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PAINEWEBBER BALANCED FUND
PAINEWEBBER TACTICAL ALLOCATION FUND
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
The two funds named above (each a "Fund") are diversified series of
professionally managed, open-end management investment companies organized as a
Maryland corporation and a Massachusetts business trust, respectively.
PaineWebber Balanced Fund ("Balanced Fund"), a series of PaineWebber Master
Series, Inc. ("Corporation"), seeks high total return with low volatility; it
invests primarily in a combination of equity securities, bonds and money market
instruments. PaineWebber Tactical Allocation Fund ("Tactical Allocation Fund"),
a series of PaineWebber Investment Trust ("Trust"), seeks total return,
consisting of long-term capital appreciation and current income, by utilizing a
systematic investment strategy that actively allocates the Fund's assets between
equity securities and U.S. Treasury notes or U.S. Treasury bills.
The investment adviser, administrator and distributor for each Fund is
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly owned
asset management subsidiary of PaineWebber Incorporated ("PaineWebber"). As
distributor for the Funds, Mitchell Hutchins has appointed PaineWebber to serve
as the exclusive dealer for the sale of Fund shares.
This Statement of Additional Information is not a prospectus and should be
read only in conjunction with the Funds' current Prospectus, dated November 30,
1998. A copy of the Prospectus may be obtained by calling any PaineWebber
investment executive or correspondent firm or by calling toll-free
1-800-647-1568. This Statement of Additional Information is dated November 30,
1998.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the Funds' investment policies and limitations. Except as otherwise
indicated in the Prospectus or the Statement of Additional Information, there
are no policy limitations on a Fund's ability to use the investments or
techniques discussed in these documents.
YIELD FACTORS AND RATINGS. Standard & Poor's, a division of The
McGraw-Hill Companies, Inc. ("S&P"), Moody's Investors Service, Inc. ("Moody's")
and other nationally recognized statistical rating organizations ("NRSROs") are
private services that provide ratings of the credit quality of bonds, other debt
obligations and certain other securities. A description of the ratings assigned
to corporate debt obligations by Moody's and S&P is included in the Appendix to
this Statement of Additional Information. The process by which S&P and Moody's
determine ratings for mortgage- and other asset-backed securities includes
consideration of the likelihood of the receipt by security holders of all
distributions, the nature of the underlying assets, the credit quality of the
guarantor, if any, and the structural, legal and tax aspects associated with
such securities. Not even the highest such ratings represents an assessment of
the likelihood that principal prepayments will be made by obligors on the
underlying assets or the degree to which such prepayments may differ from that
originally anticipated, nor do such ratings address the possibility that
investors may suffer a lower than anticipated yield or that investors in such
securities may fail to recoup fully their initial investment due to prepayments.
Balanced Fund may use these ratings in determining whether to purchase,
sell or hold a security. These ratings represent the NRSROs' opinions as to the
quality of the debt obligations that they undertake to rate. It should be
emphasized, however, that ratings are general and are not absolute standards of
quality. Consequently, debt obligations with the same maturity, interest rate
and rating may have different market prices. Subsequent to its purchase by
Balanced Fund, an issue of debt obligations may cease to be rated or its rating
may be reduced below the minimum rating required for purchase by the Fund.
Mitchell Hutchins will consider such an event in determining whether the Fund
should continue to hold the obligation but is not required to dispose of it.
In addition to ratings assigned to individual bond issues, Mitchell
Hutchins will analyze interest rate trends and developments that may affect
individual issuers, including factors such as liquidity, profitability and asset
quality. The yields on bonds and other debt securities in which Balanced Fund
invests are dependent on a variety of factors, including general money market
conditions, general conditions in the bond market, the financial condition of
the issuer, the size of the offering, the maturity of the obligation and its
rating. There is a
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wide variation in the quality of bonds, both within a particular classification
and between classifications. An issuer's obligations under its bonds are subject
to the provisions of bankruptcy, insolvency and other laws affecting the rights
and remedies of bond holders or other creditors of an issuer; litigation or
other conditions may also adversely affect the power or ability of issuers to
meet their obligations for the payment of interest and principal on their bonds.
Balanced Fund may invest in non-invesment grade securities, that is,
securities rated Ba or lower by Moody's, BB or lower by S&P, comparably rated by
another NRSRO or determined by Mitchell Hutchins to be of comparable quality.
Balanced Fund will not invest in securities rated lower than B by Moody's or
S&P, comparably rated by another NRSRO or determined by Mitchell Hutchins to be
of comparable quality. Non-investment grade securities are deemed by those
agencies to be predominantly speculative with respect to the issuer's capacity
to pay interest and repay principal and may involve major risk exposure to
adverse conditions. Non-investment grade securities are commonly referred to as
"junk bonds," and generally offer a higher current yield than that available for
investment grade issues, but they involve higher risks, in that they are
especially subject to adverse changes in general economic conditions and in the
industries in which the issuers are engaged, to changes in the financial
condition of the issuers and to price fluctuations in response to changes in
interest rates. During periods of economic downturn or rising interest rates,
highly leveraged issuers may experience financial stress which could adversely
affect their ability to make payments of interest and principal and increase the
possibility of default. In addition, such issuers may not have more traditional
methods of financing available to them and may be unable to repay debt at
maturity by refinancing. The risk of loss due to default by such issuers is
significantly greater because such securities frequently are unsecured and
subordinated to the prior payment of senior indebtedness.
The market for non-investment grade debt securities has expanded rapidly in
recent years, which has been a period of generally expanding growth and lower
inflation. These securities will be susceptible to greater risk when economic
growth slows or reverses and when inflation increases or deflation occurs. In
the past, the prices of many lower rated debt securities declined substantially,
reflecting an expectation that many issuers of such securities might experience
financial difficulties. As a result, the yields on lower rated debt securities
rose dramatically. However, such higher yields did not reflect the value of the
income stream that holders of such securities expected, but rather the risk that
holders of such securities could lose a substantial portion of their value as a
result of the issuers' financial restructuring or defaults. There can be no
assurance that such declines will not recur. The market for non-investment grade
debt issues generally is thinner and less active than that for higher quality
securities, which may limit a Fund's ability to sell such securities at fair
value in response to changes in the economy or financial markets. Adverse
publicity and investor perceptions, whether or not based on fundamental
analysis, may also decrease the values and liquidity of non-investment grade
securities, especially in a thinly traded market.
ASSET-BACKED SECURITIES. Asset-backed securities have structural
characteristics similar to mortgage-backed securities, as discussed in more
detail below. However, the underlying assets are not first lien mortgage loans
or interests therein, but include assets such as motor vehicle installment sale
contracts, other installment sale contracts, home equity loans, leases of
various types of real and personal property and receivables from revolving
credit (credit card) agreements. Such assets are securitized through the use of
trusts or special purpose corporations. Payments or distributions of principal
and interest may be guaranteed up to a certain amount and for a certain time
period by a letter of credit or pool insurance policy issued by a financial
institution unaffiliated with the issuer, or other credit enhancements may be
present.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent direct or
indirect participations in, or are secured by and payable from, mortgage loans
secured by real property and include single- and multi-class pass-through
securities and collateralized mortgage obligations. Multi-class pass-through
securities and collateralized mortgage obligations are collectively referred to
herein as CMOs. The U.S. government mortgage-backed securities in which Balanced
Fund may invest include mortgage-backed securities issued or guaranteed as to
the payment of principal and interest (but not as to market value) by Ginnie Mae
(also known as the Government National Mortgage Association), Fannie Mae (also
known as the Federal National Mortgage Association), or Freddie Mac (also known
as the Federal Home Loan Mortgage Corporation). Other mortgage-backed securities
are issued by private issuers, generally originators of and investors in
mortgage loans, including savings associations, mortgage bankers, commercial
banks, investment bankers and special purpose entities (collectively "Private
Mortgage Lenders"). Payments of principal and interest (but not the
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market value) of such private mortgage-backed securities may be supported by
pools of mortgage loans or other mortgage-backed securities that are guaranteed,
directly or indirectly, by the U.S. government or one of its agencies or
instrumentalities, or they may be issued without any government guarantee of the
underlying mortgage assets but with some form of non-government credit
enhancement.
New types of mortgage-backed securities are developed and marketed from
time to time and, consistent with its investment limitations, Balanced Fund
expects to invest in those new types of mortgage-backed securities that Mitchell
Hutchins believes may assist the Fund in achieving its investment objective.
Similarly, Balanced Fund may invest in mortgage-backed securities issued by new
or existing governmental, private or commercial issuers other than those
identified herein.
GINNIE MAE CERTIFICATES. Ginnie Mae guarantees certain mortgage
pass-through certificates ("Ginnie Mae certificates") that are issued by Private
Mortgage Lenders and that represent ownership interests in individual pools of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. Timely payment of interest
and principal is backed by the full faith and credit of the U.S. government.
Each mortgagor's monthly payments to his lending institution on his residential
mortgage are "passed through" to certificateholders such as Balanced Fund.
Mortgage pools consist of whole mortgage loans or participations in loans. The
terms and characteristics of the mortgage instruments are generally uniform
within a pool but may vary among pools. Lending institutions that originate
mortgages for the pools are subject to certain standards, including credit and
other underwriting criteria for individual mortgages included in the pools.
FANNIE MAE CERTIFICATES. Fannie Mae facilitates a national secondary
market in residential mortgage loans insured or guaranteed by U.S. government
agencies and in privately insured or uninsured residential mortgage loans
(sometimes referred to as "conventional mortgage loans" or "conventional loans")
through its mortgage purchase and mortgage-backed securities sales activities.
Fannie Mae issues guaranteed mortgage pass-through certificates ("Fannie Mae
certificates"), which represent pro rata shares of all interests and principal
payments made and owed on the underlying pools. Fannie Mae guarantees timely
payment of interest and principal on Fannie Mae certificates. The Fannie Mae
guarantee is not backed by the full faith and credit of the U.S. government.
FREDDIE MAC CERTIFICATES. Freddie Mac also facilitates a national
secondary market for conventional residential and U.S. government-insured
mortgage loans through its mortgage purchase and mortgage-backed securities
sales activities. Freddie Mac issues two types of mortgage pass-through
securities: mortgage participation certificates ("PCs") and guaranteed mortgage
certificates ("GMCs"). Each PC represents a pro rata share of all interest and
principal payments made and owed on the underlying pool. Freddie Mac generally
guarantees timely monthly payment of interest on PCs and the ultimate payment of
principal, but it also has a PC program under which it guarantees timely payment
of both principal and interest. GMCs also represent a pro rata interest in a
pool of mortgages. These instruments, however, pay interest semiannually and
return principal once a year in guaranteed minimum payments. The Freddie Mac
guarantee is not backed by the full faith and credit of the U.S. government.
PRIVATE MORTGAGE-BACKED SECURITIES. Mortgage-backed securities issued by
Private Mortgage Lenders are structured similarly to CMOs issued or guaranteed
by Ginnie Mae, Fannie Mae and Freddie Mac. Such mortgage-backed securities may
be supported by pools of U.S. government or agency insured or guaranteed
mortgage loans or by other mortgage-backed securities issued by a government
agency or instrumentality, but they generally are supported by pools of
conventional (i.e., non-government guaranteed or insured) mortgage loans. Since
such mortgage-backed securities normally are not guaranteed by an entity having
the credit standing of Ginnie Mae, Fannie Mae and Freddie Mac, they normally are
structured with one or more types of credit enhancement. See "--Types of Credit
Enhancement." These credit enhancements do not protect investors from changes in
market value.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS MORTGAGE
PASS-THROUGHS. CMOs are debt obligations that are collateralized by mortgage
loans or mortgage pass-through securities (such collateral collectively being
called "Mortgage Assets"). CMOs may be issued by Private Mortgage Lenders or by
government entities such as Fannie Mae or Freddie Mac. Multi-class mortgage
pass-through securities are interests in trusts that are comprised of Mortgage
Assets and that have multiple classes similar to those in CMOs. Unless the
context indicates otherwise, references herein to CMOs include multi-class
mortgage pass-through securities. Payments of principal of and interest on the
Mortgage Assets (and in the case of CMOs,
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any reinvestment income thereon) provide the funds to pay debt service on the
CMOs or to make schedule distributions on the multi-class mortgage pass-through
securities.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMO, also referred to as a "tranche," is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the Mortgage Assets may cause CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrued on all classes of a CMO (other than any
principal-only class) on a monthly, quarterly or semiannual basis. The principal
and interest on the Mortgage Assets may be allocated among the several classes
of a CMO in many ways. In one structure, payments of principal, including any
principal prepayments, on the Mortgage Assets are applied to the classes of a
CMO in the order of their respective stated maturities or final distribution
dates so that no payment of principal will be made on any class of the CMO until
all other classes having an earlier stated maturity or final distribution date
have been paid in full. In some CMO structures, all or a portion of the interest
attributable to one or more of the CMO classes may be added to the principal
amounts attributable to such classes, rather than passed through to
certificateholders on a current basis, until other classes of the CMO are paid
in full.
Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. These simultaneous payments are taken into
account in calculating the stated maturity date or final distribution date of
each class, which, as with other CMO structures, must be retired by its stated
maturity date or final distribution date but may be retired earlier.
Some CMO classes are structured to pay interest at rates that are adjusted
in accordance with a formula, such as a multiple or fraction of the change in a
specified interest rate index, so as to pay at a rate that will be attractive in
certain interest rate environments but not in others. For example, an inverse
floating rate CMO class pays interest at a rate that increases as a specified
interest rate index decreases but decreases as that index increases. For other
CMO classes, the yield may move in the same direction as market interest rates--
i.e., the yield may increase as rates increase and decrease as rates
decrease--but may do so more rapidly or to a greater degree. The market value of
such securities generally is more volatile than that of a fixed rate obligation.
Such interest rate formulas may be combined with other CMO characteristics. For
example, a CMO class may be an "inverse IO," on which the holders are entitled
to receive no payments of principal and are entitled to receive interest at a
rate that will vary inversely with a specified index or a multiple thereof.
TYPES OF CREDIT ENHANCEMENT. To lessen the effect of failures by obligors
on mortgage assets to make payments, mortgage-backed securities may contain
elements of credit enhancement. Such credit enhancement falls into two
categories: (1) liquidity protection and (2) protection against losses resulting
after default by an obligor on the underlying assets and collection of all
amounts recoverable directly from the obligor and through liquidation of the
collateral. Liquidity protection refers to the provision of advances, generally
by the entity administering the pool of assets (usually the bank, savings
association or mortgage banker that transferred the underlying loans to the
issuer of the security), to ensure that the receipt of payments on the
underlying pool occurs in a timely fashion. Protection against losses resulting
after default and liquidation ensures ultimate payment of the obligations on at
least a portion of the assets in the pool. Such protection may be provided
through guarantees, insurance policies or letters of credit obtained by the
issuer or sponsor, from third parties, through various means of structuring the
transaction or through a combination of such approaches. Balanced Fund will not
pay any additional fees for such credit enhancement, although the existence of
credit enhancement may increase the price of a security. Credit enhancements do
not provide protection against changes in the market value of the security.
Examples of credit enhancement arising out of the structure of the
transaction include "senior-subordinated securities" (multiple class securities
with one or more classes subordinate to other classes as to the payment of
principal thereof and interest thereon, with the result that defaults on the
underlying assets are borne first by the holders of the subordinated class),
creation of "spread accounts" or "reserve funds" (where cash or investments,
sometimes funded from a portion of the payments on the underlying assets, are
held in reserve against future losses) and "over-collateralization" (where the
scheduled payments on, or the principal amount of, the underlying assets exceed
that required to make payment of the securities and pay any servicing or other
fees). The degree of credit enhancement provided for each issue generally is
based on historical information regarding the level of credit risk associated
with the underlying assets. Delinquency or loss in excess of that anticipated
could adversely affect the return on an investment in such a security.
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SPECIAL CHARACTERISTICS OF MORTGAGE- AND ASSET-BACKED SECURITIES. The
yield characteristics of mortgage-and asset-backed securities differ from those
of traditional debt securities. Among the major differences are that interest
and principal payments are made more frequently, usually monthly, and that
principal may be prepaid at any time because the underlying mortgage loans or
other obligations generally may be prepaid at any time. Prepayments on a pool of
mortgage loans are influenced by a variety of economic, geographic, social and
other factors, including changes in mortgagors' housing needs, job transfers,
unemployment, mortgagors' net equity in the mortgaged properties and servicing
decisions. Generally, however, prepayments on fixed-rate mortgage loans will
increase during a period of falling interest rates and decrease during a period
of rising interest rates. Similar factors apply to prepayments on asset-backed
securities, but the receivables underlying asset-backed securities generally are
of a shorter maturity and thus are less likely to experience substantial
prepayments. Such securities, however, often provide that for a specified time
period the issuers will replace receivables in the pool that are repaid with
comparable obligations. If the issuer is unable to do so, repayment of principal
on the asset-backed securities may commence at an earlier date. Mortgage- and
asset-backed securities may decrease in value as a result of increases in
interest rates and may benefit less than other fixed-income securities from
declining interest rates because of the risk of prepayment.
The rate of interest on mortgage-backed securities is lower than the
interest rates paid on the mortgages included in the underlying pool due to the
annual fees paid to the servicer of the mortgage pool for passing through
monthly payments to certificateholders and to any guarantor, and due to any
yield retained by the issuer. Actual yield to the holder may vary from the
coupon rate, even if adjustable, if the mortgage-backed securities are purchased
or traded in the secondary market at a premium or discount. In addition, there
is normally some delay between the time the issuer receives mortgage payments
from the servicer and the time the issuer makes the payments on the
mortgage-backed securities, and this delay reduces the effective yield to the
holder of such securities.
Yields on pass-through securities are typically quoted by investment
dealers and vendors based on the maturity of the underlying instruments and the
associated average life assumption. The average life of pass-through pools
varies with the maturities of the underlying mortgage loans. A pool's term may
be shortened by unscheduled or early payments of principal on the underlying
mortgages. Because prepayment rates of individual pools vary widely, it is not
possible to predict accurately the average life of a particular pool. In the
past, a common industry practice has been to assume that prepayments on pools of
fixed rate 30-year mortgages would result in a 12-year average life for the
pool. At present, mortgage pools, particularly those with loans with other
maturities or different characteristics, are priced on an assumption of average
life determined for each pool. In periods of declining interest rates, the rate
of prepayment tends to increase, thereby shortening the actual average life of a
pool of mortgage-backed securities. Conversely, in periods of rising interest
rates, the rate of prepayment tends to decrease, thereby lengthening the actual
average life of the pool. However, these effects may not be present, or may
differ in degree, if the mortgage loans in the pools have adjustable interest
rates or other special payment terms, such as a prepayment charge. Actual
prepayment experience may cause the yield of mortgage-backed securities to
differ from the assumed average life yield. Reinvestments of prepayments may
occur at lower interest rates than the original investment, thus adversely
affecting the yield of Balanced Fund.
ADDITIONAL INFORMATION ON ARM AND FLOATING RATE MORTGAGE-BACKED
SECURITIES. Adjustable rate mortgage ("ARM") securities are mortgage-backed
securities that represent a right to receive interest payments at a rate that is
adjusted to reflect the interest earned on a pool of mortgage loans bearing
variable or adjustable rates of interest (such mortgage loans are referred to as
"ARMs"). Floating rate mortgage-backed securities are classes of mortgage-backed
securities that have been structured to represent the right to receive interest
payments at rates that fluctuate in accordance with an index but that generally
are supported by pools comprised of fixed-rate mortgage loans.
Because the interest rates on ARM and floating rate mortgage-backed
securities are reset in response to changes in a specified market index, the
values of such securities tend to be less sensitive to interest rate
fluctuations than the values of fixed-rate securities. As a result, during
periods of rising interest rates, ARMs generally do not decrease in value as
much as fixed rate securities. Conversely, during periods of declining rates,
ARMs generally do not increase in value as much as fixed rate securities. ARM
mortgage-backed securities represent a right to receive interest payments at a
rate that is adjusted to reflect the interest earned
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on a pool of ARMs. ARMs generally specify that the borrower's mortgage interest
rate may not be adjusted above a specified lifetime maximum rate or, in some
cases, below a minimum lifetime rate. In addition, certain ARMs provide for
limitations on the maximum amount by which the mortgage interest rate may adjust
for any single adjustment period. ARMs also may provide for limitations on
changes in the maximum amount by which the borrower's monthly payment may adjust
for any single adjustment period. In the event that a monthly payment is not
sufficient to pay the interest accruing on the ARM, any such excess interest is
added to the mortgage loan ("negative amortization"), which is repaid through
future monthly payments. If the monthly payment exceeds the sum of the interest
accrued at the applicable mortgage interest rate and the principal payment that
would have been necessary to amortize the outstanding principal balance over the
remaining term of the loan, the excess reduces the principal balance of the ARM.
Borrowers under ARMs experiencing negative amortization may take longer to build
up their equity in the underlying property and may be more likely to default.
ARMs also may be subject to a greater rate of prepayments in a declining
interest rate environment. For example, during a period of declining interest
rates, prepayments on ARMs could increase because the availability of fixed
mortgage loans at competitive interest rates may encourage mortgagors to
"lock-in" at a lower interest rate. Conversely, during a period of rising
interest rates, prepayments on ARMs might decrease. The rate of prepayments with
respect to ARMs has fluctuated in recent years.
The rates of interest payable on certain ARMs, and, therefore, on certain
ARM mortgage-backed securities, are based on indices, such as the one-year
constant maturity Treasury rate, that reflect changes in market interest rates.
Others are based on indices, such as the 11th District Federal Home Loan Bank
Cost of Funds Index ("COFI"), that tend to lag behind changes in market interest
rates. The values of ARM mortgage-backed securities supported by ARMs that
adjust based on lagging indices tend to be somewhat more sensitive to interest
rate fluctuations than those reflecting current interest rate levels, although
the values of such ARM mortgage-backed securities still tend to be less
sensitive to interest rate fluctuations than fixed-rate securities.
As with ARM mortgage-backed securities, interest rate adjustments on
floating rate mortgage-backed securities may be based on indices that lag behind
market interest rates. Interest rates on floating rate mortgage-backed
securities generally are adjusted monthly. Floating rate mortgage-backed
securities are subject to lifetime interest rate caps, but they generally are
not subject to limitations on monthly or other periodic changes in interest
rates or monthly payments.
DURATION. Duration is a measure of the expected life of a fixed income
security that was developed as a more precise alternative to the concept "term
to maturity." Traditionally, a debt security's "term to maturity" has been used
as a proxy for the sensitivity of the security's price to changes in interest
rates (which is the "interest rate risk" or "volatility" of the security).
However, "term to maturity" measures only the time until a debt security
provides for a final payment, taking no account of the pattern of the security's
payments prior to maturity.
For any fixed income security with interest payments occurring prior to the
payment of principal, duration is always less than maturity. For example,
depending upon its coupon and the level of market yields, a Treasury note with a
remaining maturity of five years might have a duration of 4.5 years. For
mortgage-backed and other securities that are subject to prepayments, put or
call features or adjustable coupons, the difference between the remaining stated
maturity and the duration is likely to be much greater. Duration also allows
Mitchell Hutchins to make certain predictions as to the effect that changes in
the level of interest rates will have on the value of Balanced Fund's portfolio.
For example, when the level of interest rates increases by 1%, the value of a
fixed income security having a positive duration of three years generally will
decrease by approximately 3%. Thus, if Mitchell Hutchins calculates the duration
of the Fund's portfolio as three years, it normally would expect the portfolio
to change in value by approximately 3% for every 1% change in the level of
interest rates. However, various factors, such as changes in anticipated
prepayment rates, qualitative considerations and market supply and demand, can
cause particular securities to respond somewhat differently to changes in
interest rates than indicated in the above example.
Futures, options and options on futures have durations that, in general,
are closely related to the duration of the securities that underlie them.
Holding long futures or call option positions (backed by a segregated account of
cash and cash equivalents) will lengthen a Fund's duration by approximately the
same amount as would holding an equivalent amount of the underlying securities.
Short futures or put options have durations roughly equal to the negative
duration of the securities that underlie these positions, and have the effect of
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reducing portfolio duration by approximately the same amount as would selling an
equivalent amount of the underlying securities.
There are some situations in which the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by the standard duration calculation is the case of mortgage-backed
securities. The stated final maturity of such securities is generally 30 years,
but current prepayment rates are critical in determining the securities'
interest rate exposure. In these and other similar situations, Mitchell Hutchins
will use more sophisticated analytical techniques that incorporate the economic
life of a security into the determination of its duration and, therefore, its
interest rate exposure.
ILLIQUID SECURITIES. Each Fund may invest up to 10% of its net assets in
illiquid securities. The term "illiquid securities" for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the amount at which the Fund has valued the
securities and includes, among other things, purchased over-the-counter ("OTC")
options, repurchase agreements maturing in more than seven days and restricted
securities (other than those Mitchell Hutchins has determined to be liquid
pursuant to guidelines established by the Corporation's board of directors or
the Trust's board of trustees (each a "board"). The assets used as cover for OTC
options written by a Fund will be considered illiquid unless the OTC options are
sold to qualified dealers who agree that the Fund may repurchase any OTC option
it writes at a maximum price to be calculated by a formula set forth in the
option agreement. The cover for an OTC option written subject to this procedure
would be considered illiquid only to the extent that the maximum repurchase
price under the formula exceeds the intrinsic value of the option. Under current
SEC guidelines, interest-only ("IO") and principal-only ("PO") classes of
mortgage-backed securities, in which Balanced Fund may invest, are considered
illiquid. However, IO and PO classes of fixed-rate mortgage-backed securities
issued by the U.S. government or one of its agencies or instrumentalities will
not be considered illiquid if Mitchell Hutchins has determined that they are
liquid pursuant to guidelines established by the board.
Restricted securities are not registered under the Securities Act of 1933
("1933 Act") and may be sold only in privately negotiated or other exempted
transactions or after a 1933 Act registration statement has become effective.
Where registration is required, a Fund may be obligated to pay all or part of
the registration expenses and a considerable period may elapse between the time
of the decision to sell and the time the Fund may be permitted to sell a
security under an effective registration statement. If, during such a period,
adverse market conditions were to develop, the Fund might obtain a less
favorable price than prevailed when it decided to sell.
Not all restricted securities are illiquid. A large institutional market
has developed for many securities that are not registered under the 1933 Act.
Institutional investors generally will not seek to sell these instruments to the
general public but, instead, will often depend either on an efficient
institutional market in which such unregistered securities can be readily resold
or on an issuer's ability to honor a demand for repayment. Therefore, the fact
that there are contractual or legal restrictions on resale to the general public
or certain institutions is not dispositive of the liquidity of such investments.
Institutional markets for restricted securities also have developed as a
result of Rule 144A, which established a "safe harbor" from the registration
requirements of the 1933 Act for resales of certain securities to qualified
institutional buyers, providing both readily ascertainable values for restricted
securities and the ability to liquidate an investment to satisfy share
redemption orders. Such markets include automated systems for the trading,
clearance and settlement of unregistered securities of domestic and foreign
issuers, such as the PORTAL System sponsored by the National Association of
Securities Dealers, Inc. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144A-eligible restricted securities held by
a Fund, however, could affect adversely the marketability of such portfolio
securities, and the Fund might be unable to dispose of such securities promptly
or at favorable prices.
Each board has delegated the function of making day-to-day determinations
of liquidity to Mitchell Hutchins, pursuant to guidelines approved by the board.
Mitchell Hutchins takes into account a number of factors in reaching liquidity
decisions, including (1) the frequency of trades for the security, (2) the
number of dealers that make quotes for the security, (3) the number of dealers
that have undertaken to make a market in the security, (4) the number of other
potential purchasers and (5) the nature of the security and how trading is
effected (e.g., the time needed to sell the security, how offers are solicited
and the mechanics of transfer).
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Mitchell Hutchins monitors the liquidity of restricted securities in each Fund's
portfolio and reports periodically on such decisions to the boards.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which a
Fund purchases securities or other obligations and simultaneously commits to
resell them to the counterparty at an agreed-upon date or upon demand and at a
price reflecting a market rate of interest unrelated to the coupon rate or
maturity of the purchased obligations. Each Fund maintains custody of the
underlying obligations prior to their repurchase, either through its regular
custodian or through a special "tri-party" custodian that maintains separate
accounts for both the Fund and its counterparty. Thus, the obligation of the
counterparty to pay the repurchase price on the date agreed to or upon demand
is, in effect, secured by such obligations. If their value becomes less than the
repurchase price, plus any agreed-upon additional amount, the counterparty must
provide additional collateral so that at all times the collateral is at least
equal to the repurchase price, plus any agreed-upon additional amount. The
difference between the total amount to be received upon repurchase of the
obligations and the price that was paid by a Fund upon their acquisition is
accrued as interest and included in the Fund's net investment income.
The Funds intend to enter into repurchase agreements only with banks and
dealers (or their affiliates) in transactions believed by Mitchell Hutchins to
present minimal credit risks in accordance with guidelines established by each
board. Mitchell Hutchins reviews and monitors the creditworthiness of those
institutions under each board's general supervision.
REVERSE REPURCHASE AGREEMENTS. Balanced Fund may enter into reverse
repurchase agreements with banks and securities dealers up to an aggregate value
of not more than 5% of its net assets. Such agreements involve the sale of
securities held by the Fund subject to the Fund's agreement to repurchase the
securities at an agreed-upon date or upon demand and at a price reflecting a
market rate of interest. Such agreements are considered to be borrowings and may
be entered into only for temporary or emergency purposes. While a reverse
repurchase agreement is outstanding, the Fund's custodian segregates assets to
cover the Fund's obligations under the reverse repurchase agreement. See
"Investment Policies and Restrictions--Segregated Accounts."
Reverse repurchase agreements involve the risk that the buyer of the
securities sold by a Fund might be unable to deliver them when the Fund seeks to
repurchase. If the buyer of securities under a reverse repurchase agreement
files for bankruptcy or becomes insolvent, the buyer or a trustee or receiver
may receive an extension of time to determine whether to enforce a Fund's
obligation to repurchase the securities, and the Fund's use of the proceeds of
the repurchase agreement may effectively be restricted pending such decision.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. Each Fund may purchase
securities on a "when-issued" basis or may purchase or sell securities for
"delayed delivery." In when-issued or delayed delivery transactions, delivery of
the securities occurs beyond normal settlement periods, but a Fund generally
would not pay for such securities or start earning interest or dividends on them
until they are delivered. However, when a Fund purchases securities on a
when-issued or delayed delivery basis, it immediately assumes the risks of
ownership, including the risk of price fluctuation. Failure by a counterparty to
deliver a security purchased on a when-issued or delayed delivery basis may
result in a loss or missed opportunity to make an alternative investment.
Depending on market conditions, a Fund's when-issued and delayed delivery
purchase commitments could cause its net asset value per share to become more
volatile, because such securities may increase the amount by which the Fund's
total assets, including the value of the when-issued and delayed delivery
securities held by the Fund, exceed its net assets.
A security purchased on a when-issued or delayed delivery basis is recorded
as an asset on the commitment date and is subject to changes in market value,
generally based upon changes in the level of interest rates. Thus, fluctuation
in the value of the security from the time of the commitment date will affect a
Fund's net asset value. When a Fund commits to purchase securities on a
when-issued or delayed delivery basis, its custodian segregates assets to cover
the amount of the commitment. See "Investment Policies and
Restrictions--Segregated Accounts." Each Fund purchases when-issued securities
only with the intention of taking delivery, but may sell the right to acquire
the security prior to delivery if Mitchell Hutchins deems it advantageous to do
so, which may result in a gain or loss to the Fund.
SECTION 4(2) PAPER. Commercial paper issues in which Balanced Fund may
invest include securities issued by major corporations without registration
under the 1933 Act in reliance on the exemption from such registration afforded
by Section 3(a)(3) thereof and commercial paper issued in reliance on the
so-called
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"private placement" exemption from registration afforded by Section 4(2) of the
1933 Act ("Section 4(2) paper"). Section 4(2) paper is restricted as to
disposition under the federal securities laws in that any resale must similarly
be made in an exempt transaction. Section 4(2) paper is normally resold to other
institutional investors through or with the assistance of investment dealers who
make a market in Section 4(2) paper, thus providing liquidity. The Fund's 10%
limitation on investments in illiquid securities includes Section 4(2) paper,
other than Section 4(2) paper that Mitchell Hutchins has determined to be liquid
pursuant to guidelines established by the board. The board has delegated to
Mitchell Hutchins the function of making day-to-day determinations of liquidity
with respect to Section 4(2) paper, pursuant to guidelines approved by the board
that require Mitchell Hutchins to take into account the same factors described
under "Illiquid Securities" above for other restricted securities and require
Mitchell Hutchins to perform the same monitoring and reporting functions.
SPECIAL CONSIDERATIONS RELATING TO FOREIGN SECURITIES. Securities of
foreign issuers may not be registered with the SEC, nor may the issuers thereof
subject to its reporting requirements. Accordingly, there may be less publicly
available information concerning foreign issuers of securities held by a Fund
than is available concerning U.S. companies. Foreign companies are not generally
subject to uniform accounting, auditing and financial reporting standards or to
other regulatory requirements comparable to those applicable to U.S. companies.
The Funds may invest in foreign securities by purchasing American
Depositary Receipts ("ADRs"). Generally, ADRs, are in registered form, are
denominated in U.S. dollars and are designed for use in the U.S. securities
markets. ADRs are receipts typically issued by a U.S. bank or trust company
evidencing ownership of the underlying securities. For purposes of each Fund's
investment policies, ADRs are deemed to have the same classification as the
underlying securities they represent. Thus, an ADR evidencing ownership of
common stock will be treated as common stock.
ADRs are publicly traded on exchanges or OTC in the United States and are
issued through "sponsored" or "unsponsored" arrangements. In a sponsored ADR
arrangement, the foreign issuer assumes the obligation to pay some or all of the
depositary's transaction fees, whereas under an unsponsored arrangement, the
foreign issuer assumes no obligations and the depositary's transaction fees are
paid directly by the ADR holders. In addition, less information is available in
the United States about an unsponsored ADR than about a sponsored ADR.
Investment income on certain foreign securities in which the Funds may
invest may be subject to foreign withholding or other taxes that could reduce
the return on these securities. Tax treaties between the United States and
foreign countries, however, may reduce or eliminate the amount of foreign taxes
to which a Fund would be subject.
CONVERTIBLE SECURITIES. Balanced Fund is permitted to invest in
convertible securities. A convertible security is a bond, debenture, note,
preferred stock or other security that may be converted into or exchanged for a
prescribed amount of common stock of the same or a different issuer within a
particular period of time at a specified price or formula. A convertible
security entitles the holder to receive interest paid or accrued on debt or the
dividend paid on preferred stock until the convertible security matures or is
redeemed, converted or exchanged. Before conversion, convertible securities have
characteristics similar to non-convertible debt securities in that they
ordinarily provide a stable stream of income with generally higher yields than
those of common stocks of the same or similar issuers. Convertible securities
rank senior to common stock in a corporation's capital structure but are usually
subordinated to comparable non-convertible securities.
Convertible securities have unique investment characteristics in that they
generally (1) have higher yields than common stocks, but lower yields than
comparable non-convertible securities, (2) are less subject to fluctuation in
value than the underlying stock because they have fixed income characteristics
and (3) provide the potential for capital appreciation if the market price of
the underlying common stock increases. The value of a convertible security is a
function of its "investment value" (determined by its yield comparison with the
yields of other securities of comparable maturity and quality that do not have a
conversion privilege) and its "conversion value" (the security's worth, at
market value, if converted into the underlying common stock). The investment
value of a convertible security is influenced by changes in interest rates, with
investment value declining as interest rates increase and increasing as interest
rates decline. The credit standing of the issuer and other factors also may have
an effect on the convertible security's investment value. The conversion value
of a convertible security is determined by the market price of the underlying
common stock. If the conversion value is low relative to the investment value,
the price of the convertible security is governed principally by its investment
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value and generally the conversion value decreases as the convertible security
approaches maturity. To the extent the market price of the underlying common
stock approaches or exceeds the conversion price, the price of the convertible
security will be increasingly influenced by its conversion value. In addition, a
convertible security generally will sell at a premium over its conversion value
determined by the extent to which investors place value on the right to acquire
the underlying common stock while holding a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by Balanced Fund is called for
redemption, the Fund will be required to permit the issuer to redeem the
security, convert it into underlying common stock or sell it to a third party.
SEGREGATED ACCOUNTS. When a Fund enters into certain transactions to make
future payments to third parties, such as reverse repurchase agreements or the
purchase of securities on a when-issued or delayed delivery basis, it will
maintain with an approved custodian in a segregated account cash or liquid
securities, marked to market daily, in an amount at least equal to the Fund's
obligation or commitment under such transactions. As described under "Strategies
Using Derivative Instruments," segregated accounts may also be required in
connection with certain transactions involving options, futures contracts, swaps
or similar instruments.
SHORT SALES "AGAINST THE BOX." Each Fund may engage in short sales of
securities it owns or has the right to acquire at no added cost through
conversion or exchange of other securities it owns (short sales "against the
box"). To make delivery to the purchaser in a short sale, the executing broker
borrows the securities being sold short on behalf of a Fund, and the Fund is
obligated to replace the securities borrowed at a date in the future. When a
Fund sells short, it establishes a margin account with the broker effecting the
short sale and deposits collateral with the broker. In addition, the Fund
maintains with its custodian, in a segregated account, the securities that could
be used to cover the short sale. A Fund incurs transaction costs, including
interest expense, in connection with opening, maintaining and closing short
sales against the box. Neither Fund currently expects to have obligations under
short sales that at any time during the coming year exceed 5% of its net assets.
A Fund might make a short sale "against the box" in order to hedge against
market risks when Mitchell Hutchins believes that the price of a security may
decline, thereby causing a decline in the value of a security owned by the Fund
or a security convertible into or exchangeable for a security owned by the Fund.
In such case, any loss in the Fund's long position after the short sale should
be reduced by a corresponding gain in the short position. Conversely, any gain
in the long position after the short sale should be reduced by a corresponding
loss in the short position. The extent to which gains or losses in the long
position are reduced will depend upon the amount of the securities sold short
relative to the amount of the securities the Fund owns, either directly or
indirectly, and in the case where the Fund owns convertible securities, changes
in the investment values or conversion premiums of such securities.
LENDING OF PORTFOLIO SECURITIES. Each Fund is authorized to lend up to
33 1/3% of its total assets to broker-dealers or institutional investors that
Mitchell Hutchins deems qualified, but only when the borrower maintains
acceptable collateral with the Fund's custodian in an amount, marked to market
daily, at least equal to the market value of the securities loaned, plus accrued
interest and dividends. Acceptable collateral is limited to cash, U.S.
government securities and irrevocable letters of credit that meet certain
guidelines established by Mitchell Hutchins. Each Fund may reinvest cash
collateral in money market instruments or other short-term liquid investments.
In determining whether to lend securities to a particular broker-dealer or
institutional investor, Mitchell Hutchins will consider, and during the period
of the loan will monitor, all relevant facts and circumstances, including the
creditworthiness of the borrower. Each Fund will retain authority to terminate
any of its loans at any time. A Fund may pay reasonable fees in connection with
a loan and may pay the borrower or placing broker a negotiated portion of the
interest earned on the cash or money market instruments held as collateral. A
Fund will receive amounts equivalent to any dividends, interest or other
distributions on the securities loaned. A Fund will regain record ownership of
loaned securities to exercise beneficial rights, such as voting and subscription
rights and rights to dividends, interest or other distributions, when regaining
such rights is considered to be in the Fund's interest.
Pursuant to procedures adopted by the boards governing the Funds'
securities lending program, PaineWebber has been retained to serve as lending
agent for each Fund. The appropriate board also has authorized the payment of
fees (including fees calculated as a percentage of invested cash collateral) to
PaineWebber for these services. Each board periodically reviews all portfolio
securities loan transactions for
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which PaineWebber acted as lending agent. PaineWebber also has been approved as
a borrower under each Fund's securities lending program.
INVESTMENT LIMITATIONS OF THE FUNDS
FUNDAMENTAL LIMITATIONS. The following fundamental investment limitations
cannot be changed for a Fund without the affirmative vote of the lesser of (1)
more than 50% of the outstanding shares of the Fund or (2) 67% or more of the
shares of the Fund present at a shareholders' meeting if more than 50% of the
outstanding shares are represented at the meeting in person or by a proxy. If a
percentage restriction is adhered to at the time of an investment or
transaction, later changes in percentage resulting from a change in values of
portfolio securities or the amount of total assets will not be considered a
violation of any of the following limitations.
Each Fund will not:
(1) purchase securities of any one issuer if, as a result, more than
5% of the Fund's total assets would be invested in securities of that
issuer or the Fund would own or hold more than 10% of the outstanding
voting securities of that issuer, except that up to 25% of the Fund's total
assets may be invested without regard to this limitation, and except that
this limitation does not apply to securities issued or guaranteed by the
U.S. government, its agencies and instrumentalities or to securities issued
by other investment companies.
The following interpretation applies to, but is not a part of, this
fundamental restriction: Mortgage- and asset-backed securities will not be
considered to have been issued by the same issuer by reason of the
securities having the same sponsor, and mortgage- and asset-backed
securities issued by a finance or other special purpose subsidiary that are
not guaranteed by the parent company will be considered to be issued by a
separate issuer from the parent company.
(2) purchase any security if, as a result of that purchase, 25% or
more of the Fund's total assets would be invested in securities of issuers
having their principal business activities in the same industry, except
that this limitation does not apply to securities issued or guaranteed by
the U.S. government, its agencies or instrumentalities or to municipal
securities.
(3) issue senior securities or borrow money, except as permitted under
the Investment Company Act of 1940 ("1940 Act") and then not in excess of
33 1/3% of the Fund's total assets (including the amount of the senior
securities issued but reduced by any liabilities not constituting senior
securities) at the time of the issuance or borrowing, except that the Fund
may borrow up to an additional 5% of its total assets (not including the
amount borrowed) for temporary or emergency purposes.
(4) make loans, except through loans of portfolio securities or
through repurchase agreements, provided that for purposes of this
restriction, the acquisition of bonds, debentures, other debt securities or
instruments, or participations or other interests therein and investments
in government obligations, commercial paper, certificates of deposit,
bankers' acceptances or similar instruments will not be considered the
making of a loan.
(5) engage in the business of underwriting securities of other
issuers, except to the extent that the Fund might be considered an
underwriter under the federal securities laws in connection with its
disposition of portfolio securities.
(6) purchase or sell real estate, except that investments in
securities of issuers that invest in real estate and investments in
mortgage-backed securities, mortgage participations or other instruments
supported by interests in real estate are not subject to this limitation,
and except that the Fund may exercise rights under agreements relating to
such securities, including the right to enforce security interests and to
hold real estate acquired by reason of such enforcement until that real
estate can be liquidated in an orderly manner.
(7) purchase or sell physical commodities unless acquired as a result
of owning securities or other instruments, but the Fund may purchase, sell
or enter into financial options and futures, forward and spot currency
contracts, swap transactions and other financial contracts or derivative
instruments.
NON-FUNDAMENTAL LIMITATIONS. The following investment restrictions are not
fundamental and may be changed by the vote of a Fund's board without shareholder
approval:
Each Fund may not:
(1) invest more than 10% of its net assets in illiquid securities.
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(2) purchase securities on margin, except for short-term credit
necessary for clearance of portfolio transactions and except that the Fund
may make margin deposits in connection with its use of financial options
and futures, forward and spot currency contracts, swap transactions and
other financial contracts or derivative instruments.
(3) engage in short sales of securities or maintain a short position,
except that the Fund may (a) sell short "against the box" and (b) maintain
short positions in connection with its use of financial options and
futures, forward and spot currency contracts, swap transactions and other
financial contracts or derivative instruments.
(4) purchase securities of other investment companies, except to the
extent permitted by the 1940 Act and except that this limitation does not
apply to securities received or acquired as dividends, through offers of
exchange, or as a result of reorganization, consolidation or merger.
(5) purchase portfolio securities while borrowings in excess of 5% of
its total assets are outstanding.
STRATEGIES USING DERIVATIVE INSTRUMENTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS. Mitchell Hutchins may use a
variety of financial instruments ("Derivative Instruments"), including certain
options, futures contracts (sometimes referred to as "futures") and options on
futures contracts, to attempt to hedge the Funds' portfolios and to enhance
income or return, including adjusting a Fund's exposure to different asset
classes or maintaining exposure to stocks or bonds while maintaining a cash
balance for Fund management purposes (such as to provide liquidity to meet
anticipated shareholder sales of Fund shares and for Fund operating expenses). A
Fund may enter into transactions involving one or more types of Derivative
Instruments under which the full value of its portfolio is at risk, and Tactical
Allocation Fund, in particular, may use Derivative Instruments to this extent in
reallocating its exposure to different asset classes when the Tactical
Allocation Model's recommended asset allocation mix changes. Under normal
circumstances, however, a Fund's use of these instruments will place at risk a
much smaller portion of its assets. Balanced Fund may also enter into certain
interest rate protection transactions. Balanced Fund may use all of the
instruments identified below. Tactical Allocation Fund is limited to stock index
options and futures, futures on five-year U.S. Treasury notes and options on
these permitted futures contracts.
OPTIONS ON EQUITY AND DEBT SECURITIES--A call option is a short-term
contract pursuant to which the purchaser of the option, in return for a premium,
has the right to buy the security underlying the option at a specified price at
any time during the term of the option or at specified times or at the
expiration of the option, depending on the type of option involved. The writer
of the call option, who receives the premium, has the obligation, upon exercise
of the option during the option term, to deliver the underlying security against
payment of the exercise price. A put option is a similar contract that gives its
purchaser, in return for a premium, the right to sell the underlying security at
a specified price during the option term or at specified times or at the
expiration of the option, depending on the type of option involved. The writer
of the put option, who receives the premium, has the obligation, upon exercise
of the option during the option term, to buy the underlying security at the
exercise price.
OPTIONS ON INDICES--A securities index assigns relative values to the
securities included in the index and fluctuates with changes in the market
values of these securities. A securities index option operates in the same way
as more traditional securities options, except that the exercise of a securities
index option is effected with cash payment and does not involve delivery of
securities. Thus, upon exercise of a securities index option, the purchaser will
realize, and the writer will pay, an amount based on the difference between the
exercise price and the closing price of the securities index.
SECURITIES INDEX FUTURES CONTRACTS--A securities index futures contract is
a bilateral agreement pursuant to which one party agrees to accept, and the
other party agrees to make, delivery of an amount of cash equal to a specified
dollar amount times the difference between the securities index value at the
close of trading of the contract and the price at which the futures contract is
originally struck. No physical delivery of the securities comprising the index
is made. Generally, contracts are closed out prior to the expiration date of the
contract.
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INTEREST RATE FUTURES CONTRACTS--Interest rate futures contracts are
bilateral agreements pursuant to which one party agrees to make, and the other
party agrees to accept, delivery of a specified type of debt security at a
specified future time and at a specified price. Although such futures contracts
by their terms call for actual delivery or acceptance of debt securities, in
most cases the contracts are closed out before the settlement date without the
making or taking of delivery.
OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities, except that an option on a futures contract gives the
purchaser the right, in return for the premium, to assume a position in a
futures contract (a long position if the option is a call and a short position
if the option is a put), rather than to purchase or sell a security, at a
specified price at any time during the option term. Upon exercise of the option,
the delivery of the futures position to the holder of the option will be
accompanied by delivery of the accumulated balance which represents the amount
by which the market price of the futures contract exceeds, in the case of a
call, or is less than, in the case of a put, the exercise price of the option on
the future. The writer of an option, upon exercise, will assume a short position
in the case of a call and a long position in the case of a put.
GENERAL DESCRIPTION OF STRATEGIES USING DERIVATIVE INSTRUMENTS. Hedging
strategies can be broadly categorized as "short hedges" and "long hedges." A
short hedge is a purchase or sale of a Derivative Instrument intended partially
or fully to offset potential declines in the value of one or more investments
held in a Fund's portfolio. Thus, in a short hedge a Fund takes a position in a
Derivative Instrument whose price is expected to move in the opposite direction
of the price of the investment being hedged. For example, a Fund might purchase
a put option on a security to hedge against a potential decline in the value of
that security. If the price of the security declined below the exercise price of
the put, the Fund could exercise that put and thus limit its loss below the
exercise price to the premium paid plus transaction costs. In the alternative,
because the value of the put option can be expected to increase as the value of
the underlying security declines, the Fund might be able to close out the put
option and realize a gain to offset the decline in the value of the security.
Conversely, a long hedge is a purchase or sale of a Derivative Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that a Fund intends to acquire. Thus, in a long
hedge a Fund takes a position in a Derivative Instrument whose price is expected
to move in the same direction as the price of the prospective investment being
hedged. For example, a Fund might purchase a call option on a security it
intends to purchase in order to hedge against an increase in the cost of the
security. If the price of the security increased above the exercise price of the
call, the Fund could exercise the call and thus limit its acquisition cost to
the exercise price plus the premium paid and transaction costs. Alternatively,
the Fund might be able to offset the price increase by closing out an
appreciated call option and realizing a gain.
Each Fund may purchase and write (sell) covered straddles on securities or
indices of securities. A long straddle is a combination of a call and a put
option purchased on the same security or on the same futures contract, where the
exercise price of the put is equal to the exercise price of the call. The Fund
might enter into a long straddle when Mitchell Hutchins believes it likely that
the prices of the securities will be more volatile during the term of the option
than the option pricing implies. A short straddle is a combination of a call and
a put written on the same security where the exercise price of the put is equal
to the exercise price of the call. A Fund might enter into a short straddle when
Mitchell Hutchins believes it unlikely that the prices of the securities will be
as volatile during the term of the option as the option pricing implies.
Derivative Instruments on securities generally are used to hedge against
price movements in one or more particular securities positions that a Fund owns
or intends to acquire. Derivative Instruments on stock indices, in contrast,
generally are used to hedge against price movements in broad equity markets
sectors in which a Fund has invested or expects to invest. Derivative
Instruments on debt securities may be used to hedge either individual securities
or broad fixed income market sectors.
Income strategies include the writing of covered options to obtain the
related option premiums. Return strategies include the use of Derivative
Instruments to increase or reduce a Fund's exposure to an asset class without
buying or selling the underlying instruments.
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The use of Derivative Instruments is subject to applicable regulations of
the SEC, the several options and futures exchanges upon which they are traded
and the Commodity Futures Trading Commission ("CFTC"). In addition, the Funds'
ability to use Derivative Instruments may be limited by tax considerations. See
"Taxes."
In addition to the products, strategies and risks described below and in
the Prospectus, Mitchell Hutchins expects to discover additional opportunities
in connection with Derivative Instruments and hedging, income and return
strategies. These new opportunities may become available as regulatory
authorities broaden the range of permitted transactions and as new Derivative
Instruments and techniques are developed. Mitchell Hutchins may utilize these
opportunities to the extent that they are consistent with a Fund's investment
objective and permitted by a Fund's investment limitations and applicable
regulatory authorities. The Funds' Prospectus or Statement of Additional
Information will be supplemented to the extent that new products or techniques
involve materially different risks than those described below or in the
Prospectus.
SPECIAL RISKS OF STRATEGIES USING DERIVATIVE INSTRUMENTS. The use of
Derivative Instruments involves special considerations and risks, as described
below. Risks pertaining to particular Derivative Instruments are described in
the sections that follow:
(1) Successful use of most Derivative Instruments depends upon Mitchell
Hutchins' ability to predict movements of the overall securities and interest
rate markets, which requires different skills than predicting changes in the
prices of individual securities. While Mitchell Hutchins is experienced in the
use of Derivative Instruments, there can be no assurance that any particular
strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Derivative Instrument and price movements of the
investments being hedged. For example, if the value of a Derivative Instrument
used in a short hedge increased by less than the decline in value of the hedged
investment, the hedge would not be fully successful. Such a lack of correlation
might occur due to factors affecting the markets in which Derivative Instruments
are traded rather than the value of the investments being hedged. The
effectiveness of hedges using Derivative Instruments on indices will depend on
the degree of correlation between price movements in the index and price
movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly or
partially offsetting the negative effect of unfavorable price movements in the
investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if a Fund entered into a short
hedge because Mitchell Hutchins projected a decline in the price of a security
in the Fund's portfolio, and the price of that security increased instead, the
gain from that increase might be wholly or partially offset by a decline in the
price of the Derivative Instrument. Moreover, if the price of the Derivative
Instrument declined by more than the increase in the price of the security, the
Fund could suffer a loss. In either case, the Fund would have been in a better
position had it not hedged at all.
(4) As described below, each Fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Derivative Instruments involving obligations to third parties
(i.e., Derivative Instruments other than purchased options). If a Fund were
unable to close out its positions in such Derivative Instruments, it might be
required to continue to maintain such assets or accounts or make such payments
until the position expired or matured. These requirements might impair a Fund's
ability to sell a portfolio security or make an investment at a time when it
would otherwise be favorable to do so, or require that the Fund sell a portfolio
security at a disadvantageous time. A Fund's ability to close out a position in
a Derivative Instrument prior to expiration or maturity depends on the existence
of a liquid secondary market or, in the absence of such a market, the ability
and willingness of a counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any position in a Derivative
Instrument can be closed out at a time and price that is favorable to a Fund.
COVER FOR STRATEGIES USING DERIVATIVE INSTRUMENTS. Transactions using
Derivative Instruments, other than purchased options, expose the Funds to an
obligation to another party. A Fund will not enter into any such transactions
unless it owns either (1) an offsetting ("covered") position in securities or
other options on futures contracts or (2) cash or liquid securities, with a
value sufficient at all times to cover its potential
14
<PAGE>
obligations to the extent not covered as provided in (1) above. The Funds will
comply with SEC guidelines regarding cover for transactions and will, if the
guidelines so require, set aside cash or liquid securities in a segregated
account with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Derivative Instrument is open, unless they are
replaced with similar assets. As a result, the commitment of a large portion of
a Fund's assets to cover positions or to segregated accounts could impede
portfolio management or the Fund's ability to meet redemption requests or other
current obligations.
OPTIONS. The Funds may purchase put and call options, and write (sell)
covered put and call options, on specific securities and on indices. The
purchase of options can serve to enhance return by increasing or reducing a
Fund's exposure to an asset class without purchasing or selling the underlying
securities. The purchase of call options serves as a long hedge, and the
purchase of put options serves as a short hedge. Writing covered put or call
options can enable a Fund to enhance income by reason of the premiums paid by
the purchasers of such options. In addition, writing covered put options serves
as a limited long hedge, because increases in the value of the hedged investment
would be offset to the extent of the premium received for writing the option.
However, if the market price of the security underlying a covered put option
declines to less than the exercise price of the option, minus the premium
received, the Fund would expect to suffer a loss. Writing covered call options
serves as a limited short hedge, because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing the
option. However, if the security appreciates to a price higher than the exercise
price of the call option, it can be expected that the option will be exercised
and the Fund will be obligated to sell the security at less than its market
value. The securities or other assets used as cover for OTC options written by a
Fund would be considered illiquid to the extent described above under
"Investment Policies and Restrictions--Illiquid Securities."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options normally have expiration dates
of up to nine months. Generally, OTC options on debt securities are
European-style options. This means that the option is only exercisable
immediately prior to its expiration. This is in contrast to American-style
options, which are exercisable at any time prior to the expiration date of the
option. Options that expire unexercised have no value.
The Funds may effectively terminate their rights or obligations under an
option by entering into a closing transaction. For example, a Fund may terminate
its obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, a Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a closing
sale transaction. Closing transactions permit the Funds to realize profits or
limit losses on an option position prior to its exercise or expiration.
The Funds may purchase or write both exchange-traded and OTC options.
Exchange markets for options on debt securities exist but are relatively new,
and these instruments are primarily traded on the OTC market. Exchange-traded
options in the United States are issued by a clearing organization affiliated
with the exchange on which the option is listed which, in effect, guarantees
completion of every exchange-traded option transaction. In contrast, OTC options
are contracts between a Fund and its counterparty (usually a securities dealer
or a bank) with no clearing organization guarantee. Thus, when a Fund purchases
or writes an OTC option, it relies on the counterparty to make or take delivery
of the underlying investment upon exercise of the option. Failure by the
counterparty to do so would result in the loss of any premium paid by the Fund
as well as the loss of any expected benefit of the transaction.
The Funds' ability to establish and close out positions in exchange-traded
options depends on the existence of a liquid market. Each Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the counterparty, or by a
transaction in the secondary market if any such market exists. Although the
Funds will enter into OTC options only with counterparties that are expected to
be capable of entering into closing transactions with the Fund, there is no
assurance that a Fund will in fact be able to close out an OTC
15
<PAGE>
option position at a favorable price prior to expiration. In the event of
insolvency of the counterparty, a Fund might be unable to close out an OTC
option position at any time prior to its expiration.
If a Fund were unable to effect a closing transaction for an option it had
purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered call option
written by a Fund could cause material losses because the Fund would be unable
to sell the investment used as cover for the written option until the option
expires or is exercised.
The Funds may purchase and write put and call options on securities indices
in much the same manner as the more traditional options discussed above, except
the index options may serve as a hedge against overall fluctuations in the
equity or bond market (or market sectors) rather than anticipated increases or
decreases in the value of a particular security.
LIMITATIONS ON THE USE OF OPTIONS. The Funds' use of options is governed
by the following guidelines, which can be changed by each board without
shareholder vote:
1. Each Fund may purchase a put or call option, including any straddle or
spread, only if the value of its premium, when aggregated with the premiums on
all other options purchased by the Fund, does not exceed 5% of its total assets.
2. The aggregate value of securities underlying put options written by each
Fund, determined as of the date the put options are written, will not exceed 50%
of its net assets.
3. The aggregate premiums paid on all options (including options on
securities and stock or bond indices and options on futures contracts) purchased
by each Fund that are held at any time will not exceed 20% of its net assets.
FUTURES. The Funds may purchase and sell interest rate futures contracts,
stock index futures contracts or bond index futures contracts. The Funds also
may purchase put and call options, and write covered put and call options, on
the futures contracts they are allowed to purchase and sell. The purchase of
futures or call options thereon can serve as a long hedge, and the sale of
futures or the purchase of put options thereon can serve as a short hedge.
Writing covered call options on futures contracts can serve as a limited short
hedge, and writing covered put options on futures contracts can serve as a
limited long hedge, using a strategy similar to that used for writing covered
call options on securities or indices. In addition, the Funds may purchase or
sell futures contracts or options thereon to enhance return by increasing or
reducing exposure to an asset class without purchasing or selling the underlying
securities.
Futures strategies also can be used to manage the average duration of a
Fund's portfolio. If Mitchell Hutchins wishes to shorten the average duration of
a Fund, the Fund may sell an interest rate futures contract or a call option
thereon, or purchase a put option on that futures contract. If Mitchell Hutchins
wishes to lengthen the average duration of a Fund's portfolio, the Fund may buy
an interest rate futures contract or a call option thereon or sell a put option
thereon.
The Funds may also write put options on interest rate futures contracts
while at the same time purchasing call options on the same futures contracts in
order synthetically to create a long futures contract position. Such options
would have the same strike prices and expiration dates. A Fund will engage in
this strategy only when it is more advantageous to the Fund than is purchasing
the futures contract.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract, a Fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, "initial margin" consisting of cash, obligations of
the United States or obligations fully guaranteed as to principal and interest
by the United States, in an amount generally equal to 10% or less of the
contract value. Margin must also be deposited when writing a call option on a
futures contract, in accordance with applicable exchange rules. Unlike margin in
securities transactions, initial margin on futures contracts does not represent
a borrowing, but rather is in the nature of a performance bond or good-faith
deposit that is returned to the Fund at the termination of the transaction if
all contractual obligations have been satisfied. Under certain circumstances,
such as periods of high volatility, a Fund may be required by an exchange to
increase the level of its initial margin payment, and initial margin
requirements might be increased generally in the future by regulatory action.
16
<PAGE>
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of a Fund's obligations to or from a futures
broker. When a Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when a Fund purchases or
sells a futures contract or writes a put or call option thereon, it is subject
to daily variation margin calls that could be substantial in the event of
adverse price movements. If a Fund has insufficient cash to meet daily variation
margin requirements, it might need to sell securities at a time when such sales
are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument held or written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
Each Fund intends to enter into futures transactions only on exchanges or boards
of trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If a Fund were unable to liquidate a futures or options position due to the
absence of a liquid secondary market or the imposition of price limits, it could
incur substantial losses. The Fund would continue to be subject to market risk
with respect to the position. In addition, except in the case of purchased
options, the Fund would continue to be required to make daily variation margin
payments and might be required to maintain the position being hedged by the
future or option or to maintain cash or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options markets
are subject to daily variation margin calls and might be compelled to liquidate
futures or related options positions whose prices are moving unfavorably to
avoid being subject to further calls. These liquidations could increase price
volatility of the instruments and distort the normal price relationship between
the futures or options and the investments being hedged. Also, because initial
margin deposit requirements in the futures market are less onerous than margin
requirements in the securities markets, there might be increased participation
by speculators in the futures markets. This participation also might cause
temporary price distortions. In addition, activities of large traders in both
the futures and securities markets involving arbitrage, "program trading" and
other investment strategies might result in temporary price distortions.
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. The Funds' use of
futures and related options is governed by the following guidelines, which can
be changed by each board without shareholder vote:
1. To the extent a Fund enters into futures contracts and options on
futures positions that are not for bona fide hedging purposes (as defined by the
CFTC), the aggregate initial margin and premiums on those positions (excluding
the amount by which options are "in-the-money") may not exceed 5% of its net
assets.
2. The aggregate premiums paid on all options (including options on
securities and stock or bond indices and options on futures contracts) purchased
by a Fund that are held at any time will not exceed 20% of its net assets.
3. The aggregate margin deposits on all futures contracts and options
thereon held at any time by a Fund will not exceed 5% of its total assets.
SWAP TRANSACTIONS. Balanced Fund may enter into swap transactions,
including interest rate swaps and interest rate caps, floors and collars. Swap
transactions involve an agreement between two parties to
17
<PAGE>
exchange payments that are based, for example, on variable and fixed rates of
interest and that are calculated on the basis of a specified amount of principal
(the "notional principal amount") for a specified period of time. Interest rate
cap and floor transactions involve an agreement between two parties in which the
first party agrees to make payments to the counterparty when a designated market
interest rate goes above (in the case of a cap) or below (in the case of a
floor) a designated level on predetermined dates or during a specified time
period. Interest rate collar transactions involve an agreement between two
parties in which payments are made when a designated market interest rate either
goes above a designated ceiling level or goes below a designated floor level on
predetermined dates or during a specified time period. The Fund intends to use
these transactions as a hedge and not as a speculative investment. Interest rate
protection transactions are subject to risks comparable to those described above
with respect to other hedging strategies.
Balanced Fund may enter into interest rate swaps, caps, floors and collars
on either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest rate
swaps on a net basis, i.e., the two payment streams are netted out, with the
Fund receiving or paying, as the case may be, only the net amount of the two
payments. Inasmuch as these interest rate protection transactions are entered
into for good faith hedging purposes, and inasmuch as segregated accounts will
be established with respect to such transactions, Mitchell Hutchins believes
such obligations do not constitute senior securities and, accordingly, will not
treat them as being subject to the Fund's borrowing restrictions. The net amount
of the excess, if any, of the Fund's obligations over its entitlements with
respect to each interest rate swap will be accrued on a daily basis and
appropriate Fund assets having an aggregate net asset value at least equal to
the accrued excess will be maintained in a segregated account as described above
in "Investment Policies and Restrictions--Segregated Accounts." The Fund also
will establish and maintain such segregated accounts with respect to its total
obligations under any swaps that are not entered into on a net basis and with
respect to any caps, floors and collars that are written by the Fund.
Balanced Fund will enter into interest rate protection transactions only
with banks and recognized securities dealers believed by Mitchell Hutchins to
present minimal credit risk in accordance with guidelines established by its
board. If there is a default by the other party to such a transaction, the Fund
will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
18
<PAGE>
DIRECTORS, TRUSTEES AND OFFICERS; PRINCIPAL HOLDERS OF SECURITIES
The directors, trustees and executive officers of the Corporation and/or
the Trust, their ages, business addresses and principal occupations during the
past five years are:
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE CORPORATION/TRUST OTHER DIRECTORSHIPS
- ------------------------------------ --------------------------- ---------------------------------------------
<S> <C> <C>
Margo N. Alexander**; 51 Director/Trustee and Mrs. Alexander is president, chief executive
President officer and a director of Mitchell Hutchins
(since January 1995) and an executive vice
president and a director of PaineWebber
(since March 1984). Mrs. Alexander is
president and a director or trustee of 32
investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
Richard Q. Armstrong; 63 Director/Trustee Mr. Armstrong is chairman and principal of
One Old Church Road R.Q.A. Enterprises (management consulting
Unit #6 firm) (since April 1991 and principal
Greenwich, CT 06830 occupation since March 1995). Mr. Arm-
strong was chairman of the board, chief
executive officer and co-owner of
Adirondack Beverages (producer and dis-
tributor of soft drinks and sparkling/still
waters) (October 1993-March 1995). He was a
partner of The New England Consulting Group
(management consulting firm) (December
1992-September 1993). He was managing
director of LVMH U.S. Corporation (U.S.
subsidiary of the French luxury goods
conglomerate, Louis Vuitton Moet Hennessey
Corporation) (1987-1991) and chairman of
its wine and spirits subsidiary,
Schieffelin & Somerset Company (1987-1991).
Mr. Armstrong is a director or trustee of
31 investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
E. Garrett Bewkes, Jr.**; 72 Director/Trustee and Mr. Bewkes is a director of Paine Webber
Chairman of the Board of Group Inc. ( "PW Group") (holding company
Directors/Trustees of PaineWebber and Mitchell Hutchins).
Prior to December 1995, he was a consultant
to PW Group. Prior to 1988, he was chairman
of the board, president and chief executive
officer of American Bakeries Company.
Mr. Bewkes is a director of Interstate
Bakeries Corporation. Mr. Bewkes is a
director or trustee of 34 investment
companies for which Mitchell Hutchins,
PaineWebber or their affiliates serve as
investment adviser.
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE CORPORATION/TRUST OTHER DIRECTORSHIPS
- ------------------------------------ --------------------------- ---------------------------------------------
<S> <C> <C>
Richard R. Burt; 51 Director/Trustee Mr. Burt is chairman of IEP Advisors, Inc.
1275 Pennsylvania Avenue, N.W. (international investments and consulting
Washington, D.C. 20004 firm) (since March 1994) and a partner of
McKinsey & Company (management consulting
firm) (since 1991). He is also a director
of Archer-Daniels-Midland Co. (ag-
ricultural commodities), Hollinger Inter-
national Co. (publishing), Homestake Mining
Corp., Powerhouse Technologies Inc. and
Wierton Steel Corp. He was the chief
negotiator in the Strategic Arms Re-
duction Talks with the former Soviet Union
(1989-1991) and the U.S. Ambassador to the
Federal Republic of Germany (1985-1989).
Mr. Burt is a director or trustee of 31
investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
Mary C. Farrell**; 48 Director/Trustee Ms. Farrell is a managing director, senior
investment strategist and member of the In-
vestment Policy Committee of PaineWebber.
Ms. Farrell joined PaineWebber in 1982. She
is a member of the Financial Women's
Association and Women's Economic
Roundtable, and appears as a regular
panelist on Wall $treet Week with Louis
Rukeyser. She also serves on the Board of
Overseers of New York University's Stern
School of Business. Ms. Farrell is a
director or trustee of 31 investment
companies for which Mitchell Hutchins,
PaineWebber or their affiliates serve as
investment adviser.
Meyer Feldberg; 56 Director/Trustee Mr. Feldberg is Dean and Professor of Man-
Columbia University agement of the Graduate School of Busi-
101 Uris Hall ness, Columbia University. Prior to 1989,
New York, New York 10027 he was president of the Illinois Institute
of Technology. Dean Feldberg is also a di-
rector of Primedia Inc., Federated De-
partment Stores, Inc. and Revlon Inc. Dean
Feldberg is a director or trustee of 33
investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
George W. Gowen; 69 Director/Trustee Mr. Gowen is a partner in the law firm of
666 Third Avenue Dunnington, Bartholow & Miller. Prior to
New York, New York 10017 May 1994, he was a partner in the law firm
of Fryer, Ross & Gowen. Mr. Gowen is a
director or trustee of 31 investment com-
panies for which Mitchell Hutchins,
PaineWebber or their affiliates serve as
investment adviser.
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE CORPORATION/TRUST OTHER DIRECTORSHIPS
- ------------------------------------ --------------------------- ---------------------------------------------
<S> <C> <C>
Frederic V. Malek; 61 Director/Trust Mr. Malek is chairman of Thayer Capital
1455 Pennsylvania Avenue, N.W. Partners (merchant bank). From January 1992
Suite 350 to November 1992, he was campaign manager
Washington, D.C. 20004 of Bush-Quayle '92. From 1990 to 1992, he
was vice chairman and, from 1989 to 1990,
he was president of Northwest Airlines
Inc., NWA Inc. (holding company of
Northwest Airlines Inc.) and Wings Holdings
Inc. (holding company of NWA Inc.). Prior
to 1989, he was
employed by the Marriott Corporation
(hotels, restaurants, airline catering and
contract feeding), where he most recently
was an executive vice president and presi-
dent of Marriott Hotels and Resorts. Mr.
Malek is also a director of American
Management Systems, Inc. (management
consulting and computer-related services),
Automatic Data Processing, Inc., CB
Commercial Group, Inc. (real estate
services), Choice Hotels International
(hotel and hotel franchising), FPL Group,
Inc. (electric services), Manor Care, Inc.
(healthcare), and Northwest Airlines Inc.
Mr. Malek is a director or trustee of 31
investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
Carl W. Schafer; 62 Director/Trust Mr. Schafer is president of the Atlantic
66 Witherspoon Street Foundation (charitable foundation sup-
#1100 porting mainly oceanographic exploration
Princeton, New Jersey 08542 and research). He also is a director of
Base Ten Systems, Inc. (software), Road-
way Express, Inc. (trucking), The Guardi-
an Group of Mutual Funds, the Harding
Loevner Funds, Evans Systems, Inc. (a motor
fuels, convenience store and diversified
company), Electronic Clearing House, Inc.
(financial transactions pro-
cessing), Frontier Oil Corporation and
Nutraceutix Inc. (biotechnology company.)
Prior to January 1993, he was chairman of
the Investment Advisory Committee of the
Howard Hughes Medical Institute.
Mr. Schafer is a director or trustee of 31
investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE CORPORATION/TRUST OTHER DIRECTORSHIPS
- ------------------------------------ --------------------------- ---------------------------------------------
<S> <C> <C>
T. Kirkham Barneby; 52 Vice President Mr. Barneby is a managing director and chief
investment officer--quantitative invest-
ments of Mitchell Hutchins. Prior to Sep-
tember 1994, he was a senior vice presi-
dent at Vantage Global Management.
Mr. Barneby is a vice president of six in-
vestment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
Lawrence Chinsky; 29 Vice President and Mr. Chinsky is an assistant vice president
Assistant Treasurer and investment monitoring officer of the
mutual fund finance department of Mitchell
Hutchins. Prior to August 1997, he was a
securities compliance examiner with the
Office of Compliance, Inspections and
Examinations in the New York Regional
Office of the United States Securities and
Exchange Commission. Mr. Chinsky is vice
president and assistant treasurer of 32
investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
John J. Lee; 30 Vice President and Mr. Lee is a vice president and a manager of
Assistant Treasurer the mutual fund finance department of
Mitchell Hutchins. Prior to September 1997,
he was an audit manager in the financial
services practice of Ernst & Young LLP. Mr.
Lee is a vice president and assistant
treasurer of 32 investment companies for
which Mitchell Hutchins, PaineWebber or
their affiliates serve as investment
adviser.
Dennis McCauley; 52 Vice President (Master Mr. McCauley is a managing director and chief
Series, Inc.) investment officer--fixed income of
Mitchell Hutchins. Prior to December 1994,
he was director of fixed income in-
vestments of IBM Corporation. Mr. Mc-
Cauley is a vice president of 22 investment
companies for which Mitchell Hutchins,
PaineWebber or their affiliates serve as
investment adviser.
Ann E. Moran; 41 Vice President amd Ms. Moran is a vice president and a manager
Assistant Treasurer of the mutual fund finance department of
Mitchell Hutchins. Ms. Moran is a vice
president and assistant treasurer of 32 in-
vestment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
Dianne E. O'Donnell; 46 Vice President and Ms. O'Donnell is a senior vice president
Secretary and deputy general counsel of Mitchell
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE CORPORATION/TRUST OTHER DIRECTORSHIPS
- ------------------------------------ --------------------------- ---------------------------------------------
<S> <C> <C>
Hutchins. Ms. O'Donnell is a vice presi-
dent and secretary of 31 investment com-
panies and a vice president and assistant
secretary of one investment company for
which Mitchell Hutchins, Paine Webber or
their affiliates serve as investment
adviser.
Emil Polito; 38 Vice President Mr. Polito is a senior vice president and di-
rector of operations and control for Mitch-
ell Hutchins. Mr. Polito is also vice
president of 32 investment companies for
which Mitchell Hutchins, PaineWebber or
their affiliates serve as investment
adviser.
Susan P. Ryan; 38 Vice President (Master Ms. Ryan is a senior vice president and port-
Series, Inc.) folio manager of Mitchell Hutchins and has
been with Mitchell Hutchins since 1982.
Ms. Ryan is a vice president of five
investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
Victoria E. Schonfeld; 47 Vice President Ms. Schonfeld is a managing director and
general counsel of Mitchell Hutchins. Prior
to May 1994, she was a partner in the law
firm of Arnold & Porter. Ms. Schonfeld is a
vice president of 31 investment companies
and a vice president and secretary of one
investment company for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
Paul H. Schubert; 35 Vice President and Mr. Schubert is a senior vice president and
Treasurer the director of the mutual fund finance
department of Mitchell Hutchins. From
August 1992 to August 1994, he was a
vice president of BlackRock Financial
Management, Inc. Mr. Schubert is a vice
president and treasurer of 32 investment
companies for which Mitchell Hutchins,
PaineWebber or their affiliates serve as
investment adviser.
Nirmal Singh; 42 Vice President (Master Mr. Singh is a senior vice president and a
Series, Inc.) portfolio manager of Mitchell Hutchins.
Mr. Singh is a vice president of four
investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
Barney A. Taglialatela; 37 Vice President Assistant Mr. Taglialatela is a vice president and a
Treasurer manager of the mutual fund finance de-
partment of Mitchell Hutchins. Prior to
February 1995, he was a manager of the
mutual fund finance division of Kidder
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE CORPORATION/TRUST OTHER DIRECTORSHIPS
- ------------------------------------ --------------------------- ---------------------------------------------
<S> <C> <C>
Peabody Asset Management, Inc. Mr.
Taglialatela is a vice president and assis-
tant treasurer of 32 investment companies
for which Mitchell Hutchins, PaineWebber or
their affiliates serve as investment
adviser.
Mark A. Tincher; 43 Vice President (Investment Mr. Tincher is a managing director and chief
Trust) investment officer--equities of Mitchell
Hutchins. Prior to March 1995, he was a
vice president and directed the U.S. funds
management and equity research areas of
Chase Manhattan Private Bank. Mr. Tincher
is a vice president of 13 investment
companies for which Mitchell Hutchins,
PaineWebber or their affiliates serve as
investment adviser.
Craig M. Varrelman; 39 Vice President (Master Mr. Varrelman is a senior vice president and
Series, Inc.) a portfolio manager of Mitchell Hutchins.
Mr. Varrelman is a vice president of four
investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
Keith A. Weller; 37 Vice President and Mr. Weller is a first vice president and as-
Assistant Secretary sociate general counsel of Mitchell
Hutchins. Prior to May 1995, he was an at-
torney in private practice. Mr. Weller is a
vice president and assistant secretary of
31 investment companies for which Mitchell
Hutchins, PaineWebber or their affiliates
serve as investment adviser.
</TABLE>
- ------------------
* Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019.
** Mrs. Alexander, Mr. Bewkes and Ms. Farrell are "interested persons" of the
Corporation and the Trust as defined in the 1940 Act by virtue of their
positions with PW Group, PaineWebber and/or Mitchell Hutchins.
The Corporation and the Trust each pays board members who are not
"interested persons" of the Corporation/Trust $1,500 annually for Balanced Fund
or Tactical Allocation Fund, as applicable, an additional $1,000 for the
Corporation's or Trust's second series, and $150 per series for each board
meeting and separate meeting of a board committee (other than committee meetings
that are held on the same day as a board meeting). Thus, the Corporation and
Trust each pays an independent board member $2,500 annually plus any additional
amounts due for board or committee meetings. Each chairman of the audit and
contract review committees of individual funds within the PaineWebber fund
complex receives additional compensation, aggregating $15,000 annually from the
relevant funds. All board members are reimbursed for any expenses incurred in
attending meetings. Board members and officers of the Corporation/Trust own in
the aggregate less than 1% of the shares of either Fund. Because PaineWebber and
Mitchell Hutchins perform substantially all of the services necessary for the
operation of the Corporation, the Trust and the Funds, the Corporation and the
Trust require no employees. No officer, director or employee of PaineWebber or
Mitchell Hutchins presently receives any compensation from the Corporation or
the Trust for acting as director, trustee or officer.
24
<PAGE>
The table below includes certain information relating to the compensation
of the Corporation's and the Trust's current board members who held office with
the Corporation or Trust or with other PaineWebber funds during the fiscal year
indicated.
COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
FROM THE
AGGREGATE AGGREGATE CORPORATION,
COMPENSATION COMPENSATION THE TRUSTS
FROM THE FROM THE AND THE
NAME OF PERSON, POSITION CORPORATION*++ TRUST*++ COMPLEX+
- ------------------------------------------------------------- ------------- -------------- ------------
<S> <C> <C> <C>
Richard Q. Armstrong, Director/Trustee....................... $ 5,585 $4,300 $ 94,885
Richard R. Burt, Director/Trustee............................ 3,285 4,000 87,085
Meyer Feldberg, Director/Trustee............................. 5,585 5,815 117,853
George W. Gowen, Director/Trustee............................ 6,450 4,000 101,567
Frederic V. Malek, Director/Trustee.......................... 5,585 4,300 95,845
Carl W. Schafer, Director/Trustee............................ 5,585 4,300 94,885
</TABLE>
- ------------------
(1) Only independent members of the board are compensated by the Corporation or
the Trust and identified above; board members who are "interested persons,"
as defined by the 1940 Act, do not receive compensation.
* Represents fees paid to each board member during the fiscal year ended
August 31, 1998 for the Trust and the Corporation.
+ Represents total compensation paid to each board member during the calendar
year ended December 31, 1997; no fund within the fund complex has a bonus,
pension, profit sharing or retirement plan.
++ Aggregate compensation for the Corporation and the Trust are divided among
other portfolios.
PRINCIPAL HOLDERS OF SECURITIES. The Funds' records as of October 31, 1998
did not indicate that any shareholder owned of record more than 5% of any class
of a Fund's shares and the Trust and Corporation are not aware of any
shareholder who is the beneficial owner of 5% or more of a Fund's shares.
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator of each Fund pursuant to a contract with the
Corporation dated August 4, 1988 and a contract with the Trust dated April 13,
1995 (each an "Advisory Contract"). Under the Advisory Contracts each Fund pays
Mitchell Hutchins an annual fee, computed daily and paid monthly, according to
the schedule set forth below:
<TABLE>
<CAPTION>
BALANCED FUND
ANNUAL
AVERAGE DAILY NET ASSETS RATE
- ------------------------------------------------------------------------------------- ------
<S> <C>
Up to $500 million................................................................... 0.750%
In excess of $500 million up to $1.0 billion......................................... 0.725
In excess of $1.0 billion up to $1.5 billion......................................... 0.700
In excess of $1.5 billion up to $2.0 billion......................................... 0.675
Over $2.0 billion.................................................................... 0.650
TACTICAL ALLOCATION FUND
<CAPTION>
ANNUAL
AVERAGE DAILY NET ASSETS RATE
- ------------------------------------------------------------------------------------- ------
<S> <C>
Up to $250 million................................................................... 0.500%
Over $250 million.................................................................... 0.450
</TABLE>
During the fiscal years ended August 31, 1998 and August 31, 1997, the
period March 1, 1996 through August 31, 1996 and the fiscal year ended February
29, 1996, the Corporation paid (or accrued) to Mitchell
25
<PAGE>
Hutchins investment advisory and administrative fees of $1,709,264, $1,465,166,
$739,209, and $1,584,083, respectively, with respect to Balanced Fund.
For the fiscal years ended August 31, 1998, August 31, 1997, and August 31,
1996, the Trust paid (or accrued) to Mitchell Hutchins management fees of
$4,895,190, $1,756,146 and $402,466, respectively, with respect to Tactical
Allocation Fund.
Prior to August 1, 1997, pursuant to a service agreement, PaineWebber
provided certain services to Balanced Fund not otherwise provided by the Fund's
transfer agent PFPC Inc. ("PFPC"). No such service agreement was in effect with
respect to Tactical Allocation Fund. Pursuant to the service agreement between
PaineWebber and Balanced Fund, during the period September 1, 1996 to August 1,
1997, the period March 1, 1996 to August 31, 1996, and the fiscal years ended
February 29, 1996, PaineWebber earned fees in the amounts of $54,420, $32,992
and $77,050, respectively. Subsequent to August 1, 1997, PFPC (not the Funds)
pays PaineWebber for certain transfer agency related services that PFPC has
delegated to PaineWebber.
During the fiscal year ended August 31, 1998, the Funds paid (or accrued)
the following fees to PaineWebber for its services as securities lending agent:
<TABLE>
<CAPTION>
FUND SECURITIES LENDING FEES
- ------------------------------------------------- -----------------------
<S> <C>
Balanced Fund.................................... $ 28,144
Tactical Allocation Fund......................... $ 134,065
</TABLE>
Under the terms of the Advisory Contracts, each Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. General expenses of the Corporation or the Trust not readily
identifiable as belonging to the Funds or to the Corporation's or Trust's other
series are allocated among series by or under the direction of the board in such
manner as the board deems to be fair and equitable. Expenses borne by each Fund
include the following (or the Fund's share of the following): (1) the cost
(including brokerage commissions) of securities purchased or sold by the Fund
and any losses incurred in connection therewith; (2) fees payable to and
expenses incurred on behalf of the Fund by Mitchell Hutchins; (3) organizational
expenses; (4) filing fees and expenses relating to the registration and
qualification of the Fund's shares and the Corporation/Trust under federal and
state securities laws and maintenance of such registrations and qualifications;
(5) fees and salaries payable to board members who are not interested persons of
the Corporation/Trust or Mitchell Hutchins; (6) all expenses incurred in
connection with the board members' services, including travel expenses;
(7) taxes (including any income or franchise taxes) and governmental fees;
(8) costs of any liability, uncollectible items of deposit and other insurance
or fidelity bonds; (9) any costs, expenses or losses arising out of a liability
of or claim for damages or other relief asserted against the Corporation/Trust
or the Fund for violation of any law; (10) legal, accounting and auditing
expenses, including legal fees of special counsel for the independent board
members; (11) charges of custodians, transfer agents and other agents;
(12) costs of preparing share certificates; (13) expenses of setting in type and
printing prospectuses and supplements thereto, statements of additional
information and supplements thereto, reports and proxy materials for existing
shareholders, and costs of mailing such materials to existing shareholders;
(14) any extraordinary expenses (including fees and disbursements of counsel)
incurred by the Corporation/Trust or the Fund; (15) fees, voluntary assessments
and other expenses incurred in connection with membership in investment company
organizations; (16) costs of mailing and tabulating proxies and costs of
meetings of shareholders, the board and any committees thereof; (17) the cost of
investment company literature and other publications provided to board members
and officers; and (18) costs of mailing, stationery and communications
equipment.
Under the Advisory Contracts, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by either Fund in
connection with the performance of the Advisory Contracts, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part of
Mitchell Hutchins in the performance of its duties or from reckless disregard of
its duties and obligations thereunder. Each Advisory Contract terminates
automatically with respect to a Fund upon assignment and is terminable at any
time without penalty by the Corporation's or Trust's board or by vote of the
holders of a majority of a Fund's outstanding voting securities on 60 days'
written notice to Mitchell Hutchins, or by Mitchell Hutchins on 60 days' written
notice to the Corporation or the Trust.
26
<PAGE>
The following table shows the approximate net assets as of October 31,
1998, sorted by category of investment objective, of the investment companies as
to which Mitchell Hutchins serves as adviser or sub-adviser.
An investment company may fall into more than one of the categories below.
<TABLE>
<CAPTION>
NET ASSETS
INVESTMENT CATEGORY ($ MIL)
- ---------------------------------------------------------------------------------- ----------
<S> <C>
Domestic (excluding Money Market)................................................. $7,761.7
Global............................................................................ 3,627.2
Equity/Balanced................................................................... 6,301.2
Fixed Income (excluding Money Market)............................................. 5,087.7
Taxable Fixed Income......................................................... 3,496.1
Tax-Free Fixed Income........................................................ 1,591.6
Money Market Funds................................................................ 31,335.1
</TABLE>
PERSONNEL TRADING POLICIES. Mitchell Hutchins personnel may invest in
securities for their own accounts pursuant to a code of ethics that describes
the fiduciary duty owed to shareholders of PaineWebber mutual funds and other
Mitchell Hutchins' advisory accounts by all Mitchell Hutchins' directors,
officers and employees, establishes procedures for personal investing and
restricts certain transactions. For example, employee accounts generally must be
maintained at PaineWebber, personal trades in most securities require
pre-clearance and short-term trading and participation in initial public
offerings generally are prohibited. In addition, the code of ethics puts
restrictions on the timing of personal investing in relation to trades by
PaineWebber funds and other Mitchell Hutchins' advisory clients.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of
each class of shares of each Fund under separate distribution contracts with the
Corporation and the Trust (collectively, "Distribution Contracts") that require
Mitchell Hutchins to use its best efforts, consistent with its other businesses,
to sell shares of the applicable Fund. Shares of the Funds are offered
continuously. Under separate exclusive dealer agreements between Mitchell
Hutchins and PaineWebber relating to each class of shares of the Funds
(collectively, "Exclusive Dealer Agreements"), PaineWebber and its correspondent
firms sell each Fund's shares.
Under separate plans of distribution pertaining to the Class A, Class B and
Class C shares of each Fund adopted by the Corporation and the Trust in the
manner prescribed under Rule 12b-1 under the 1940 Act ("Class A Plan," "Class B
Plan" and "Class C Plan," collectively, "Plans"), each Fund pays Mitchell
Hutchins a service fee, accrued daily and payable monthly, at the annual rate of
0.25% of the average daily net assets of each class of shares. Under the
Class B Plan and Class C Plan each Fund pays Mitchell Hutchins a distribution
fee, accrued daily and payable monthly, at the annual rate of 0.75% of the
average daily net assets of those classes of shares. There is no distribution
plan with respect to the Funds' Class Y shares.
Among other things, each Plan provides that (1) Mitchell Hutchins will
submit to the applicable board at least quarterly, and the board members will
review, reports regarding all amounts expended under the Plan and the purposes
for which such expenditures were made, (2) the Plan will continue in effect only
so long as it is approved at least annually, and any material amendment thereto
is approved, by the applicable board, including those board members who are not
"interested persons" of the Corporation/Trust and who have no direct or indirect
financial interest in the operation of the Plan or any agreement related to the
Plan, acting in person at a meeting called for that purpose, (3) payments by a
Fund under the Plan shall not be materially increased without the affirmative
vote of the holders of a majority of the outstanding shares of the relevant
class and (4) while the Plan remains in effect, the selection and nomination of
board members who are not "interested persons" of the Corporation/Trust shall be
committed to the discretion of the board members who are not interested persons
of the Corporation/Trust.
In reporting amounts expended under the Plans to the board members,
Mitchell Hutchins will allocate expenses attributable to the sale of each class
of Fund shares to such class based on the ratio of sales of shares of such class
to the sales of all three classes of shares. The fees paid by one class of Fund
shares will not be used to subsidize the sale of any other class of Fund shares.
27
<PAGE>
The Funds paid (or accrued) the following fees to Mitchell Hutchins under
the Class A, Class B and Class C Plans during the fiscal year ended August 31,
1998:
<TABLE>
<CAPTION>
TACTICAL
BALANCED FUND ALLOCATION FUND
------------- ---------------
<S> <C> <C>
Class A..................................................... $ 480,384 $ 688,221
Class B..................................................... 244,383 3,844,046
Class C..................................................... 112,695 3,395,234
</TABLE>
Mitchell Hutchins estimates that it and its parent corporation,
PaineWebber, incurred the following shareholder service-related and
distribution-related expenses with respect to each Fund during the fiscal year
ended August 31, 1998.
CLASS A
<TABLE>
<CAPTION>
TACTICAL
BALANCED FUND ALLOCATION FUND
------------- ---------------
<S> <C> <C>
Marketing and advertising................................... $ 133,430 $ 651,985
Printing of prospectuses and statements of additional
information for other than current shareholders........... 3,389 4,261
Branch network costs allocated and interest expense......... 620,019 333,297
Service fees paid to PaineWebber investment executives...... 182,546 262,404
CLASS B
Marketing and advertising................................... $ 16,852 $ 901,704
Amortization of commissions................................. 72,325 1,149,132
Printing of prospectuses and statements of additional
information for other than current shareholders........... 421 5,893
Branch network costs allocated and interest expense......... 85,540 699,253
Service fees paid to PaineWebber investment executives...... 23,215 366,410
CLASS C
Marketing and advertising................................... $ 7,718 $ 779,562
Amortization of commissions................................. 32,119 880,992
Printing of prospectuses and statements of additional
information for other than current shareholders........... 190 5,095
Branch network costs allocated and interest expense......... 36,259 418,905
Service fees paid to PaineWebber investment executives...... 10,705 323,607
</TABLE>
"Marketing and advertising" includes various internal costs allocated by
Mitchell Hutchins to its efforts at distributing Fund shares. These internal
costs encompass office rent, salaries and other overhead expenses of various
departments and areas of operations of Mitchell Hutchins. "Branch network costs
allocated and interest expense" consist of an allocated portion of the expenses
of various PaineWebber departments involved in the distribution of the Fund's
shares, including the PaineWebber retail branch system.
In approving each Fund's overall Flexible Pricing(Service Mark) system of
distribution, each board considered several factors, including that
implementation of Flexible Pricing would (1) enable investors to choose the
purchasing option best suited to their individual situation, thereby encouraging
current shareholders to make additional investments in the Funds and attracting
new investors and assets to the Funds to the benefit of each Fund and its
shareholders; (2) facilitate distribution of each Fund's shares; and (3)
maintain the competitive position of each Fund in relation to other funds that
have implemented or are seeking to implement similar distribution arrangements.
In approving the Class A Plan each board considered all the features of the
distribution system, including (1) the conditions under which initial sales
charges would be imposed and the amount of such charges, (2) Mitchell Hutchins'
belief that the initial sales charge combined with a service fee would be
attractive to PaineWebber investment executives and correspondent firms,
resulting in a greater growth of the Funds than
28
<PAGE>
might otherwise be the case, (3) the advantages to the shareholders of economies
of scale resulting from growth in each Fund's assets and potential continued
growth, (4) the services provided to each Fund and its shareholders by Mitchell
Hutchins, (5) the services provided by PaineWebber pursuant to its Exclusive
Dealer Agreement with Mitchell Hutchins and (6) Mitchell Hutchins' shareholder
service-related expenses and costs.
In approving the Class B Plan each board considered all the features of the
distribution system, including (1) the conditions under which contingent
deferred sales charges would be imposed and the amount of such charges, (2) the
advantage to investors in having no initial sales charges deducted from each
Fund's purchase payments and instead having the entire amount of their purchase
payments immediately invested in Fund shares, (3) Mitchell Hutchins' belief that
the ability of PaineWebber investment executives and correspondent firms to
receive sales commissions when Class B shares are sold and continuing service
fees thereafter while their customers invest their entire purchase payments
immediately in Class B shares would prove attractive to the investment
executives and correspondent firms, resulting in greater growth of each Fund
than might otherwise be the case, (4) the advantages to the shareholders of
economies of scale resulting from growth in each Fund's assets and potential
continued growth, (5) the services provided to each Fund and its shareholders by
Mitchell Hutchins, (6) the services provided by PaineWebber pursuant to its
Exclusive Dealer Agreement with Mitchell Hutchins and (7) Mitchell Hutchins'
shareholder service- and distribution-related expenses and costs. The board
members also recognized that Mitchell Hutchins' willingness to compensate
PaineWebber and its investment executives, without the concomitant receipt by
Mitchell Hutchins of initial sales charges, was conditioned upon its expectation
of being compensated under the Class B Plan.
In approving the Class C Plan each board considered all the features of the
distribution system, including (1) the advantage to investors in having no
initial sales charges deducted from Fund purchase payments and instead having
the entire amount of their purchase payments immediately invested in Fund
shares, (2) the advantage to investors in being free from contingent deferred
sales charges upon redemption for shares held more than one year and paying for
distribution on an ongoing basis, (3) Mitchell Hutchins' belief that the ability
of PaineWebber investment executives and correspondent firms to receive sales
compensation for their sales of Class C shares on an ongoing basis, along with
continuing service fees, while their customers invest their entire purchase
payments immediately in Class C shares and generally do not face contingent
deferred sales charges, would prove attractive to the investment executives and
correspondent firms, resulting in greater growth to each Fund than might
otherwise be the case, (4) the advantages to the shareholders of economies of
scale resulting from growth in each Fund's assets and potential continued
growth, (5) the services provided to each Fund and its shareholders by Mitchell
Hutchins, (6) the services provided by PaineWebber pursuant to its Exclusive
Dealer Agreement with Mitchell Hutchins and (7) Mitchell Hutchins' shareholder
service-and distribution-related expenses and costs. The board members also
recognized that Mitchell Hutchins' willingness to compensate PaineWebber and its
investment executives, without the concomitant receipt by Mitchell Hutchins of
initial sales charges or contingent deferred sales charges upon redemption, was
conditioned upon its expectation of being compensated under the Class C Plan.
With respect to each Plan, the boards considered all compensation that
Mitchell Hutchins would receive under the Plan and the Distribution Contract,
including service fees and, as applicable, initial sales charges, distribution
fees and contingent deferred sales charges. The boards also considered the
benefits that would accrue to Mitchell Hutchins under each Plan in that Mitchell
Hutchins would receive service, distribution and advisory fees that are
calculated based upon a percentage of the average net assets of a Fund, which
fees would increase if the Plan were successful and the Funds attained and
maintained significant asset levels.
Under the Distribution Contracts between the Corporation and the Trust and
Mitchell Hutchins for the Class A shares for the fiscal years set forth below,
Mitchell Hutchins earned the following approximate amounts of initial sales
charges and retained the following approximate amounts, net of concessions to
PaineWebber as exclusive dealer:
BALANCED FUND
<TABLE>
<CAPTION>
FISCAL YEAR FISCAL YEAR FOR THE PERIOD
ENDED ENDED MARCH 1, 1996
AUGUST 31, AUGUST 31, THROUGH AUGUST 31,
1998 1997 1996
----------- ----------- ------------------
<S> <C> <C> <C>
Earned....................................... $ 368,103 $61,774 $7,576
Retained..................................... 16,048 2,215 459
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
TACTICAL ALLOCATION FUND
FISCAL YEARS ENDED
AUGUST 31,
------------------------------------------------
1998 1997 1996
----------- ----------- ------------------
<S> <C> <C> <C>
Earned....................................... $ 3,764,774 $ 2,887,643 $474,448
Retained..................................... 243,663 182,132 166,202
</TABLE>
For the fiscal year ended August 31, 1998, Mitchell Hutchins earned and
retained the following contingent deferred sales charges paid upon certain
redemptions of Class A, Class B and Class C shares:
<TABLE>
<CAPTION>
TACTICAL
ALLOCATION
BALANCED FUND FUND
--------------- --------
<S> <C> <C>
Class A......................................................... $ 0 $ 0
Class B......................................................... 28,910 638,930
Class C......................................................... 2,013 120,905
</TABLE>
PORTFOLIO TRANSACTIONS
Subject to policies established by each board, Mitchell Hutchins is
responsible for the execution of each Fund's portfolio transactions and the
allocation of brokerage transactions. In executing portfolio transactions,
Mitchell Hutchins seeks to obtain the best net results for the Funds, taking
into account such factors as price (including the applicable brokerage
commission or dealer spread), size of order, difficulty of execution and
operational facilities of the firm involved. While Mitchell Hutchins generally
seeks reasonably competitive commission rates, payment of the lowest commission
is not necessarily consistent with obtaining the best net results. Prices paid
to dealers in principal transactions, through which most bonds and some equity
securities are traded, generally include a "spread," which is the difference
between the prices at which the dealer is willing to purchase and sell a
specific security at the time. Balanced Fund, for fiscal years ended August 31,
1998, and August 31, 1997 for the period March 1, 1996 through August 31, 1996,
and for the fiscal year ended February 29, 1996, paid $290,954, $249,609,
$134,453, and $335,166, respectively, in aggregate brokerage commissions.
Tactical Allocation Fund, for the fiscal years ended August 31, 1998, August 31,
1997, and August 31, 1996, paid, $440,215, $211,116, and $41,271 respectively,
in aggregate brokerage commissions.
Neither Fund has any obligation to deal with any broker or group of brokers
in the execution of portfolio transactions. Each Fund contemplates that,
consistent with the policy of obtaining the best net results, brokerage
transactions may be conducted through Mitchell Hutchins or its affiliates,
including PaineWebber. Each board has adopted procedures in conformity with
Rule 17e-1 under the 1940 Act to ensure that all brokerage commissions paid to
Mitchell Hutchins and its affiliates are reasonable and fair. Specific
provisions in each Advisory Contract authorize Mitchell Hutchins and any of its
affiliates that are members of a national securities exchange to effect
portfolio transactions for each Fund on such exchange and to retain compensation
in connection with such transactions. Any such transactions will be effected and
related compensation paid only in accordance with applicable SEC regulations.
For the fiscal year ended August 31, 1997, the period March 1, 1996 to
August 31, 1996 and the fiscal year ended February 29, 1996, Balanced Fund paid
$15,564, $2,220 and $1,350 in brokerage commissions to PaineWebber. For the
fiscal year ended August 31, 1998, Balanced Fund paid $1,038 in brokerage
commissions to PaineWebber, which represented 0.4% of the total commissions paid
by the Fund and 0.5% of the aggregate dollar amount of transactions involving
brokerage commission payments.
For the fiscal years ended August 31, 1998, August 31, 1997, and August 31,
1996, Tactical Allocation Fund paid $5,496, $2,422 and $0 commissions to
PaineWebber. For the fiscal year ended August 31, 1998, Tactical Allocation Fund
paid $5,496 in brokerage commissions to PaineWebber, which represented 1.25% of
total commission paid by the Fund, and 0.16% of the aggregate dollar amount of
transactions involving brokerage commissions.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs"), who receive brokerage commissions for their services. The
Funds' procedures in selecting FCMs to execute the
30
<PAGE>
Funds' transactions in futures contracts, including procedures permitting the
use of Mitchell Hutchins and its affiliates, are similar to those in effect with
respect to brokerage transactions in securities.
Consistent with the interest of each Fund and subject to the review of the
applicable board, Mitchell Hutchins may cause the Fund to purchase and sell
portfolio securities through brokers who provide Mitchell Hutchins with
research, analysis, advice and similar services. A Fund may pay to those brokers
a higher commission than may be charged by other brokers, provided that Mitchell
Hutchins determines in good faith that such commission is reasonable in terms
either of that particular transaction or of the overall responsibility of
Mitchell Hutchins to the Fund and its other clients and that the total
commissions paid by the Fund will be reasonable in relation to the benefits to
the Fund over the long term. For Balanced Fund's fiscal year ended August 31,
1998 Mitchell Hutchins directed $86,827,625 in portfolio transactions to brokers
chosen because they provided research services, for which Balanced Fund paid
$105,579 in commissions. For Tactical Allocation Fund's fiscal year ended
August 31, 1998, Mitchell Hutchins directed no transactions to brokers chosen
for research services.
For purchases or sales with broker-dealer firms which act as principal,
Mitchell Hutchins seeks best execution. Although Mitchell Hutchins may receive
certain research or execution services in connection with those transactions,
Mitchell Hutchins will not purchase securities at a higher price or sell
securities at a lower price than would otherwise be paid if no weight was
attributed to the services provided by the executing dealer. Moreover, Mitchell
Hutchins will not enter into any explicit soft dollar arrangements relating to
principal transactions and will not receive in principal transactions the types
of services which could be purchased for hard dollars. Mitchell Hutchins may
engage in agency transactions in OTC equity and debt securities in return for
research and execution services. These transactions are entered into only in
compliance with procedures ensuring that the transaction (including commissions)
is at least as favorable as it would have been if effected directly with a
market-maker that did not provide research or execution services. These
procedures include Mitchell Hutchins' receiving multiple quotes from dealers
before executing the transactions on an agency basis.
Information and research services furnished by the brokers or dealers
through which or with which a Fund effects securities transactions may be used
by Mitchell Hutchins in advising other funds or accounts and, conversely,
research services furnished to Mitchell Hutchins by brokers or dealers in
connection with other funds or accounts that Mitchell Hutchins advises may be
used by Mitchell Hutchins in advising the Fund. Information and research
received from such brokers will be in addition to, and not in lieu of, the
services required to be performed by Mitchell Hutchins under the Advisory
Contracts.
Investment decisions for each Fund and for other investment accounts
managed by Mitchell Hutchins are made independently of each other in light of
differing considerations for the various accounts. However, the same investment
decision may occasionally be made for a Fund and one or more of such accounts.
In such cases, simultaneous transactions are inevitable. Purchases or sales are
then averaged as to price and allocated between a Fund and such other
account(s) as to amount according to a formula deemed equitable to the Fund and
such other account(s). While in some cases this practice could have a
detrimental effect upon the price or value of the security as far as the Fund is
concerned or upon its ability to complete its entire order, in other cases it is
believed that coordination and the ability to participate in volume transactions
will be beneficial to the Fund.
The Funds will not purchase securities in underwritings in which Mitchell
Hutchins or any of its affiliates is a member of the underwriting or selling
group, except pursuant to procedures adopted by each board pursuant to Rule
10f-3 under the 1940 Act. Among other things, these procedures require that the
commission or spread paid in connection with such a purchase be reasonable and
fair, that the purchase be at not more than the public offering price prior to
the end of the first business day after the date of the public offering and that
Mitchell Hutchins or any affiliate thereof not participate in or benefit from
the sale to the Fund.
PORTFOLIO TURNOVER. The Funds' annual portfolio turnover rates may vary
greatly from year to year, but they will not be a limiting factor when
management deems portfolio changes appropriate. The portfolio turnover rate for
each Fund is calculated by dividing the lesser of the Fund's annual sales or
purchases of portfolio securities (exclusive of purchases or sales of securities
whose maturities at the time of acquisition
31
<PAGE>
were one year or less) by the monthly average value of the securities in the
portfolio during the year. For the fiscal years indicated, the Funds' portfolio
turnover rates were:
<TABLE>
<S> <C>
BALANCED FUND
Fiscal Year ended August 31, 1998............................... 190%
Fiscal Year ended August 31, 1997............................... 188%
TACTICAL ALLOCATION FUND
Fiscal Year ended August 31, 1998............................... 33%
Fiscal Year ended August 31, 1997............................... 6%
</TABLE>
REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHER SERVICES
COMBINED PURCHASE PRIVILEGE--CLASS A SHARES. Investors and eligible groups
of related Fund investors may combine purchases of Class A shares of each Fund
with concurrent purchases of Class A shares of any other PaineWebber mutual fund
and thus take advantage of the reduced sales charges for Class A shares
indicated in the table of sales charges in the Prospectus. The sales charge
payable on the purchase of Class A shares of each Fund and Class A shares of
such other funds will be at the rates applicable to the total amount of the
combined concurrent purchases.
An "eligible group of related Fund investors" can consist of any
combination of the following:
(a) an individual, that individual's spouse, parents and children;
(b) an individual and his or her Individual Retirement Account
("IRA");
(c) an individual (or eligible group of individuals) and any company
controlled by the individual(s) (a person, entity or group that holds 25%
or more of the outstanding voting securities of a corporation will be
deemed to control the corporation, and a partnership will be deemed to be
controlled by each of its general partners);
(d) an individual (or eligible group of individuals) and one or more
employee benefit plans of a company controlled by the individual(s);
(e) an individual (or eligible group of individuals) and a trust
created by the individual(s), the beneficiaries of which are the individual
and/or the individual's spouse, parents or children;
(f) an individual and a Uniform Gifts to Minors Act/Uniform Transfers
to Minors Act account created by the individual or the individual's spouse;
(g) an employer (or a group of related employers) and one or more
qualified retirement plans of such employer or employers (an employer
controlling, controlled by or under common control with another employer is
deemed related to that other employer); or
(h) individual accounts related together under one registered
investment adviser having full discretion and control over the accounts.
The registered investment adviser must communicate at least quarterly
through a newsletter or investment update establishing a relationship with
all of the accounts.
RIGHTS OF ACCUMULATION--CLASS A SHARES. Reduced sales charges are
available through a right of accumulation, under which investors and eligible
groups of related Fund investors (as defined above) are permitted to purchase
Class A shares of the Funds among related accounts at the offering price
applicable to the total of (1) the dollar amount then being purchased plus (2)
an amount equal to the then-current net asset value of the purchaser's combined
holdings of Class A Fund shares and Class A shares of any other PaineWebber
mutual fund. The purchaser must provide sufficient information to permit
confirmation of his or her holdings, and the acceptance of the purchase order is
subject to such confirmation. The right of accumulation may be amended or
terminated at any time.
WAIVERS OF SALES CHARGES--CLASS B SHARES. Among other circumstances, the
contingent deferred sales charge on Class B shares of the Funds is waived where
a total or partial redemption is made within one year following the death of the
shareholder. The contingent deferred sales charge waiver is available where the
decedent is either the sole shareholder or owns the shares with his or her
spouse as a joint tenant with right of survivorship. This waiver applies only to
redemption of shares held at the time of death.
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<PAGE>
ADDITIONAL EXCHANGE AND REDEMPTION INFORMATION. As discussed in the
Prospectus, eligible shares of each Fund may be exchanged for shares of the
corresponding class of other PaineWebber mutual funds. Shareholders will receive
at least 60 days' notice of any termination or material modification of the
exchange offer and no notice need be given if, under extraordinary
circumstances, either redemptions are suspended under the circumstances
described below or a Fund temporarily delays or ceases the sales of its shares
because it is unable to invest amounts effectively in accordance with the Fund's
investment objective, policies and restrictions.
If conditions exist that make cash payments undesirable, each Fund reserves
the right to honor any request for redemption by making payment in whole or in
part in securities chosen by the Fund and valued in the same way as they would
be valued for purposes of computing the Fund's net asset value. Any such
redemption in kind will be made with readily marketable securities, to the
extent available. If payment is made in securities, a shareholder may incur
brokerage expenses in converting those securities into cash. The Corporation and
the Trust have each elected, however, to be governed by Rule 18f-1 under the
1940 Act, under which a Fund is obligated to redeem shares solely in cash up to
the lesser of $250,000 or 1% of the net asset value of the Fund during any
90-day period for one shareholder. This election is irrevocable unless the SEC
permits its withdrawal. Each Fund may suspend redemption privileges or postpone
the date of payment during any period (1) when the New York Stock Exchange
("NYSE") is closed or trading on the NYSE is restricted as determined by the
SEC, (2) when an emergency exists, as defined by the SEC, that makes it not
reasonably practicable for the Fund to dispose of securities owned by it or
fairly to determine the value of its assets, or (3) as the SEC may otherwise
permit. The redemption price may be more or less than the shareholder's cost,
depending on the market value of a Fund's portfolio at the time.
SERVICE ORGANIZATIONS. A Fund may authorize service organizations, and
their agents, to accept on its behalf purchase and redemption orders that are in
"good form." A Fund will be deemed to have received these purchase and
redemption orders when a service organization or its agent accepts them. Like
all customer orders, these orders will be priced based on the Fund's net asset
value next computed after receipt of the order by the service organizations or
their agents. Service organizations may include retirement plan service
providers who aggregate purchase and redemption instructions received from
numerous retirement plans or plan participants.
AUTOMATIC INVESTMENT PLAN. Participation in the Automatic Investment Plan
enables an investor to use the technique of "dollar cost averaging." When an
investor invests the same dollar amount each month under the Plan, the investor
will purchase more shares when a Fund's net asset value per share is low and
fewer shares when the net asset value per share is high. Using this technique,
an investor's average purchase price per share over any given period will be
lower than if the investor purchased a fixed number of shares on a monthly basis
during the period. Of course, investing through the automatic investment plan
does not assure a profit or protect against loss in declining markets.
Additionally, because the automatic investment plan involves continuous
investing regardless of price levels, an investor should consider his or her
financial ability to continue purchases through periods of both low and high
price levels.
SYSTEMATIC WITHDRAWAL PLAN. An investor's participation in the systematic
withdrawal plan will terminate automatically if the "Initial Account Balance" (a
term that means the value of the Fund account at the time the investor elects to
participate in the systematic withdrawal plan) less aggregate redemptions made
other than pursuant to the systematic withdrawal plan is less than $5,000 for
Class A and Class C shareholders or $20,000 for Class B shareholders. Purchases
of additional shares of a Fund concurrent with withdrawals are ordinarily
disadvantageous to shareholders because of tax liabilities and, for Class A
shares, initial sales charges. On or about the 20th of a month for monthly,
quarterly, semiannual or annual plans, PaineWebber will arrange for redemption
by a Fund of sufficient Fund shares to provide the withdrawal payment specified
by participants in the Fund's systematic withdrawal plan. The payment generally
is mailed approximately five Business Days (defined under "Valuation of Shares")
after the redemption date. Withdrawal payments should not be considered
dividends, but redemption proceeds, with the tax consequences described under
"Dividends & Taxes" in the Prospectus. If periodic withdrawals continually
exceed reinvested dividends and other distributions, a shareholder's investment
may be correspondingly reduced. A shareholder may change the amount of the
systematic withdrawal or terminate participation in the systematic withdrawal
plan at any time without charge or penalty by written instructions with
signatures guaranteed to PaineWebber or PFPC Inc. ("Transfer Agent").
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<PAGE>
Instructions to participate in the plan, change the withdrawal amount or
terminate participation in the plan will not be effective until five days after
written instructions with signatures guaranteed are received by the Transfer
Agent. Shareholders may request the forms needed to establish a systematic
withdrawal plan from their PaineWebber investment executives, correspondent
firms or the Transfer Agent at 1-800-647-1568.
REINSTATEMENT PRIVILEGE--CLASS A SHARES. As described in the Prospectus,
shareholders who have redeemed Class A shares of a Fund may reinstate their
account without a sales charge. Shareholders may exercise the reinstatement
privilege by notifying the Transfer Agent of such desire and forwarding a check
for the amount to be purchased within 365 days after the date of redemption. The
reinstatement will be made at the net asset value per share next computed after
the notice of reinstatement and check are received. The amount of a purchase
under this reinstatement privilege cannot exceed the amount of the redemption
proceeds. Gain on a redemption is taxable regardless of whether the
reinstatement privilege is exercised; however, a loss arising out of a
redemption will not be deductible to the extent the redemption proceeds are
reinvested, if the reinstatement privilege is exercised within 30 days after
redemption, and an adjustment will be made to the shareholder's tax basis for
the shares acquired pursuant to the reinstatement privilege. Gain or loss on a
redemption also will be adjusted for federal income tax purposes by the amount
of any sales charge paid on Class A shares, under the circumstances and to the
extent described in "Dividends & Taxes" in the Prospectus.
PAINEWEBBER RMA RESOURCE ACCUMULATION PLAN(Service Mark);
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(REGISTERED) (RMA(REGISTERED))
Shares of the PaineWebber mutual funds (each a "PW Fund" and, collectively,
the "PW Funds") are available for purchase through the RMA Resource Accumulation
Plan ("Plan") by customers of PaineWebber and its correspondent firms who
maintain Resource Management Accounts ("RMA accountholders"). The Plan allows an
RMA accountholder to continually invest in one or more of the PW Funds at
regular intervals, with payment for shares purchased automatically deducted from
the client's RMA account. The client may elect to invest at monthly or quarterly
intervals and may elect either to invest a fixed dollar amount (minimum $100 per
period) or to purchase a fixed number of shares. A client can elect to have Plan
purchases executed on the first or fifteenth day of the month. Settlement occurs
three Business Days (defined under "Valuation of Shares") after the trade date,
and the purchase price of the shares is withdrawn from the investor's RMA
account on the settlement date from the following sources and in the following
order: uninvested cash balances, balances in RMA money market funds, or margin
borrowing power, if applicable to the account.
To participate in the Plan, an investor must be an RMA accountholder, must
have made an initial purchase of the shares of each PW Fund selected for
investment under the Plan (meeting applicable minimum investment requirements)
and must complete and submit the RMA Resource Accumulation Plan Client Agreement
and Instruction Form available from PaineWebber. The investor must have received
a current prospectus for each PW Fund selected prior to enrolling in the Plan.
Information about mutual fund positions and outstanding instructions under the
Plan are noted on the RMA accountholder's account statement. Instructions under
the Plan may be changed at any time, but may take up to two weeks to become
effective.
The terms of the Plan or an RMA accountholder's participation in the Plan
may be modified or terminated at any time. It is anticipated that, in the
future, shares of other PW Funds and/or mutual funds other than the PW Funds may
be offered through the Plan.
PERIODIC INVESTING AND DOLLAR COST AVERAGING. Periodic investing in the PW
Funds or other mutual funds, whether through the Plan or otherwise, helps
investors establish and maintain a disciplined approach to accumulating assets
over time, de-emphasizing the importance of timing the market's highs and lows.
Periodic investing also permits an investor to take advantage of "dollar cost
averaging." By investing a fixed amount in mutual fund shares at established
intervals, an investor purchases more shares when the price is lower and fewer
shares when the price is higher, thereby increasing his or her earning
potential. Of course, dollar cost averaging does not guarantee a profit or
protect against a loss in a declining market, and an investor should consider
his or her financial ability to continue investing through periods of both low
and high share prices. However, over time, dollar cost averaging generally
results in a lower average original investment cost than if an investor invested
a larger dollar amount in a mutual fund at one time.
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<PAGE>
PAINEWEBBER'S RESOURCE MANAGEMENT ACCOUNT. In order to enroll in the Plan,
an investor must have opened an RMA account with PaineWebber or one of its
correspondent firms. The RMA account is PaineWebber's comprehensive asset
management account and offers investors a number of features, including the
following:
o monthly Premier account statements that itemize all account activity,
including investment transactions, checking activity and Gold
MasterCard(Registered) transactions during the period, and provide
unrealized and realized gain and loss estimates for most securities held
in the account;
o comprehensive preliminary 9-month and year-end summary statements that
provide information on account activity for use in tax planning and tax
return preparation;
o automatic "sweep" of uninvested cash into the RMA accountholder's choice
of one of the six RMA money market funds--RMA Money Market Portfolio, RMA
U.S. Government Portfolio, RMA Tax-Free Fund, RMA California Municipal
Money Fund, RMA New Jersey Municipal Money Fund and RMA New York
Municipal Money Fund. An investment in a money market fund is not insured
or guaranteed by the Federal Deposit Insurance Corporation or any other
government agency. Although a money market fund seeks to preserve the
value of your investment at $1.00 per share, it is possible to lose money
by investing in a money market fund.
o check writing, with no per-check usage charge, no minimum amount on
checks and no maximum number of checks that can be written. RMA
accountholders can code their checks to classify expenditures. All
canceled checks are returned each month;
o Gold MasterCard, with or without a line of credit, which provides RMA
accountholders with direct access to their accounts and can be used with
automatic teller machines worldwide. Purchases on the Gold MasterCard are
debited to the RMA account once monthly, permitting accountholders to
remain invested for a longer period of time;
o 24-hour access to account information through toll-free numbers, and more
detailed personal assistance during business hours from the RMA Service
Center;
o expanded account protection to $100 million in the event of the
liquidation of PaineWebber. This protection does not apply to shares of
the RMA money market funds or the PW Funds because those shares are held
at the transfer agent and not through PaineWebber; and
o automatic direct deposit of checks into your RMA account and automatic
withdrawals from the account.
The annual account fee for an RMA account is $85, which includes the Gold
MasterCard, with an additional fee of $40 if the investor selects an optional
line of credit with the Gold MasterCard.
CONVERSION OF CLASS B SHARES
Class B shares of each Fund will automatically convert to Class A shares of
that Fund, based on the relative net asset values per share of the two classes,
as of the close of business on the first Business Day (as defined under
"Valuation of Shares") of the month in which the sixth anniversary of the
initial issuance of such Class B shares occurs. For the purpose of calculating
the holding period required for conversion of Class B shares, the date of
initial issuance shall mean (1) the date on which such Class B shares were
issued, or (2) for Class B shares obtained through an exchange, or a series of
exchanges, the date on which the original Class B shares were issued. For
purposes of conversion to Class A shares, Class B shares purchased through the
reinvestment of dividends and other distributions paid in respect of Class B
shares will be held in a separate sub-account. Each time any Class B shares in
the shareholder's regular account (other than those in the sub-account) convert
to Class A shares, a pro rata portion of the Class B shares in the sub-account
also converts to Class A shares. The portion will be determined by the ratio
that the shareholder's Class B shares converting to Class A shares bears to the
shareholder's total Class B shares not acquired through dividends and other
distributions.
The availability of the conversion feature is subject to the continuing
availability of an opinion of counsel to the effect that the dividends and other
distributions paid on Class A and Class B shares will not result in
"preferential dividends" under the Internal Revenue Code and the conversion of
shares does not constitute a taxable event. If the conversion feature ceased to
be available, the Class B shares would not be converted and
35
<PAGE>
would continue to be subject to the higher ongoing expenses of the Class B
shares beyond six years from the date of purchase. Mitchell Hutchins has no
reason to believe that this condition for the availability of the conversion
feature will not continue to be met.
VALUATION OF SHARES
Each Fund determines the net asset value per share separately for each
class of shares, normally as of the close of regular trading on the NYSE
(usually 4:00 p.m., Eastern time) on each Business Day, which is defined as each
Monday through Friday when the NYSE is open. Prices will be calculated earlier
when the NYSE closes early because trading has been halted for the day.
Currently, the NYSE is closed on the observance of the following holidays: New
Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Securities that are listed on exchanges are valued at the last sale price
prior to valuation on the day the securities are being valued or, lacking any
sales on such day, at the last available bid price. In cases where securities
are traded on more than one exchange, the securities are generally valued on the
exchange considered by Mitchell Hutchins as the primary market. Securities
traded in the OTC market and listed on the Nasdaq Stock Market ("Nasdaq") are
valued at the last available sale price on Nasdaq prior to valuation; other OTC
securities are valued at the last bid price available prior to valuation (other
than short-term investments that mature in 60 days or less, which are valued as
described further below). Securities and assets for which market quotations are
not readily available are valued at fair value as determined in good faith by or
under the direction of each board.
It should be recognized that judgment often plays a greater role in valuing
thinly traded securities and lower rated bonds than is the case with respect to
securities for which a broader range of dealer quotations and last-sale
information is available. The amortized cost method of valuation generally is
used to value debt obligations with 60 days or less remaining to maturity,
unless the applicable board determines that this does not represent fair value.
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<PAGE>
PERFORMANCE INFORMATION
Each Fund's performance data quoted in advertising and other promotional
materials ("Performance Advertisements") represent past performance and are not
intended to indicate future performance. The investment return and principal
value of an investment will fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their original cost.
TOTAL RETURN CALCULATIONS. Average annual total return quotes ("Standardized
Return") used in each Fund's Performance Advertisements are calculated according
to the following formula:
<TABLE>
<C> <S>
n
P(1 + T) = ERV
where: P = a hypothetical initial payment of $1,000 to purchase shares of a specified class
T = average annual total return of shares of that class
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of that
period.
</TABLE>
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the last
day of the most recent quarter prior to submission of the advertisement for
publication. Total return, or "T" in the formula above, is computed by finding
the average annual change in the value of an initial $1,000 investment over the
period. In calculating the ending redeemable value for Class A shares, each
Fund's maximum 4.5% initial sales charge is deducted from the initial $1,000
payment and, for Class B and Class C shares, the applicable contingent deferred
sales charge imposed on a redemption of Class B and Class C shares held for the
period is deducted. All dividends and other distributions are assumed to have
been reinvested at net asset value.
Each Fund also may refer in Performance Advertisements to total return
performance data that are not calculated according to the formula set forth
above ("Non-Standardized Return"). Each Fund calculates Non-Standardized Return
for specified periods of time by assuming the investment of $1,000 in Fund
shares and assuming the reinvestment of all dividends and other distributions.
The rate of return is determined by subtracting the initial value of the
investment from the ending value and by dividing the remainder by the initial
value. Neither initial nor contingent deferred sales charges are taken into
account in calculating Non-Standardized Return; the inclusion of these charges
would reduce the return.
Both Standardized Return and Non-Standardized Return for Class B shares for
periods of over six years will reflect conversion of the Class B shares to
Class A shares at the end of the sixth year.
The following table shows performance information for each class of the
Funds outstanding, for the periods indicated. All returns for periods of more
than one year are expressed as an average return.
BALANCED FUND
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
<S> <C> <C> <C> <C>
Fiscal year ended August 31, 1998:
Standardized Return*.................. (0.03%) (0.64%) 2.99% N/A
Non-Standardized Return............... 4.69% 3.87% 3.89% N/A
Five years ended August 31, 1998:
Standardized Return*.................. 9.42% 9.86% 10.11% N/A
Non-Standardized Return................. 10.93% 10.12% 10.11% N/A
Ten years ended August 31, 1998:
Standardized Return*.................. N/A 10.22% N/A N/A
Non-Standardized Return............... N/A 10.22% N/A N/A
Inception** to August 31, 1998:
Standardized Return*.................. 10.52% 9.16% 10.42% (9.41%)
Non-Standardized Return............... 11.23% 9.16% 10.42% (9.41%)
</TABLE>
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<PAGE>
TACTICAL ALLOCATION FUND
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
<S> <C> <C> <C> <C>
Fiscal year ended August 31, 1998:
Standardized Return*.................. 2.47% 1.49% 5.49% 7.62%
Non-Standardized Return............... 7.31% 6.49% 6.49% 7.62%
Five years ended August 31, 1998:
Standardized Return*.................. 15.62% N/A 15.84% 17.00%
Non-Standardized Return............... 16.70% N/A 15.84% 17.00%
Inception** to August 31, 1998:
Standardized Return*.................. 15.74% 16.86% 15.17% 17.06%
Non-Standardized Return............... 16.75% 17.76% 15.17% 17.06%
</TABLE>
- ------------------
* All Standardized Return figures for Class A shares reflect deduction of the
current maximum sales charge of 4.5%. All Standardized Return figures for
Class B and Class C shares reflect deduction of the applicable contingent
deferred sales charges imposed on a redemption of shares held for the period.
Class Y shares do not impose an initial or contingent deferred sales charge;
therefore the performance information is the same for both standardized
return and non-standardized return for the periods indicated.
** The inception date for each class of shares is as follows:
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Balanced Fund........................... 07/01/91 12/12/86 07/02/92 03/26/98
Tactical Allocation Fund................ 05/10/93 01/30/96 07/22/92 05/10/93
</TABLE>
OTHER INFORMATION. In Performance Advertisements, each Fund may compare
its Standardized Return and/or its Non-Standardized Return with data published
by Lipper Analytical Services, Inc. ("Lipper"); CDA Investment Technologies,
Inc. ("CDA"); Wiesenberger Investment Companies Service ("Wiesenberger");
Investment Company Data Inc. ("ICD"); or Morningstar Mutual Funds
("Morningstar"); or with the performance of recognized stock and other indices,
including the Standard & Poor's 500 Composite Stock Price Index ("S&P 500"), the
Dow Jones Industrial Average ("DJIA"), the International Finance Corporation
Global Total Return Index the Nasdaq Composite Index, the Russell 2000 Index,
the Wilshire 5000 Index, the Lehman Bond Index, the Morgan Stanley Capital
International Perspective Indices, the Morgan Stanley Capital International
Energy Sources Index, The Standard & Poor's Oil Composite Index, Morgan Stanley
International Capital World Index, the Lehman Brothers 20+ Year Treasury Bond
Index, the Lehman Brothers Government/Corporate Bond Index, other similar Lehman
Brother indices or components thereof, the Salomon Brothers Non-U.S. World
Government Bond Index, and changes in the Consumer Price Index as published by
the U.S. Department of Commerce. Each Fund also may refer in such materials to
mutual fund performance rankings and other data, such as comparative asset,
expense and fee levels, published by Lipper, CDA, Wiesenberger, ICD or
Morningstar. Performance Advertisements also may refer to discussions of the
Funds and comparative mutual fund data and ratings reported in independent
periodicals, including The Wall Street Journal, Money Magazine, Forbes, Business
Week, Financial World, Barron's, Fortune, The New York Times, The Chicago
Tribune, The Washington Post and The Kiplinger Letters. Comparisons in
Performance Advertisements may be in graphic form.
Each Fund may include discussions or illustrations of the effects of
compounding in Performance Advertisements. "Compounding" refers to the fact
that, if dividends or other distributions on the Fund investment are reinvested
by being paid in additional Fund shares, any future income or capital
appreciation of the Fund would increase the value, not only of the original Fund
investment, but also of the additional Fund shares received through
reinvestment. As a result, the value of the Fund investment would increase more
quickly than if dividends or other distributions had been paid in cash.
Each Fund may also compare its performance with the performance of bank
certificates of deposits (CDs) as measured by the CDA, Certificate of Deposit
Index, the Bank Rate Monitor National Index and the averages of yields of CDs of
major banks published by Banxquote(Registered) Money Markets. In comparing a
Fund's performance to CD performance, investors should keep in mind that bank
CDs are insured in whole or in part by an agency of the U.S. government and
offer fixed principal and fixed or variable rates of interest, and that
38
<PAGE>
bank CD yields may vary depending on the financial institution offering the CD
and prevailing interest rates. Fund shares are not insured or guaranteed by the
U.S. government and returns thereon and net asset value will fluctuate. The debt
securities held by each Fund mayhave longer maturities than most CDs and may
reflect interest rate fluctuations for longer term debt securities. An
investment in either Fund involves greater risks than an investment in either a
money market fund or a CD.
TAXES
To continue to qualify for treatment as a regulated investment company
("RIC") under the Internal Revenue Code, each Fund must distribute to its
shareholders for each taxable year at least 90% of its investment company
taxable income (consisting generally of net investment income and net short-term
capital gain) ("Distribution Requirement") and must meet several additional
requirements. For each Fund, these requirements include the following: (1) the
Fund must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans and gains from
the sale or other disposition of securities, or other income (including gains
from options and futures) derived with respect to its business of investing in
securities ("Income Requirement"); (2) at the close of each quarter of the
Fund'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 these other securities limited, in respect
of any one issuer, to an amount that does not exceed 5% of the value of the
Fund's total assets and that does not represent more than 10% of the issuer's
outstanding voting securities; and (3) at the close of each quarter of the
Fund's taxable year, not more than 25% of the value of its total assets may be
invested in securities (other than U.S. government securities or the securities
of other RICs) of any one issuer. If a Fund failed to qualify for treatment as a
RIC for any taxable year, it would be taxed as an ordinary corporation on its
taxable income for that year (even if that income was distributed to its
shareholders) and all distributions out of its earnings and profits would be
taxable to its shareholders as dividends (that is, ordinary income).
Dividends and other distributions declared by a Fund in October, November
or December of any year and payable to shareholders of record on a date in any
of those months will be deemed to have been paid by the Fund and received by the
shareholders on December 31 of that year if the distributions are paid by the
Fund during the following January. Accordingly, those distributions will be
taxed to shareholders for the year in which that December 31 falls.
A portion of the dividends from each Fund's investment company taxable
income (whether paid in cash or in additional Fund shares) may be eligible for
the dividends-received deduction allowed to corporations. The eligible portion
may not exceed the aggregate dividends received by a Fund from U.S.
corporations. However, dividends received by a corporate shareholder and
deducted by it pursuant to the dividends-received deduction are subject
indirectly to the alternative minimum tax.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares. Investors
also should be aware that if shares are purchased shortly before the record date
for any dividend or capital gain distribution, the shareholder will pay full
price for the shares and receive some portion of the price back as a taxable
distribution.
Each Fund will be subject to a nondeductible 4% excise tax ("Excise Tax")
to the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gain net
income for the one-year period ending on October 31 of that year, plus certain
other amounts.
Balanced Fund may invest in the stock of "passive foreign investment
companies" ("PFICs") if the stock is denominated in U.S. dollars and otherwise
is a permissible investment. A PFIC is a foreign corporation--other than a
"controlled foreign corporation" (i.e., a foreign corporation in which, on any
day during its taxable year, more than 50% of the total voting power of all
voting stock therein or the total value of all stock therein is owned, directly,
indirectly, or constructively, by "U.S. shareholders," defined as U.S. persons
that individually own, directly, indirectly, or constructively, at least 10% of
that voting power) as to which the Fund is a shareholder--that, in general,
meets either of the following tests: (1) at least 75% of its gross income is
passive or (2) an average of at least 50% of its assets produce, or are held for
the production of, passive income. Under
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<PAGE>
certain circumstances, the Fund will be subject to federal income tax on a
portion of any "excess distribution" received on the stock of a PFIC or of any
gain from disposition of that stock (collectively "PFIC income"), plus interest
thereon, even if the Fund distributes the PFIC income as a taxable dividend to
its shareholders. The balance of the PFIC income will be included in the Fund's
investment company taxable income and, accordingly, will not be taxable to it to
the extent it distributes that income to its shareholders.
If Balanced Fund invests in a PFIC and elects to treat the PFIC as a
"qualified electing fund" ("QEF"), then in lieu of the foregoing tax and
interest obligation, the Fund would be required to include in income each year
its pro rata share of the QEF's annual ordinary earnings and net capital gain
(the excess of net long-term capital gain over net short-term capital
loss)--which probably would have to be distributed by the Fund to satisfy the
Distribution Requirement and avoid imposition of the Excise Tax--even if those
earnings and gain were not distributed to the Fund by the QEF. In most instances
it will be very difficult, if not impossible, to make this election because of
certain requirements thereof.
Balanced Fund may elect to "mark to market" its stock in any PFIC.
"Marking-to-market," in this context, means including in ordinary income each
taxable year the excess, if any, of the fair market value of a PFIC's stock over
the Fund's adjusted basis therein as of the end of that year. Pursuant to the
election, the Fund also would be allowed to deduct (as an ordinary, not capital,
loss) the excess, if any, of its adjusted basis in PFIC stock over the fair
market value thereof as of the taxable year-end, but only to the extent of any
net mark-to-market gains with respect to that stock included by the Fund for
prior taxable years. The Fund's adjusted basis in each PFIC's stock with respect
to which it makes this election will be adjusted to reflect the amounts of
income included and deductions taken thereunder (and under regulations proposed
in 1992 that provided a similar election with respect to the stock of certain
PFICs).
The use of hedging strategies involving Derivative Instruments, such as
writing (selling) and purchasing options and futures, involves complex rules
that will determine for income tax purposes the amount, character and timing of
recognition of the gains and losses each Fund realizes in connection therewith.
Gains from options and futures derived by a Fund with respect to its business of
investing in securities will qualify as permissible income under the Income
Requirement.
If a Fund has an "appreciated financial position"--generally, an interest
(including an interest through an option, futures contract or short sale) with
respect to any stock, debt instrument (other than "straight debt") or
partnership interest the fair market value of which exceeds its adjusted
basis--and enters into a "constructive sale" of the same or substantially
similar property, the Fund will be treated as having made an actual sale
thereof, with the result that gain will be recognized at that time. A
constructive sale generally consists of a short sale, an offsetting notional
principal contract or a futures contract entered into by a Fund or a related
person with respect to the same or substantially similar property. In addition,
if the appreciated financial position is itself a short sale or such a contract,
acquisition of the underlying property or substantially similar property will be
deemed a constructive sale. The foregoing will not apply, however, to any
transaction during any taxable year that otherwise would be treated as a
constructive sale if the transaction is closed within 30 days after the end of
that year and the Fund holds the appreciated financial position unhedged for 60
days after that closing (i.e., at no time during that 60-day period is the
Fund's risk of loss with respect to that position reduced by reason of certain
specified transactions with respect to substantially similar or related
property, such as having an option to sell, being contractually obligated to
sell, making a short sale or granting an option to buy substantially identical
stock or securities).
Balanced Fund may acquire zero coupon securities or other securities issued
with original issue discount ("OID"). As a holder of such securities, the Fund
must include in its gross income the portion of the OID that accrues on the
securities during the taxable year, even if it receives no corresponding payment
on them during the year. Because the Fund annually must distribute substantially
all of its investment company taxable income, including any accrued OID, to
satisfy the Distribution Requirement and avoid imposition of the Excise Tax, the
Fund may be required in a particular year to distribute as a dividend an amount
that is greater than the total amount of cash it actually receives. Those
distributions will be made from the Fund's cash assets or from the proceeds of
sales of portfolio securities, if necessary. The Fund may realize capital gains
or losses from those sales, which would increase or decrease its investment
company taxable income and/or net capital gain.
40
<PAGE>
OTHER INFORMATION
Prior to August 1995, Balanced Fund was named "PaineWebber Asset Allocation
Fund." Prior to November 1, 1995, Tactical Allocation Fund was named "Mitchell
Hutchins/Kidder, Peabody Asset Allocation Fund" and prior to February 13, 1995,
it was named "Kidder, Peabody Asset Allocation Fund." Prior to November 10,
1995, Tactical Allocation Fund's Class C shares were called "Class B" shares and
Balanced Fund's Class C shares were called "Class D" shares.
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of a series of the Trust
could, under certain circumstances, be held personally liable for the
obligations of the Trust or series. The Declaration of Trust states that persons
with claims against the Trust shall look solely to the Trust property or to the
property of one or more series of the Trust for satisfaction of claims. It also
states that notice of such disclaimer may be given in any obligation, contract,
instrument, certificate or undertaking made or issued by the trustees of the
Trust on behalf of the Trust. The Declaration of Trust also provides for
indemnification from the Trust's property for all losses and expenses of any
shareholder held personally liable for the obligations of the Trust or a series.
Thus, the risk of a shareholder's incurring financial loss on account of
shareholder liability is limited to circumstances in which the Trust or series
would be unable to meet its obligations, a possibility that Mitchell Hutchins
believes is remote.
CLASS-SPECIFIC EXPENSES. Each Fund might determine to allocate certain of
its expenses (in addition to service and distribution fees) to the specific
classes of its shares to which those expenses are attributable. For example,
Class B and Class C shares of a Fund bear higher transfer agency fees per
shareholder account than those borne by Class A or Class Y. The higher fee is
imposed due to the higher costs incurred by the Transfer Agent in tracking
shares subject to a contingent deferred sales charge because, upon redemption,
the duration of the shareholder's investment must be determined in order to
determine the applicable charge. Although the transfer agency fee will differ on
a per account basis as stated above, the specific extent to which the transfer
agency fees will differ between the classes as a percentage of net assets is not
certain, because the fee as a percentage of net assets will be affected by the
number of shareholder accounts in each class and the relative amounts of net
assets in each class.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Ave., N.W., Washington, D.C., 20036-1800, serves as counsel to the Corporation
and the Trust. Kirkpatrick & Lockhart LLP also acts as counsel to PaineWebber
and Mitchell Hutchins in connection with other matters.
AUDITORS. PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New
York, New York 10036, serves as Balanced Fund's independent accountants. Ernst &
Young LLP, 787 Seventh Avenue, New York, New York 10019, serves as Tactical
Allocation Fund's independent auditors.
FINANCIAL STATEMENTS
Each Fund's Annual Report to Shareholders for the most recent fiscal year
is a separate document supplied with this Statement of Additional Information
and the financial statements, accompanying notes and report of independent
accountants or independent auditors appearing therein are incorporated herein by
this reference.
41
<PAGE>
APPENDIX
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Aaa. Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues; Aa. Bonds which are rated Aa
are judged to be of high quality by all standards. Together with the Aaa group
they comprise what are generally known as high grade bonds. They are rated lower
than the best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risk appear
somewhat larger than in Aaa securities; A. Bonds which are rated A possess
many favorable investment attributes and are to be considered as upper medium
grade obligations. Factors giving security to principal and interest are
considered adequate, but elements may be present which suggest a susceptibility
to impairment sometime in the future; Baa. Bonds which are rated Baa are
considered as medium grade obligations, i.e., they are neither highly protected
nor poorly secured. Interest payments and principal security appear adequate for
the present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds lack
outstanding investment characteristics and in fact have speculative
characteristics as well; Ba. Bonds which are rated Ba are judged to have
speculative elements; their future cannot be considered as well assured. Often
the protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class; B. Bonds which are
rated B generally lack characteristics of the desirable investment. Assurance of
interest and principal payments or of maintenance of other terms of the contract
over any long period of time may be small.
Note: Moody's may apply numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
DESCRIPTION OF S&P CORPORATE DEBT RATINGS
AAA. An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong; AA. An obligation rated AA differs from the higher rated
issues only in small degree; A. An obligation rated A is somewhat more
susceptible to the adverse effects of changes in circumstances and economic
conditions than obligations in higher rated categories. However, the obligor's
capacity to meet its financial commitment on the obligation is still
strong; BBB. An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation; BB, B, CCC, CC, C. Obligations rated BB, B, CCC, CC and C
are regarded as having significant speculative characteristics. BB indicates the
lowest degree of speculation and C the highest. While such debt will likely have
some quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions; BB. An obligation
rated BB is less vulnerable to nonpayment than other speculative issues.
However, it faces major ongoing uncertainties or exposure to adverse business,
financial, or economic conditions which could lead to the obligor's inadequate
capacity to meet its financial commitment on the obligation; B. An obligation
rated B is more vulnerable to nonpayment than obligations rated BB, but the
obligor currently has the capacity to meet its financial commitment on the
obligation. Adverse business, financial, or economic conditions will likely
impair the obligor's capacity or willingness to meet its financial commitment on
the obligation.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
NR: "NR" indicates that no public rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate a
particular type of obligation as a matter of policy.
A-1
<PAGE>
DESCRIPTION OF MOODY'S SHORT-TERM DEBT RATINGS
PRIME-1. Issuers rated Prime-1 (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics: leading market positions in well established industries; high
rates of return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins in earnings
coverage of fixed financial charges and high internal cash generation; well
established access to a range of financial markets and assured sources of
alternate liquidity; PRIME-2. Issuers rated Prime-2 (or supporting
institutions) have a strong ability for repayment of senior short-term debt
obligations. This will normally be evidenced by many of the characteristics
cited above but to a lesser degree. Earnings trends and coverage ratios, while
sound, may be more subject to variation. Capitalization characteristics, while
still appropriate, may be more affected by external conditions. Ample alternate
liquidity is maintained.
DESCRIPTION OF S&P COMMERCIAL PAPER RATINGS
A-1. This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus (+) sign
designation; A-2. Capacity for timely payment on issues with this designation
is satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
A-2
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THE PROSPECTUS OR IN THIS STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY EITHER FUND OR ITS DISTRIBUTOR. THE PROSPECTUS
AND THIS STATEMENT OF ADDITIONAL INFORMATION DO NOT CONSTITUTE AN OFFERING BY
EITHER FUND OR BY THE DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY
NOT LAWFULLY BE MADE.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Policies and Restrictions........... 1
Strategies Using Derivative Instruments........ 12
Directors, Trustees and Officers; Principal
Holders of Securities........................ 19
Investment Advisory and Distribution
Arrangements................................. 25
Portfolio Transactions......................... 30
Reduced Sales Charges, Additional
Exchange and Redemption Information
and Other Services........................... 32
Conversion of Class B Shares................... 35
Valuation of Shares............................ 36
Performance Information........................ 37
Taxes.......................................... 39
Other Information.............................. 41
Financial Statements........................... 41
Appendix....................................... A-1
</TABLE>
(Copyright)1998 PaineWebber Incorporated
PAINEWEBBER
BALANCED FUND
PAINEWEBBER
TACTICAL ALLOCATION FUND
- ----------------------------------------
Statement of Additional Information
November 30, 1998
- ----------------------------------------
PAINEWEBBER
