders.
Such majority is defined in the 1940 Act as the lesser of (i) 67% or more of the
voting securities of the Portfolio present in person or by proxy at a meeting,
if the holders of more than 50% of the outstanding voting securities are present
or represented by proxy; or (ii) more than 50% of the outstanding voting
securities of the Portfolio.
Each Portfolio may not:
1. Acquire more than 10% of the voting securities of any one issuer.
2. Invest in companies for the purpose of exercising control.
3. Borrow money except for temporary or emergency purposes and then only
in an amount not exceeding 331/3% of the value of its total assets.
This borrowing provision is included solely to facilitate the orderly
sale of portfolio securities to accommodate substantial redemption
requests if they should occur and is not for investment purposes. All
borrowings in excess of 5% of the Portfolio's total assets will be
repaid before making investments.
4. Make loans, except that each Portfolio, in accordance with that
Portfolio's investment objectives and policies, may (i) purchase or
hold debt instruments, and (ii) enter into repurchase agreements as
described in the Portfolios Prospectus and Statement of Additional
Information.
S - 10
<PAGE>
5. Pledge, mortgage or hypothecate assets, except (i) to secure temporary
borrowings permitted by each Portfolio's limitation on permitted
borrowings, or (ii) in connection with permitted transactions regarding
options and futures contracts.
6. Purchase or sell real estate, real estate limited partnership
interests, futures contracts, commodities or commodity contracts,
except that this shall not prevent a Portfolio from: (i) investing in
readily marketable securities of issuers which can invest in real
estate or commodities, institutions that issue mortgages, or real
estate investment trusts which deal in real estate or interests
therein, pursuant to the Portfolio's investment objective and policies,
and (ii) entering into futures contracts and options thereon that are
listed on a national securities or commodities exchange where, as a
result thereof, no more than 5% of the total assets for that Portfolio
(taken at market value at the time of entering into the futures
contracts) would be committed to margin deposits on such futures
contracts and premiums paid for unexpired options on such futures
contracts; provided that, in the case of an option that is
"in-the-money" at the time of purchase, the "in-the-money" amount, as
defined under Commodity Futures Trading Commission regulations, may be
excluded in computing the 5% limit. Each Portfolio (as a matter of
operating policy) will utilize only listed futures contracts and
options thereon.
7. Make short sales of securities, maintain a short position or purchase
securities except that each Portfolio may: (i) obtain short-term
credits as necessary for the clearance of security transactions, and
(ii) establish margin accounts as may be necessary in connection with
the Portfolio's use of options and futures contracts.
8. Act as an underwriter of securities of other issuers except as it may
be deemed an underwriter in selling a portfolio security.
9. Purchase securities of other investment companies except as permitted
by the 1940 Act and the rules and regulations thereunder.
10. Issue senior securities (as defined in the 1940 Act) except in
connection with permitted borrowing money or pledging, mortgaging or
hypothecating assets, as described in each Portfolio's limitation on
borrowing money, each Portfolio's limitation on permitted borrowings
and each Portfolio's limitation on pledging, mortgaging or
hypothecating assets, or as permitted by rule, regulation or orders of
the SEC.
11. Invest in interests in oil, gas or other mineral exploration or
development programs.
12. Purchase securities of any issuer (except securities issued or
guaranteed by the United States, its agencies or instrumentalities and
repurchase agreements involving such securities) if, as a result, more
than 5% of the total assets of a Portfolio would be invested in the
securities of such issuer. This restriction applies to 75% of each
Portfolio's total assets.
S - 11
<PAGE>
13. Purchase any securities which would cause 25% or more of the total
assets of the Portfolio to be invested in the securities of one or more
issuers conducting their principal business activities in the same
industry, provided that this limitation does not apply to investments
in obligations issued or guaranteed by the U.S. Government or its
agencies and instrumentalities and repurchase agreements involving such
securities. For purposes of this limitation, (i) utility companies will
be divided according to their services, for example, gas distribution,
gas transmission, electric and telephone will each be considered a
separate industry, and (ii) financial service companies will be
classified according to the end users of their services, for example,
automobile finance, bank finance and diversified finance will each be
considered a separate industry. For purposes of this limitation,
supranational organizations are deemed to be issuers conducting their
principal business activities in the same industry.
Non-Fundamental Policies
In addition to the foregoing, and the policies set forth in the Portfolios'
Prospectus, each Portfolio has adopted additional investment restrictions which
may be amended by the Board of Directors without a vote of shareholders.
Each Portfolio may not:
1. Invest in illiquid securities in an amount exceeding, in the aggregate,
15% of its net assets. This limitation does not include any Rule 144A
restricted security that has been determined by, or pursuant to
procedures established by, the Board, based on trading markets for such
security, to be liquid.
2. Purchase or sell puts, calls, straddles, spreads, and any combination
thereof, if by reason thereof the value of its aggregate investment in
such classes of securities will exceed 5% of its total assets.
THE ADVISER
The Fund and Pilgrim Baxter & Associates, Ltd. have entered into an advisory
agreement (the "Advisory Agreement"). The Advisory Agreement provides certain
limitations on the Adviser's liability, but also provides that the Adviser shall
not be protected against any liability to the Fund or each of its Portfolios or
its shareholders by reason of willful misfeasance, bad faith or gross negligence
on its part in the performance of its duties or from reckless disregard of its
obligations or duties thereunder.
The Advisory Agreement obligates the Adviser to: (1) provide a program of
continuous investment management for each Portfolio in accordance with the
Portfolio's investment objectives, policies and limitations; (2) make investment
decisions for each Portfolio; and (3) place orders to purchase and sell
securities for each Portfolio, subject to the supervision of the Board of
Directors. The Advisory Agreement provides that the Adviser is not responsible
for
S - 12
<PAGE>
other expenses of operating the Fund. (See the Prospectuses for a description of
expenses borne by the Fund.)
The Adviser is entitled to a fee which is calculated daily and paid monthly. The
fees to be paid under the Advisory Agreement are set forth in the Prospectus.
The Adviser has also agreed to waive or limit its advisory fees and to assume
certain operating expenses of each of the Portfolios in order that each
Portfolio's total annual operating expenses (expressed as a percentage of
Portfolio's average daily net assets) be limited to 1.50%, as described in
greater detail in the Prospectus.
The continuance of the Advisory Agreement with respect to each Portfolio after
the first two years must be specifically approved at least annually (i) by the
Fund's Board of Directors or by vote of a majority of the outstanding voting
securities of such Portfolio and (ii) by the affirmative vote of a majority of
the Directors who are not parties to the agreement or interested persons of any
such party by votes cast in person at a meeting called for such purpose. The
Advisory Agreement with respect to each Portfolio may be terminated (i) at any
time without penalty by the Fund upon the vote of a majority of the Directors or
by vote of the majority of the outstanding voting securities of such Portfolio
upon sixty (60) days' written notice to the Adviser or (ii) by the Adviser at
any time without penalty upon sixty (60) days' written notice to the Fund. The
Advisory Agreement will also terminate automatically in the event of its
assignment (as defined in the 1940 Act).
THE SUB-ADVISER
The Fund, on behalf of the Portfolio, and the Adviser have entered into a
sub-advisory agreement ("Sub-Advisory Agreement") with Newbold's Asset
Management, Inc. The Sub- Advisory Agreement provides certain limitations on the
Sub-Adviser's liability, but also provides that the Sub-Adviser shall not be
protected against any liability to the Fund or its shareholders by reason of
willful misfeasance, bad faith or gross negligence on its part in the
performance of its duties or from reckless disregard of its obligations or
duties thereunder.
The Sub-Advisory Agreement obligates the Sub-Adviser to: (1) manage the
investment operations of the Portfolios and the composition of the Portfolios'
investment portfolios, including the purchase, retention and disposition thereof
in accordance with the Portfolios' investment objective, policies and
limitation; (2) provide supervision of the Portfolios' investments and to
determine from time to time what investment and securities will be purchased,
retained or sold by the Portfolios and what portion of the assets will be
invested or held uninvested in cash; and (3) determine the securities to be
purchased or sold by the Portfolios and will place orders with or through such
persons, brokers or dealers to carry out the policy with respect to brokerage
set forth in the Portfolios' Prospectus or as the Fund's Board of Directors or
the Adviser may direct from time to time, in conformity with federal securities
laws.
The continuance of the Sub-Advisory Agreement with respect to each Portfolio
after the first two years must be specifically approved at least annually (i) by
the Fund's Board of Directors or by
S - 13
<PAGE>
vote of a majority of the outstanding voting securities of each Portfolio and
(ii) by the affirmative vote of a majority of the Directors who are not parties
to the agreement or interested persons of any such party by votes cast in person
at a meeting called for such purpose. The Sub-Advisory Agreement with respect to
each Portfolio may be terminated (i) by the Fund, without the payment of any
penalty, by the vote of a majority of the Directors of the Fund or by the vote
of a majority of the outstanding voting securities of the Portfolio, (ii) by the
Adviser at any time, without the payment of any penalty, on not more than sixty
(60) days' nor less than thirty (30) days' written notice to the other parties,
or (iii) by the Sub-Adviser at any time, without the payment of any penalty, on
ninety (90) days' written notice to the other parties. The Sub-Advisory
Agreement will also terminate automatically in the event of its assignment (as
defined in the 1940 Act).
THE ADMINISTRATOR AND SUB-ADMINISTRATOR
The Fund and PBHG Fund Services (the "Administrator") entered into the
Administrative Services Agreement (the "Administrative Agreement") on July 1,
1996, pursuant to which the Administrator oversees the administration of the
business and affairs of the Fund, including services provided to it by various
third parties. The Administrator was organized as a Pennsylvania business trust
and has its principal place of business at 1255 Drummers Lane, Suite 300, Wayne,
Pennsylvania 19087. Under the Administrative Agreement, the Administrator is
entitled to a fee from the Fund, which is calculated daily and paid monthly, at
an annual rate of 0.15% of the average daily net assets of each series of the
Fund, including each Portfolio. The Administrative Agreement provides that the
Administrator shall not be liable for any error of judgment or mistake of law or
for any loss suffered by the Fund in connection with the matters to which the
Administrative Agreement relates, except a loss resulting from willful
misfeasance, bad faith or negligence on the part of the Administrator in the
performance of its duties. The Administrative Agreement shall remain in effect
until December 31, 1998 and shall thereafter continue in effect for successive
periods of one year, unless terminated by either party upon not less than ninety
(90) days' prior written notice to the other party.
The Fund, the Administrator and SEI Fund Resources (the "Sub-Administrator")
entered into the Sub-Administrative Services Agreement ("Sub-Administrative
Agreement") on July 1, 1996 pursuant to which the Sub-Administrator assists the
Administrator in connection with the administration of the business and affairs
of the Fund. Prior to July 1, 1996, the Sub- Administrator served as the
administrator of the Fund. The Sub-Administrator is a wholly-owned subsidiary of
SEI Financial Management Company ("SEI Financial"), which is a wholly-owned
subsidiary of SEI Corporation ("SEI"). The Sub-Administrator was organized as a
Delaware business trust, and has its principal business offices at 680 East
Swedesford Road, Wayne, Pennsylvania 19087-1658. Under the Sub-Administrative
Agreement, the Sub- Administrator is entitled to a fee from the Administrator,
which is calculated daily and paid monthly, (i) at an annual rate of 0.07% of
the average daily net assets of each series of the Fund, including the
Portfolios, with respect to the first $2.5 billion of the total average daily
net assets of the Fund; and (ii) at the annual rate of .025% of average daily
net assets of each series of the Fund, including the Portfolios, with respect to
the total average daily net assets of the Fund in excess of $2.5 billion. The
Sub-Administrative Agreement provides that the Sub-
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<PAGE>
Administrator shall not be liable for any error of judgment or mistake of law or
for any loss suffered by the Fund in connection with the matters to which the
Sub-Administrative Agreement relates, except a loss resulting from willful
misfeasance, bad faith or negligence on the part of the Sub-Administrator in the
performance of its duties. The Sub-Administrative Agreement shall remain in
effect until December 31, 1998 and shall thereafter continue in effect for
successive periods of one year, unless terminated by either party upon not less
than ninety (90) days' prior written notice to the other party.
THE DISTRIBUTOR
SEI Financial Services Company (the "Distributor"), a wholly-owned subsidiary of
SEI Corporation, and the Fund are parties to a distribution agreement (the
"Distribution Agreement") dated July 1, 1996 pursuant to which the Distributor
serves as principal underwriter for the Fund. The Distributor will receive no
compensation for serving in such capacity.
The Distribution Agreement is renewable annually. The Distribution Agreement may
be terminated by the Distributor, by a majority vote of the Directors who are
not interested persons and have no financial interest in the Distribution
Agreement or by a majority vote of the outstanding securities of the Fund upon
not more than sixty (60) days' written notice by either party or upon assignment
by the Distributor.
DIRECTORS AND OFFICERS OF THE FUND
The management and affairs of the Fund are supervised by the Directors under the
laws of the State of Maryland. The Directors and executive officers of the Fund
and the principal occupations for the last five years are set forth below. Each
may have held other positions with the named companies during that period. The
age of each Director and officer is indicated in the parenthesis.
JOHN R. BARTHOLDSON (51) - Director - Triumph Group Holdings, Inc.
(manufacturing), 1255 Drummers Lane, Suite 200, Wayne, PA 19087-1590. Chief
Financial Officer and Director, The Triumph Group Holdings, Inc. since 1992.
Senior Vice President and Chief Financial Officer, Lukens, Inc., 1978-1992.
HAROLD J. BAXTER (50)* - Director - Chairman, Chief Executive Officer and
Director, the Adviser, 1255 Drummers Lane, Suite 300, Wayne, PA 19087-1590.
Trustee, the Administrator since May 1996 and Chief Executive Officer, the
Sub-Adviser, 950 Haverford Road, Bryn Mawr, PA 19010, since June 1996.
JETTIE M. EDWARDS (49) - Director - Syrus Associates, 76 Seaview Drive, Santa
Barbara, California 93108. Consultant, Syrus Associates since 1986. Trustee,
Provident Investment Counsel Trust (investment company) since 1992.
ALBERT A. MILLER (62) - Director - 7 Jennifer Drive, Holmdel, New Jersey 07733.
Principal and Treasurer, JK Equipment Exporters since 1995. Advisor and
Secretary, The
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<PAGE>
Underwoman Shoppes Inc. (retail clothing stores) since 1980. Merchandising Group
Vice President, R.H. Macy & Co. 1958-1995 (retired).
GARY PILGRIM (55) - President - President, Treasurer and Director, the Adviser
since 1982. Trustee, the Administrator since May 1996.
SANDRA K. ORLOW (42) - Vice President, Assistant Secretary - Vice President and
Assistant Secretary of SEI, the Sub-Administrator and the Distributor since 1983
and SEI Financial since June 1996.
KEVIN P. ROBINS (35) - Vice President, Assistant Secretary - Senior Vice
President, Secretary and General Counsel of SEI, the Sub-Administrator and the
Distributor since 1994. Vice President and Assistant Secretary of SEI, the
Sub-Administrator and the Distributor since 1992 and SEI Financial since June
1996. Associate, Morgan, Lewis & Bockius LLP (law firm), 1988-1992.
KATHRYN L. STANTON (37) - Vice President, Assistant Secretary - Vice President,
Assistant Secretary of SEI, the Sub-Administrator and the Distributor since 1994
and SEI Financial since June 1996. Associate, Morgan, Lewis & Bockius LLP (law
firm), 1989-1994.
TODD CIPPERMAN (30) - Vice President, Assistant Secretary - Vice President,
Assistant Secretary of SEI, the Sub-Administrator and the Distributor since 1995
and SEI Financial since June 1996. Associate, Dewey Ballantine (law firm)
1994-1995, Associate, Winston & Strawn (law firm) 1991-1994.
JOSEPH LYDON (36) - Vice President, Assistant Secretary - Director of Business
Administration, SEI since April, 1995. Vice President of Fund Group, Vice
President of the Advisor - Dreman Value Management, LP, President of Dreman
Financial Services, Inc., 1989- 1995.
BARBARA A. NUGENT (40) - Vice President, Assistant Secretary - Vice President
and Assistant Secretary, SEI since April 1996. Associate, Drinker, Biddle &
Reath (law firm), 1994-1996. Assistant Vice President, Delaware Service Company,
Inc. (transfer agent), 1988- 1993.
STEPHEN G. MEYER (31) - Chief Financial Officer and Controller - Director of
Internal Audit and Risk Management at SEI Corporation since 1992. Senior
Associate at Coopers & Lybrand, LLP (accounting firm), 1990-1992.
MICHAEL HARRINGTON (27) - Assistant Vice President - Mutual Fund Coordinator,
the Adviser since 1994. Secretary, the Administrator since May 1996. Account
Manager, SEI, 1991-1994.
LEE T. CUMMINGS (32) - Vice President - Director of Mutual Fund Operations, the
Adviser since 1996. Treasurer, the Administrator since May 1996. Investment
Accounting Officer,
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<PAGE>
Delaware Group of Funds, 1994-1996. Vice President, Fund/Plan Services, Inc.,
1992-1994. Assistant Vice President, Fund/Plan Services, Inc., 1990-1992.
BRIAN BEREZNAK (34) - Vice President and Assistant Secretary. Trustee and
President, the Administrator since May 1996, Chief Operating Officer, the
Adviser from 1989 through December 31, 1996.
JOHN M. ZERR (34) - Vice President and Secretary - General Counsel and
Secretary, the Adviser since November 1996. Vice President and Assistant
Secretary, Delaware Management Company, Inc. and the Delaware Group of Funds,
1995-1996. Associate, Ballard Spahr Andrews & Ingersoll (law firm), 1987-1995.
DARLENE DEREMER (40) - Vice President - President, DeRemer Associates (financial
consulting), 155 South Street, Wrentham, MA 02093 since 1987.
JANE A. KANTER (47) - Vice President and Assistant Secretary - Partner, Katten
Muchin & Zavis, 1025 Thomas Jefferson Street, N.W., East Lobby - Suite 700,
Washington, D.C. 20007 (law firm) since 1994. Partner, Freedman Levy Kroll &
Simonds (law firm), 1987-1994.
- -------------------
*Mr. Baxter is a Director who may be deemed to be an "interested person" of the
Fund as that term is defined in the 1940 Act.
Each current Director of the Registrant who is not an "interested person" of the
Registrant received the following compensation during the fiscal year ending
March 31, 1997:
<TABLE>
<CAPTION>
===========================================================================================================================
Total
Pension or Compenation
Retirement from the
Aggregate Benefits Estimated Registrant and
Compensation Accrued as Part Annual Fund Complex
Name of Person, from each of Benefits Upon Paid to
Position Portfolio* Fund Expenses Retirement Directors
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John R. Bartholdson, less than N/A N/A $22,333
Director $2,200
- ---------------------------------------------------------------------------------------------------------------------------
Harold J. Baxter, N/A N/A N/A N/A
Director**
- ---------------------------------------------------------------------------------------------------------------------------
Jettie M. Edwards, less than N/A N/A $22,333
Director $2,200
- ---------------------------------------------------------------------------------------------------------------------------
Albert A. Miller, less than N/A N/A $22,333
Director $2,200
===========================================================================================================================
</TABLE>
- -------------------
*The Registrant and Fund Complex are expected to pay in the aggregate
approximately $47,000 to each Director who is not an "interested person" of the
Registrant for the fiscal year ending March 31, 1998.
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<PAGE>
**Mr. Baxter is a Director who may be deemed to be an "interested person" of the
Fund, as that term is defined in the 1940 Act, and consequently will be
receiving no compensation from the Fund.
As the Portfolio's initial shareholder, SEI Financial, 680 East Swedesford Road,
Wayne, PA 19087-1658, holds all of the outstanding shares, both beneficially and
of record, of the Portfolio as of the date of this Statement of Additional
Information.
COMPUTATION OF YIELD
From time to time, a Portfolio may advertise yield. These figures will be based
on historical earnings and are not intended to indicate future performance. The
yield of a Portfolio refers to the annualized income generated by an investment
in the Portfolio over a specified 30-day period. The yield is calculated by
assuming that the income generated by the investment during that period
generated each period over one year and is shown as a percentage of the
investment. In particular, yield will be calculated according to the following
formula:
Yield = (2 (a-b/cd + 1)6 - 1) where a = dividends and interest earned during the
period; b = expenses accrued for the period (net of reimbursement); c = the
current daily number of shares outstanding during the period that were entitled
to receive dividends; and d = the maximum offering price per share on the last
day of the period.
CALCULATION OF TOTAL RETURN
From time to time, a Portfolio may advertise total return. The total return of a
Portfolio refers to the average compounded rate of return to a hypothetical
investment for designated time periods (including but not limited to, the period
from which the Portfolio commenced operations through the specified date),
assuming that the entire investment is redeemed at the end of each period. In
particular, total return will be calculated according to the following formula:
P (1 + T)n = ERV, where P = a hypothetical initial payment of $1,000; T =
average annual total return; n = number of years; and ERV = ending redeemable
value of a hypothetical $1,000 payment made at the beginning of the designated
time period as of the end of such period.
Quotations of total return, which are not annualized, represent historical
earnings and asset value fluctuations. Total return is based on past performance
and is not a guarantee of future results.
PURCHASE AND REDEMPTION OF SHARES
Purchases and redemptions may be made through the Distributor on any day on
which the New York Stock Exchange is open for business. Currently, the following
holidays are observed by the Fund: New Year's Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Shares of each Portfolio are offered on a continuous basis.
It is currently the Fund's policy to pay all redemptions in cash. The Fund
retains the right, however, to alter this policy to provide for redemptions in
whole or in part by a distribution in-
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kind of securities held by each Portfolio in lieu of cash. Shareholders may
incur brokerage charges on the sale of any such securities so received in
payment of redemptions.
The Fund reserves the right to suspend the right of redemption and/or to
postpone the date of payment upon redemption for any period on which trading on
the New York Stock Exchange is restricted, or during the existence of an
emergency (as determined by the SEC by rule or regulation) as a result of which
disposal or valuation of each Portfolio's securities is not reasonably
practicable, or for such other periods as the SEC has by order permitted. The
Fund also reserves the right to suspend sales of shares of a Portfolio for any
period during which the New York Stock Exchange, the Adviser, the Administrator,
the Sub-Administrator, the Transfer Agent and/or the Custodian are not open for
business.
DETERMINATION OF NET ASSET VALUE
The securities of each Portfolio are valued by the Sub-Administrator. The
Sub-Administrator will use an independent pricing service to obtain valuations
of securities. The pricing service relies primarily on prices of actual market
transactions as well as trade quotations. The procedures of the pricing service
and its valuations are reviewed by the officers of the Fund under the general
supervision of the Fund's Board of Directors.
Portfolio securities listed on an exchange or quoted on a national market system
are valued at the last sales price. Other securities are quoted at the mean
between the most recent bid and asked prices. In the event a listed security is
traded on more than one exchange, it is valued at the last sale price on the
exchange on which it is principally traded. If there are no transactions in a
security during the day, it is valued at the mean between the most recent bid
and asked prices. However, debt securities (other than short-term obligations)
including listed issues, are valued on the basis of valuations furnished by a
pricing service which utilizes electronic data processing techniques to
determine valuations for normal institutional size trading units of debt
securities, without exclusive reliance upon exchange or over-the-counter prices.
Short-term obligations are valued at amortized cost. Securities for which market
quotations are not readily available and other assets held by the Fund, if any,
are valued at their fair value as determined in good faith by the Fund's Board
of Directors.
TAXES
The following is only a summary of certain income tax considerations generally
affecting a Portfolio and its shareholders, and is not intended as a substitute
for careful tax planning. Shareholders are urged to consult their tax advisors
with specific reference to their own tax situations, including their state and
local income tax liabilities.
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Federal Income Tax
The following discussion of federal income tax consequences is based on the
Internal Revenue Code of 1986, as amended (the "Code"), and the regulations
issued thereunder as in effect on the date of this Statement of Additional
Information. New legislation, as well as administrative changes or court
decisions, may significantly change the conclusions expressed herein, and may
have a retroactive effect with respect to the transactions contemplated herein.
Each Portfolio intends to qualify as a "regulated investment company" ("RIC") as
defined under Subchapter M of the Code. By maintaining its qualifications as a
RIC, each Portfolio intends to eliminate or reduce to a nominal amount the
federal taxes to which it may be subject.
In order to qualify for treatment as a RIC under the Code, a Portfolio must
distribute annually to its shareholders at least the sum of 90% of its net
interest income excludable from gross income plus 90% of its investment company
taxable income (generally, net investment income plus net short-term capital
gain) ("Distribution Requirement") and also must meet several additional
requirements. Among these requirements are the following: (i) at least 90% of
the Portfolio's gross income each taxable year must be derived from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stock or securities, or certain other income; (ii) the
Portfolio must derive less than 30% of its gross income each taxable year from
the sale or other disposition of stocks or securities held for less than three
months; (iii) at the close of each quarter of the Portfolio's taxable year, at
least 50% of the value of its total assets must be represented by cash and cash
items, U.S. Government securities, securities of other RICs and other
securities, with such other securities limited, in respect to any one issuer, to
an amount that does not exceed 5% of the value of the Portfolio's assets and
that does not represent more than 10% of the outstanding voting securities of
such issuer; and (iv) at the close of each quarter of the Portfolio's taxable
year, not more than 25% of the value of its assets may be invested in securities
(other than U.S. Government securities or the securities of other RICs) of
anyone issuer or of two or more issuers which are engaged in the same, similar
or related trades or businesses if the Portfolio owns at least 20% of the voting
power of such issuers.
Notwithstanding the Distribution Requirement described above, which requires
only that a Portfolio distribute at least 90% of its annual investment company
taxable income and does not require any minimum distribution of net capital gain
(the excess of net long-term capital gain over net short-term capital loss), the
Portfolio will be subject to a nondeductible 4% federal excise tax to the extent
it fails to distribute by the end of any calendar year 98% of its ordinary
income for that year and 98% of its capital gain net income (the excess of
short- and long-term capital gains over short- and long-term capital losses) for
the one-year period ending on October 31 of that calendar year, plus certain
other amounts.
In certain cases, a Portfolio will be required to withhold, and remit to the
U.S. Treasury, 31% of any distributions paid to a shareholder who (1) has failed
to provide a correct taxpayer identification number, (2) is subject to backup
withholding by the Internal Revenue Service, or (3) has not certified to the
Portfolio that such shareholder is not subject to backup withholding.
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If a Portfolio fails to qualify as a RIC for any taxable year, it will be
taxable at regular corporate rates on its net investment income and net capital
gain without any deductions for amounts distributed to shareholders. In such an
event, all distributions (including capital gains distributions) will be taxable
as ordinary dividends to the extent of that Portfolio's current and accumulated
earnings and profits and such distributions will generally be eligible for the
corporate dividends-received deduction.
State Taxes
Distributions by a Portfolio to shareholders and the ownership of shares maybe
subject to state and local taxes.
PORTFOLIO TRANSACTIONS
The Advisers are authorized to select brokers and dealers to effect securities
transactions for each Portfolio. The Advisers will seek to obtain the most
favorable net results by taking into account various factors, including price,
commission, if any, size of the transactions and difficulty of executions, the
firm's general execution and operational facilities and the firm's risk in
positioning the securities involved. While the Advisers generally seek
reasonably competitive commissions, the Fund will not necessarily be paying the
lowest spread or commission available. The Advisers seek to select brokers or
dealers that offer the Portfolios best price and execution or other services
which are of benefit to the Portfolios. Certain brokers or dealers assist their
clients in the purchase of shares from the Distributor and charge a fee for this
service in addition to the Portfolio's public offering price. In the case of
securities traded in the over-the-counter market, the Advisers expect normally
to seek to select primary market makers.
The Advisers may, consistent with the interests of the Portfolios, select
brokers on the basis of the research services they provide to the Advisers. Such
services may include analyses of the business or prospects of a company,
industry or economic sector, or statistical and pricing services. Information so
received by the Advisers will be in addition to and not in lieu of the services
required to be performed by the Advisers under the Advisory Agreement and
Sub-Advisory Agreement. If, in the judgment of the Advisers, the Portfolios or
other accounts managed by the Advisers will be benefitted by supplemental
research services, the Advisers are authorized to pay brokerage commissions to a
broker furnishing such services which are in excess of commissions which another
broker may have charged for effecting the same transaction. These research
services include advice, either directly or through publications or writings, as
to the value of securities, the advisability of investing in, purchasing or
selling securities, and the availability of securities or purchasers or sellers
of securities; furnishing of analyses and reports concerning issuers, securities
or industries; providing information on economic factors and trends; assisting
in determining portfolio strategy; providing computer software used in security
analyses; and providing portfolio performance evaluation and technical market
analyses. The expenses of the Advisers will not necessarily be reduced as a
result of the receipt of such information, and such services may not be used
exclusively, or at all, with respect to each Portfolio or account generating the
brokerage, and there can be no guarantee that the Advisers will find all of such
services of value in advising the Portfolios.
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It is expected that the Portfolios may execute brokerage or other agency
transactions through the Distributor, which is a registered broker-dealer, for a
commission in conformity with the 1940 Act, the Securities Exchange Act of 1934,
as amended, and rules promulgated by the SEC. Under these provisions, the
Distributor is permitted to receive and retain compensation for effecting
portfolio transactions for the Portfolios on an exchange if a written contract
is in effect between the Distributor and the Portfolios expressly permitting the
Distributor to receive and retain such compensation. These rules further require
that commissions paid to the Distributor by the Portfolio for exchange
transactions not exceed "usual and customary" brokerage commissions. The rules
define "usual and customary" commissions to include amounts which are
"reasonable and fair compared to the commission, fee or other remuneration
received or to be received by other brokers in connection with comparable
transactions involving similar securities being purchased or sold on a
securities exchange during a comparable period of time." In addition, the
Advisers may direct commission business to one or more designated
broker-dealers, including the Distributor, in connection with such
broker-dealer's payment of certain of the Portfolio's or the Fund's expenses.
However, the Advisers may place orders for the purchase or sale of portfolio
securities of the Portfolios with qualified broker-dealers that refer
prospective shareholders to the Portfolios. The Directors, including those who
are not "interested persons" of the Fund, have adopted procedures for evaluating
the reasonableness of commissions paid to the Distributor and will review these
procedures periodically.
Consistent with the Conduct Rules of the National Association of Securities
Dealers, Inc. and subject to seeking best execution and such other policies as
the Fund's Board of Directors may determine, the Advisers may consider sales of
a Portfolio's shares as a factor in the selection of broker-dealers to execute
portfolio transactions for the Portfolios.
The Fund's Board of Directors has adopted a Code of Ethics governing personal
trading by persons who manage, or who have access to trading activity by the
Portfolios. The Code of Ethics allows trades to be made in securities that may
be held by a Portfolio, however, it prohibits a person from taking advantage of
Portfolio trades or from acting on inside information.
DESCRIPTION OF SHARES
The Fund is authorized to issue an unlimited number of shares of each Portfolio
and to create additional portfolios of the Fund. Each share of a Portfolio
represents an equal proportionate interest in that Portfolio with each other
share. Shareholders are entitled upon liquidation to a pro rata share in the net
assets of the Portfolio available for distribution to shareholders. Shareholders
have no preemptive rights. All consideration received by the Fund for shares of
any Portfolio and all assets in which such consideration is invested belong to
that Portfolio and would be subject to the liabilities related thereto.
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