<PAGE>
------------------
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PaineWebber Balanced Fund
PaineWebber Tactical Allocation Fund
1285 Avenue of the Americas, New York, New York 10019
Prospectus -- January 1, 1998
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PaineWebber Asset Allocation Funds are designed for investors generally seeking
high total return. PaineWebber Balanced Fund invests in a combination of equity
securities, investment grade bonds and money market instruments and maintains a
fixed income allocation of at least 25% at all times. PaineWebber Tactical Al-
location Fund follows a systematic investment strategy that allocates its as-
sets between equity securities and U.S. Treasury notes or U.S. Treasury bills.
This Prospectus concisely sets forth information that a prospective investor
should know about the Funds before investing. Please read this Prospectus care-
fully and retain a copy for future reference.
A Statement of Additional Information dated January 1, 1998 has been filed with
the Securities and Exchange Commission and is legally part of this Prospectus.
The Statement of Additional Information can be obtained without charge, and
further inquiries can be made, by contacting an individual Fund, your invest-
ment executive at PaineWebber or one of its correspondent firms or by calling
toll-free 1-800-647-1568.
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THE PAINEWEBBER FAMILY OF MUTUAL FUNDS
The PaineWebber Family of Mutual Funds consists of six broad categories, which
are presented here. Generally, investors seeking to maximize return must assume
greater risk. The Funds offered by this Prospectus are both in the ASSET
ALLOCATION category.
[ ] Money Market Fund for
income and stability by [ ] Asset Allocation Funds for high total return
investing in high- by investing in stocks and bonds.
quality, short-term
investments.
[ ] Bond Funds for income
by investing mainly in [ ] Stock Funds for long-term growth by investing
bonds. mainly in stocks.
[ ] Tax-Free Bond Funds for
income exempt from
federal income tax and, [ ] Global Funds for long-term growth by investing
in some cases, state mainly in foreign stocks or high current
and local income taxes, income by investing mainly in global debt
by investing in instruments.
municipal bonds.
A complete listing of the PaineWebber Family of Mutual Funds is found on the
back cover of this Prospectus.
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INVESTORS SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR REFERRED TO IN THIS
PROSPECTUS. THE FUNDS AND THEIR DISTRIBUTOR HAVE NOT AUTHORIZED ANYONE TO PRO-
VIDE INVESTORS WITH INFORMATION THAT IS DIFFERENT. THE PROSPECTUS IS NOT AN OF-
FER TO SELL SHARES OF THE FUNDS IN ANY JURISDICTION WHERE THE FUNDS OR THEIR
DISTRIBUTOR MAY NOT LAWFULLY SELL THOSE SHARES.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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Prospectus Page 1
<PAGE>
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PaineWebber Tactical Allocation Fund
Balanced Fund
Table of Contents
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<TABLE>
<CAPTION>
Page
----
<S> <C>
The Funds at a Glance...................................................... 3
Expense Table.............................................................. 5
Financial Highlights....................................................... 8
Investment Objectives & Policies........................................... 12
Investment Philosophy & Process............................................ 13
Performance................................................................ 15
The Funds' Investments..................................................... 17
Flexible PricingSM......................................................... 22
How to Buy Shares.......................................................... 26
How to Sell Shares......................................................... 27
Other Services............................................................. 28
Management................................................................. 29
Determining the Shares' Net Asset Value.................................... 31
Dividends & Taxes.......................................................... 31
General Information........................................................ 33
</TABLE>
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Prospectus Page 2
<PAGE>
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PaineWebber Tactical Allocation Fund
Balanced Fund
The Funds at a Glance
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The Funds offered by this Prospectus are not intended to provide a complete
investment program, but one or both of them may be appropriate as a component
of an investor's overall portfolio. Some common reasons to invest in these
Funds are to finance college educations, plan for retirement or diversify a
portfolio. When selling shares, investors should be aware that they may get
more or less for their shares than they originally paid for them. As with any
mutual fund, there is no assurance that the Funds will achieve their goals.
BALANCED FUND
GOAL: To increase the value of your investment by investing in a combination
of equity securities, investment grade bonds and money market instruments,
while maintaining a fixed income allocation of at least 25% at all times
(including bonds and cash).
INVESTMENT OBJECTIVE: High total return with low volatility.
RISKS: Equity securities historically have shown greater growth potential than
other types of securities, but they have also shown greater volatility.
Because the Fund invests in equity securities, its price will rise and fall.
Certain investment grade debt securities in which the Fund may invest have
speculative characteristics. The debt instruments in which the Fund may invest
are subject to interest rate risk, which means that their prices can be
expected to decrease when interest rates rise. The Fund may invest in
mortgage- and asset-backed securities, which involve additional risks, such as
those relating to the prepayment of principal on the underlying obligations.
The Fund may invest in U.S. dollar-denominated securities of foreign
companies, which can involve more risk than investing in the securities of
U.S. companies. The Fund also may invest up to 10% of its total assets in high
yield, high risk convertible securities, which are considered predominantly
speculative and involve major risk exposure to adverse conditions. The Fund
may use derivatives, such as options and futures, in its investment
activities, which may involve additional risks. Investors may lose money by
investing in the Fund; the investment is not guaranteed.
SIZE: On November 30, 1997, the Fund had over $210.8 million in assets.
TACTICAL ALLOCATION FUND
GOAL: To increase the value of your investment by following a systematic
investment strategy that allocates the Fund's assets between equity securities
and U.S. Treasury notes or U.S. Treasury bills.
INVESTMENT OBJECTIVE: Total return, consisting of long-term capital
appreciation and current income.
RISKS: Although the Fund seeks total return, it may not achieve as high a
level of either capital appreciation or current income as a fund that has only
one of those objectives as its primary objective. The Fund invests in equity
securities included in the Standard & Poor's 500 Composite Stock Price Index
(the "S&P 500 Index"). Equity securities historically have shown greater
growth potential than other types of securities, but they have also shown
greater volatility. Because the Fund invests in equity securities, its price
will rise and fall. The Fund may invest in U.S. dollar-denominated securities
of foreign companies, which can involve more risk than investing in the
securities of U.S. companies. The U.S. Treasury notes and U.S. Treasury bills
in which the Fund may invest are subject to interest rate risk, which means
that their prices can be expected to decrease when interest rates rise. The
Fund may use derivatives, such as options and futures, in its investment
activities, which may involve additional risks. Investors may lose money by
investing in the Fund; the investment is not guaranteed.
SIZE: On November 30, 1997, the Fund had over $822.1 million in assets.
MANAGEMENT
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), an asset
management subsidiary of PaineWebber Incorporated ("PaineWebber"), is the
investment adviser and administrator of Balanced Fund and Tactical Allocation
Fund (each a "Fund" and, collectively, the "Funds").
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Prospectus Page 3
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PaineWebber Tactical Allocation Fund
Balanced Fund
The Funds at a Glance
(Continued)
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MINIMUM INVESTMENT
To open an account, investors need $1,000; to add to an account, investors
need only $100.
WHO SHOULD INVEST
BALANCED FUND is for investors who want high total return with relatively low
volatility through investments in equity securities, investment grade bonds
and money market instruments. The Fund is designed for investors who want an
investment that maintains a fixed income allocation at all times, yet has the
flexibility to change its investment mix in response to changing market
conditions. Over time, the 25% minimum in fixed income investments (including
bonds and cash) should result in a lower risk profile for the Fund than if it
could invest 100% of its assets in stocks.
TACTICAL ALLOCATION FUND is for investors who want total return, consisting of
long-term capital appreciation and current income, through a systematic
investment strategy that allocates assets between equity securities included
in the S&P 500 Index and U.S. Treasury notes or U.S. Treasury bills. The Fund
is designed for investors who want to participate in the broad stock market,
yet want the flexibility to take a more defensive posture when a cyclical
decline in stock prices is anticipated. This disciplined approach to investing
in stocks attempts to shift the asset mix in anticipation of, not in response
to, changing market trends.
* * * *
See page 14 for a summary of the differences between Balanced Fund and
Tactical Allocation Fund.
HOW TO PURCHASE SHARES OF THE FUNDS
Investors may select among these classes of shares:
CLASS A SHARES
The price is the net asset value plus the initial sales charge; the maximum
sales charge is 4.5% of the public offering price. Although investors pay an
initial sales charge when they buy Class A shares, the ongoing expenses for
this class are lower than the ongoing expenses of Class B and Class C shares.
CLASS B SHARES
The price is the net asset value. Investors do not pay an initial sales charge
when they buy Class B shares. As a result, 100% of their purchase is
immediately invested. However, Class B shares have higher ongoing expenses
than Class A shares. Depending upon how long they own the shares, investors
may have to pay a sales charge when they sell Class B shares. This sales
charge is called a "contingent deferred sales charge" and applies when
investors sell their Class B shares within six years after purchase. After six
years, Class B shares convert to Class A shares, which have lower ongoing
expenses and no contingent deferred sales charge.
CLASS C SHARES
The price is the net asset value. Investors do not pay an initial sales charge
when they buy Class C shares. As a result, 100% of their purchase is
immediately invested. However, Class C shares have higher ongoing expenses
than Class A shares. A contingent deferred sales charge of 1% is charged on
shares sold within one year of purchase. Class C shares never convert to any
other class of shares.
CLASS Y SHARES
Class Y shares are offered only to limited groups of investors. The price is
the net asset value. Investors do not pay an initial sales charge when they
buy Class Y shares. As a result, 100% of their purchase is immediately
invested. Investors also do not pay a contingent deferred sales charge when
they sell Class Y shares. Class Y shares have lower ongoing expenses than any
other class of shares.
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Prospectus Page 4
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PaineWebber Tactical Allocation Fund
Balanced Fund
Expense Table
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The following tables are intended to assist investors in understanding the
expenses associated with investing in each class of shares of the Funds.
Expenses shown below represent those incurred for the most recent fiscal year,
except that "Other Expenses" for Class Y shares of Balanced Fund have been
estimated because no Class Y shares were outstanding.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
SHAREHOLDER TRANSACTION EXPENSES ------- ------- ------- -------
<S> <C> <C> <C> <C>
Maximum Sales Charge on Purchases of Shares (as
a % of offering price)........................ 4.5% None None None
Sales Charge on Reinvested Dividends (as a % of
offering price)............................... None None None None
Maximum Contingent Deferred Sales Charge (as a
% of offering price or net asset value at the
time of sale, whichever is less).............. None 5% 1% None
ANNUAL FUND OPERATING EXPENSES (as a % of
average net assets)
BALANCED FUND
Management Fees................................ 0.75% 0.75% 0.75% 0.75%
12b-1 Fees..................................... 0.25 1.00 1.00 0.00
Other Expenses................................. 0.46 0.47 0.46 0.46
---- ---- ---- ----
Total Operating Expenses....................... 1.46% 2.22% 2.21% 1.21%
==== ==== ==== ====
TACTICAL ALLOCATION FUND
Management Fees................................ 0.50% 0.50% 0.50% 0.50%
12b-1 Fees..................................... 0.25 1.00 1.00 0.00
Other Expenses................................. 0.24 0.24 0.25 0.24
---- ---- ---- ----
Total Operating Expenses....................... 0.99% 1.74% 1.75% 0.74%
==== ==== ==== ====
</TABLE>
CLASS A SHARES: Sales charge waivers and a reduced sales charge purchase
plan are available. Purchases of $1 million or more are not subject to an
initial sales charge. However, if such shares are sold within one year after
purchase, a contingent deferred sales charge of 1% of the offering price or
the net asset value of the shares at the time of sale by the shareholder,
whichever is less, is imposed.
CLASS B SHARES: Sales charge waivers are available. The maximum 5%
contingent deferred sales charge applies to sales of shares during the first
year after purchase. The charge generally declines by 1% annually, reaching
zero after six years.
CLASS C SHARES: If shares are sold within one year after purchase, a
contingent deferred sales charge of 1% of the offering price or the net
asset value of the shares at the time of sale, whichever is less, is
imposed.
CLASS Y SHARES: No initial or contingent deferred sales charge is imposed,
nor are Class Y shares subject to 12b-1 distribution or service fees. Class
Y shares may be purchased by participants in certain investment programs
that are sponsored by PaineWebber and that may invest in PaineWebber mutual
funds ("PW Programs"), when Class Y shares are purchased through that
Program. Participation in a PW Program is subject to an advisory fee at an
annual rate of no more than 1.5% of assets held through that PW Program.
This account charge is not included in the table because investors who are
not PW Program participants also are permitted to purchase Class Y shares.
12b-1 distribution fees are asset-based sales charges. Long-term Class B and
Class C shareholders may pay more in direct and indirect sales charges
(including 12b-1 distribution fees) than the economic equivalent of the
maximum
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Prospectus Page 5
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PaineWebber Tactical Allocation Fund
Balanced Fund
Expense Table
(Continued)
- -------------------------------------------------------------------------------
front-end sales charge permitted by the National Association of Securities
Dealers, Inc. 12b-1 fees have two components, as follows:
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
<S> <C> <C> <C> <C>
12b-1 service fees.............................. 0.25% 0.25% 0.25% N/A
12b-1 distribution fees......................... 0.00 0.75 0.75 N/A
</TABLE>
For more information, see "Management" and "Flexible Pricing SM."
EXAMPLES OF EFFECT OF FUND EXPENSES
The following examples should assist investors in understanding various costs
and expenses they would incur as shareholders of a Fund. The assumed 5% annual
return shown in the examples is required by regulations of the Securities and
Exchange Commission ("SEC") applicable to all mutual funds. THESE EXAMPLES
SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL
EXPENSES OF A FUND MAY BE MORE OR LESS THAN THOSE SHOWN.
An investor would pay the following expenses, directly or indirectly, on a
$1,000 investment in a Fund, assuming a 5% annual return:
BALANCED FUND
<TABLE>
<CAPTION>
EXAMPLE 1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ------- ------ ------- ------- --------
<S> <C> <C> <C> <C>
Class A........................................ $59 $89 $121 $212
Class B (Assuming sale of all shares at end of
period)....................................... $73 $99 $139 $219
Class B (Assuming no sale of shares)........... $23 $69 $119 $219
Class C (Assuming sale of all shares at end of
period)....................................... $32 $69 $118 $254
Class C (Assuming no sale of shares)........... $22 $69 $118 $254
Class Y........................................ $12 $38 $ 67 $147
</TABLE>
TACTICAL ALLOCATION FUND
<TABLE>
<CAPTION>
EXAMPLE 1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ------- ------ ------- ------- --------
<S> <C> <C> <C> <C>
Class A........................................ $55 $75 $ 97 $161
Class B (Assuming sale of all shares at end of
period)....................................... $68 $85 $114 $167
Class B (Assuming no sale of shares)........... $18 $55 $ 94 $167
Class C (Assuming sale of all shares at end of
period)....................................... $28 $55 $ 95 $206
Class C (Assuming no sale of shares)........... $18 $55 $ 95 $206
Class Y........................................ $ 8 $24 $ 41 $ 92
</TABLE>
ASSUMPTIONS MADE IN THE EXAMPLES
. ALL CLASSES: Reinvestment of all dividends and other distributions;
percentage amounts listed under "Annual Fund Operating Expenses" remain
the same for years shown.
. CLASS A SHARES: Deduction of the maximum 4.5% initial sales charge at
the time of purchase.
. CLASS B SHARES: Deduction of the maximum applicable contingent deferred
sales charge at the time of sale, which declines over a period of six
years. Ten-year figures assume that Class B shares convert to Class A
shares at the end of the sixth year.
. CLASS C SHARES: Deduction of a 1% contingent deferred sales charge for
sales of shares within one year of purchase.
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Prospectus Page 6
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[THIS PAGE INTENTIONALLY LEFT BLANK]
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Prospectus Page 7
<PAGE>
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PaineWebber Tactical Allocation Fund
Balanced Fund
Financial Highlights
- -------------------------------------------------------------------------------
BALANCED FUND
The following tables provide investors with data and ratios for one Class A,
Class B and Class C share for each of the periods shown. This information is
supplemented by the financial statements, accompanying notes and the report of
Price Waterhouse LLP, independent accountants, which appear in the Fund's
Annual Report to Shareholders for the fiscal year ended August 31, 1997, and
are incorporated by reference into the Statement of Additional Information.
The financial statements and notes, as well as the information in the table
below relating to the fiscal year ended August 31, 1997, the period March 1,
1996 through August 31, 1996 and to each of the four years in the period ended
February 29, 1996, have been audited by Price Waterhouse LLP. Further
information about the Fund's performance is also included in the Annual Report
to Shareholders, which may be obtained without charge by calling 1-800-647-
1568. Prior to August 14, 1995, the Fund pursued certain different investment
policies; thus, the information shown below for periods prior to that date may
not necessarily be indicative of current or future operations. The Fund had no
Class Y shares outstanding during the periods shown.
<TABLE>
<CAPTION>
BALANCED FUND
-------------------------------------------------------------------------------------------
CLASS A
-------------------------------------------------------------------------------------------
FOR THE
FOR THE FOR THE PERIOD
YEAR SIX MONTHS FOR THE FOR THE YEARS ENDED JULY 1,
ENDED ENDED YEAR ENDED FEBRUARY 28, 1991+ TO
AUGUST 31, AUGUST 31, FEBRUARY 29, ------------------------------ FEBRUARY 29,
1997 1996(3) 1996 1995 1994 1993 1992
---------- ---------- ------------ -------- -------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net asset value,
beginning of
period......... $ 10.27 $ 10.85 $ 9.80 $ 12.04 $ 11.54 $ 11.01 $10.09
-------- -------- -------- -------- -------- -------- ------
Net investment
income......... 0.23++ 0.12++ 0.27++ 0.26 0.22 0.33 0.19
Net realized and
unrealized
gains (losses)
from
investments.... 2.79++ (0.12)++ 1.84++ (1.07) 1.31 0.54 0.96
-------- -------- -------- -------- -------- -------- ------
Net increase
(decrease) from
investment
operations..... 3.02 0.00 2.11 (0.81) 1.53 0.87 1.15
-------- -------- -------- -------- -------- -------- ------
Dividends from
net investment
income......... (0.24) (0.10) (0.31) (0.23) (0.25) (0.34) (0.23)
Distributions
from net
realized gains
from investment
transactions... (0.55) (0.48) (0.75) (1.20) (0.78) -- --
-------- -------- -------- -------- -------- -------- ------
Total dividends
and other
distributions
to
shareholders... (0.79) (0.58) (1.06) (1.43) (1.03) (0.34) (0.23)
-------- -------- -------- -------- -------- -------- ------
Net asset value,
end of period.. $ 12.50 $ 10.27 $ 10.85 $ 9.80 $ 12.04 $ 11.54 $11.01
======== ======== ======== ======== ======== ======== ======
Total investment
return (1)..... 30.67 % 0.03 % 22.08 % (6.02)% 13.57 % 8.09 % 11.43 %
======== ======== ======== ======== ======== ======== ======
Ratios/Supplemental
data:
Net assets, end
of period
(000's)........ $176,403 $157,525 $171,609 $174,761 $216,492 $154,594 $ 916
Expenses to
average net
assets......... 1.46 % 1.34 %* 1.29 % 1.26 % 1.21 % 1.18 % 1.30 %*
Net investment
income to
average net
assets......... 2.02 % 2.19 %* 2.55 % 2.41 % 1.74 % 2.52 % 3.43 %*
Portfolio
turnover rate.. 188 % 103 % 188 % 107 % 69 % 33 % 84 %
Average
commission rate
paid(2)........ $ 0.0600 $ 0.0600 -- -- -- -- --
<CAPTION>
-------------------------------------------------------------------------------------------
CLASS B
-------------------------------------------------------------------------------------------
FOR THE FOR THE FOR THE
YEAR SIX MONTHS FOR THE YEARS ENDED
ENDED ENDED YEAR ENDED FEBRUARY 28,
AUGUST 31, AUGUST 31, FEBRUARY 29, -------------------
1997 1996(3) 1996 1995 1994
----------- ------------ ------------ --------- ---------
<S> <C> <C> <C> <C> <C>
Net asset value,
beginning of
period......... $ 10.42 $ 11.00 $ 9.90 $ 12.10 $ 11.56
----------- ------------ ------------ --------- ---------
Net investment
income......... 0.14++ 0.08++ 0.19++ 0.44 0.26
Net realized and
unrealized
gains (losses)
from
investments.... 2.84++ (0.11)++ 1.86++ (1.32) 1.18
----------- ------------ ------------ --------- ---------
Net increase
(decrease) from
investment
operations..... 2.98 (0.03) 2.05 (0.88) 1.44
----------- ------------ ------------ --------- ---------
Dividends from
net investment
income......... (0.15) (0.07) (0.20) (0.12) (0.12)
Distributions
from net
realized gains
from investment
transactions... (0.55) (0.48) (0.75) (1.20) (0.78)
----------- ------------ ------------ --------- ---------
Total dividends
and other
distributions
to
shareholders... (0.70) (0.55) (0.95) (1.32) (0.90)
----------- ------------ ------------ --------- ---------
Net asset value,
end of period.. $ 12.70 $ 10.42 $ 11.00 $ 9.90 $ 12.10
=========== ============ ============ ========= =========
Total investment
return (1)..... 29.70 % (0.30)% 21.20 % (6.68)% 12.62 %
=========== ============ ============ ========= =========
Ratios/Supplemental
data:
Net assets, end
of period
(000's)........ $22,768 $22,307 $26,627 $37,104 $83,178
Expenses to
average net
assets......... 2.22 % 2.09 %* 2.05 % 1.98 % 2.05 %
Net investment
income to
average net
assets......... 1.27 % 1.43 %* 1.81 % 1.60 % 1.00 %
Portfolio
turnover rate.. 188 % 103 % 188 % 107 % 69 %
Average
commission rate
paid(2)........ $0.0600 $0.0600 -- -- --
</TABLE>
- -------
* Annualized.
+ Commencement of issuance of shares.
++ Calculated using the average shares outstanding for the year.
(1) Total investment return is calculated assuming a $1,000 investment on the
first day of each period reported, reinvestment of all dividends and other
distributions at net asset value on the payable dates and a sale at net
asset value on the last day of each period reported. The figures do not
include sales charges; results for each class would be lower if sales
charges were included. Total investment returns for periods of less than
one year have not been annualized.
(2) Effective for fiscal years beginning on or after September 1, 1995, the
Fund is required to disclose the average commission rate paid per share of
common stock investments purchased or sold.
(3) Fiscal year changed to August 31.
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Prospectus Page 8
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PaineWebber Tactical Allocation Fund
Balanced Fund
Financial Highlights
(Continued)
- --------------------------------------------------------------------------------
BALANCED FUND
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
- ---------------------------------------------------------------
FOR THE YEARS ENDED FEBRUARY 28 OR 29,
- ---------------------------------------------------------------
1993 1992 1991 1990 1989 1988
- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
$ 10.99 $ 10.21 $ 9.86 $ 9.92 $ 10.18 $ 10.40
- -------- -------- -------- -------- -------- --------
0.30 0.35 0.59 0.65 0.54 0.48
0.48 0.78 0.38 0.10 (0.28) (0.09)
- -------- -------- -------- -------- -------- --------
0.78 1.13 0.97 0.75 0.26 0.39
- -------- -------- -------- -------- -------- --------
(0.21) (0.35) (0.62) (0.70) (0.52) (0.44)
-- -- -- (0.11) -- (0.17)
- -------- -------- -------- -------- -------- --------
(0.21) (0.35) (0.62) (0.81) (0.52) (0.61)
- -------- -------- -------- -------- -------- --------
$ 11.56 $ 10.99 $ 10.21 $ 9.86 $ 9.92 $ 10.18
======== ======== ======== ======== ======== ========
7.25 % 11.24 % 10.29 % 7.53 % 2.73 % 4.31 %
======== ======== ======== ======== ======== ========
$160,115 $346,290 $403,557 $557,646 $651,003 $715,771
1.98 % 2.02 % 1.83 % 1.84 % 1.94 % 1.98 %
2.02 % 3.25 % 5.46 % 6.04 % 5.37 % 5.01 %
33 % 84 % 169 % 327 % 159 % 129 %
-- -- -- -- -- --
<CAPTION>
CLASS C
- ---------------------------------------------------------------------------------------------------------
FOR THE FOR THE
FOR THE SIX MONTHS FOR THE YEARS ENDED FOR THE PERIOD
YEAR ENDED ENDED YEAR ENDED FEBRUARY 28 JULY 2, 1992+ TO
AUGUST 31, AUGUST 31, FEBRUARY 29, ------------------- FEBRUARY 28,
1997 1996(3) 1996 1995 1994 1993
- ----------- ------------ ------------ -------- --------- ----------------
<C> <C> <C> <C> <C> <C>
$ 10.29 $ 10.88 $ 9.82 $12.03 $ 11.54 $10.86
- ----------- ------------ ------------ -------- --------- ----------------
0.14++ 0.08++ 0.19++ 0.19 0.14 0.13
2.80++ (0.12)++ 1.84++ (1.07) 1.30 0.71
- ----------- ------------ ------------ -------- --------- ----------------
2.94 (0.04) 2.03 (0.88) 1.44 0.84
- ----------- ------------ ------------ -------- --------- ----------------
(0.16) (0.07) (0.22) (0.13) (0.17) (0.16)
(0.55) (0.48) (0.75) (1.20) (0.78) --
- ----------- ------------ ------------ -------- --------- ----------------
(0.71) (0.55) (0.97) (1.33) (0.95) (0.16)
- ----------- ------------ ------------ -------- --------- ----------------
$ 12.52 $ 10.29 $10.88 $ 9.82 $ 12.03 $11.54
=========== ============ ============ ======== ========= ================
29.70 % (0.38)% 21.12 % (6.69)% 12.75 % 7.78 %
=========== ============ ============ ======== ========= ================
$ 8,736 $6,979 $7,469 $8,525 $12,916 $7,058
2.21 % 2.09 %* 2.08 % 2.01 % 1.96 % 1.95 %*
1.27 % 1.44 %* 1.77 % 1.62 % 0.97 % 1.91 %*
188 % 103 % 188 % 107 % 69 % 33 %
$0.0600 $0.0600 -- -- -- --
</TABLE>
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Prospectus Page 9
<PAGE>
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-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
Financial Highlights
(Continued)
- -------------------------------------------------------------------------------
TACTICAL ALLOCATION FUND
The following tables provide investors with data and ratios for one Class A,
Class B, Class C and Class Y share for each of the periods shown. This
information is supplemented by the financial statements, accompanying notes
and the report of Ernst & Young LLP, independent auditors, which appear in the
Fund's Annual Report to Shareholders for the fiscal year ended August 31,
1997, and are incorporated by reference into the Statement of Additional
Information. The financial statements and notes, as well as the financial
information in the tables below relating to each of the three fiscal years in
the period ended August 31, 1997 have been audited by Ernst & Young LLP. The
financial information for the year ended August 31, 1994 and the prior periods
was audited by other auditors, whose report on this data was unqualified.
Further information about the Fund's performance is also included in the
Annual Report to Shareholders, which may be obtained without charge by calling
1-800-647-1568.
<TABLE>
<CAPTION>
TACTICAL ALLOCATION FUND
---------------------------------------------------------------------------
CLASS A CLASS B
------------------------------------------------- -------------------------
FOR THE PERIOD FOR THE PERIOD
FOR THE YEARS MAY 10, FOR THE JANUARY 30,
ENDED 1993+ YEAR ENDED 1996+ TO
AUGUST 31, TO AUGUST 31, AUGUST 31, AUGUST 31,
--------------------------------- -------------- ---------- --------------
1997 1996 1995** 1994 1993 1997 1996
-------- ------- ------ ------ -------------- ---------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net asset value,
beginning of period..... $ 16.15 $ 14.86 $13.78 $13.50 $12.90 $ 16.13 $ 15.54
-------- ------- ------ ------ ------ -------- -------
Net investment income... 0.18@ 0.18 0.22 0.24 0.08 0.03@ 0.02
Net realized and
unrealized gains from
investment transactions. 6.12@ 2.31 2.05 0.32 0.59 6.09@ 0.57
-------- ------- ------ ------ ------ -------- -------
Net increase from
investment operations... 6.30 2.49 2.27 0.56 0.67 6.12 0.59
-------- ------- ------ ------ ------ -------- -------
Dividends from net
investment income....... (0.14) (0.14) (0.22) (0.24) (0.07) (0.09) --
Distributions from net
realized gains from
investment transactions. (0.08) (1.06) (0.97) (0.04) -- (0.08) --
-------- ------- ------ ------ ------ -------- -------
Total dividends and
other distributions to
shareholders............ (0.22) (1.20) (1.19) (0.28) (0.07) (0.17) --
-------- ------- ------ ------ ------ -------- -------
Net asset value, end of
period.................. $ 22.23 $ 16.15 $14.86 $13.78 $13.50 $ 22.08 $ 16.13
======== ======= ====== ====== ====== ======== =======
Total investment
return(1)............... 39.26% 17.35% 18.43% 4.21% 5.17% 38.14% 3.80%
======== ======= ====== ====== ====== ======== =======
Ratios/Supplemental
data:
Net assets, end of
period (000's).......... $170,759 $23,551 $1,944 $1,801 $3,007 $239,836 $28,495
Expenses to average net
assets.................. 0.99% 1.17% 1.46% 1.13% 1.06%* 1.74% 1.84%*
Net investment income to
average net assets...... 0.88% 1.12% 1.60% 1.64% 1.71%* 0.13% 0.47%*
Portfolio turnover rate. 6% 6% 53% 4% 0% 6% 6%
Average commission rate
paid (2)................ $ 0.0250 $0.0250 -- -- -- $ 0.0250 $0.0250
</TABLE>
- -------
+ Commencement of issuance of shares.
* Annualized.
** Investment advisory functions for the Fund were transferred from Kidder
Peabody Asset Management, Inc. to Mitchell Hutchins on February 13, 1995.
@ Calculated using the average shares outstanding for the period.
(1) Total investment return is calculated assuming a $1,000 investment on the
first day of each period reported, reinvestment of all dividends and other
distributions at net asset value on the payable dates and a sale at net
asset value on the last day of each period reported. The figures do not
include sales charges; results for Class A, B and C would be lower if
sales charges were included. Total investment returns for periods of less
than one year have not been annualized.
(2) Effective for fiscal years beginning on or after September 1, 1995, the
Fund is required to disclose the average commission rate paid per share of
common stock investments purchased or sold.
----------
Prospectus Page 10
<PAGE>
- --------------------------------------------------------------------------------
-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
Financial Highlights
(Concluded)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
TACTICAL ALLOCATION FUND
- --------------------------------------------------------------------------------------------------------------
CLASS C CLASS Y
- ------------------------------------------------------------- ------------------------------------------------
FOR THE PERIOD
JULY 22, FOR THE PERIOD
FOR THE YEARS 1992+ FOR THE YEARS MAY 10,
ENDED AUGUST 31, TO AUGUST 31, ENDED AUGUST 31, 1993+ TO
- --------------------------------------------- -------------- -------------------------------- AUGUST 31,
1997 1996 1995** 1994 1993 1992 1997 1996 1995** 1994 1993
- -------- ------- ------- ------- -------- -------------- ------- ------- ------ ------ --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 16.12 $ 14.87 $ 13.78 $ 13.49 $ 12.12 $ 12.00 $ 16.20 $ 14.88 $13.79 $13.52 $12.90
- -------- ------- ------- ------- -------- ------- ------- ------- ------ ------ ------
0.03@ 0.06 0.12 0.13 0.18 0.03 0.23@ 0.30 0.23 0.25 0.09
6.11@ 2.32 2.06 0.33 1.34 0.09 6.13@ 2.24 2.09 0.33 0.60
- -------- ------- ------- ------- -------- ------- ------- ------- ------ ------ ------
6.14 2.38 2.18 0.46 1.52 0.12 6.36 2.54 2.32 0.58 0.69
- -------- ------- ------- ------- -------- ------- ------- ------- ------ ------ ------
-- (0.07) (0.12) (0.13) (0.15) -- (0.15) (0.16) (0.26) (0.27) (0.07)
(0.08) (1.06) (0.97) (0.04) -- -- (0.08) (1.06) (0.97) (0.04) --
- -------- ------- ------- ------- -------- ------- ------- ------- ------ ------ ------
(0.08) (1.13) (1.09) (0.17) (0.15) -- (0.23) (1.22) (1.23) (0.31) (0.07)
- -------- ------- ------- ------- -------- ------- ------- ------- ------ ------ ------
$ 22.18 $ 16.12 $ 14.87 $ 13.78 $ 13.49 $ 12.12 $ 22.33 $ 16.20 $14.88 $13.79 $13.52
======== ======= ======= ======= ======== ======= ======= ======= ====== ====== ======
38.20% 16.52% 17.57% 3.46% 12.61% 0.98% 39.55% 17.70% 18.79% 4.41% 5.30%
======== ======= ======= ======= ======== ======= ======= ======= ====== ====== ======
$233,044 $73,630 $48,105 $62,970 $107,761 $50,222 $36,467 $12,803 $2,506 $3,880 $3,379
1.75% 1.95% 2.22% 1.88% 1.73% 1.75%* 0.74% 0.95% 1.23% 0.88% 0.81%*
0.14% 0.35% 0.86% 0.89% 1.04% 2.42%* 1.16% 1.38% 1.86% 1.90% 1.96%*
6% 6% 53% 4% 0% 0% 6% 6% 53% 4% 0%
$ 0.0250 $0.0250 -- -- -- -- $0.0250 $0.0250 -- -- --
</TABLE>
----------
Prospectus Page 11
<PAGE>
- -------------------------------------------------------------------------------
------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
Investment Objectives & Policies
- -------------------------------------------------------------------------------
The Funds' investment objectives may not be changed without shareholder
approval. Their other investment policies, except where noted, are not
fundamental and may be changed by the Funds' boards. See the summary on page
14 for the differences between Balanced Fund and Tactical Allocation Fund.
BALANCED FUND
Balanced Fund's investment objective is high total return with low volatility.
The Fund pursues this objective by investing primarily in a combination of
three asset classes: stocks (equity securities), bonds (investment grade
bonds) and cash (money market securities). The portion invested in each of
these asset classes is based on Mitchell Hutchins' judgment of the best
allocation of the Fund's assets. However, the Fund maintains a fixed income
allocation (including bonds and cash) of at least 25% at all times.
The Fund may invest in a broad range of:
. Equity securities issued by companies believed by Mitchell Hutchins to have
the potential for rapid earnings growth;
. Investment grade bonds, that is, bonds that, at the time of purchase, are
assigned one of the four highest grades by Standard & Poor's, a division of
The McGraw-Hill Companies, Inc. ("S&P"), or Moody's Investors Service, Inc.
("Moody's"), are comparably rated by another nationally recognized rating
agency or, if unrated, are determined by Mitchell Hutchins to be of
comparable quality;
. U.S. government securities;
. Convertible securities rated at least B by S&P or Moody's, comparably rated
by another nationally recognized rating agency or, if unrated, determined by
Mitchell Hutchins to be of comparable quality. Securities rated BB or B by
S&P (or Ba or B by Moody's) are below investment grade and regarded as
having predominantly speculative characteristics with respect to the ability
to pay interest and repay principal. While such securities may have some
quality and protective characteristics, these are outweighed by large
uncertainties or major exposures to adverse conditions. The Fund will not
invest more than 10% of its total assets in convertible securities rated
below investment grade; and
. High quality money market securities.
TACTICAL ALLOCATION FUND
Tactical Allocation Fund's investment objective is total return, consisting of
long-term capital appreciation and current income. The Fund seeks to achieve
its objective by using a systematic investment strategy that allocates its
assets between common stocks and U.S. Treasury notes or U.S. Treasury bills.
In seeking total return, the Fund shifts its asset mix between an equity
portion designed to track the performance of the S&P 500 Index (the Fund holds
approximately 450 of the 500 stocks in the S&P 500 Index), and a bond portion,
consisting of five-year U.S. Treasury notes, or a cash portion, consisting of
30-day U.S. Treasury bills. The allocation among these three segments is based
on the asset mix recommendation of the Mitchell Hutchins Tactical Allocation
Model.
The Fund seeks to achieve total return during all economic and financial
market cycles, with lower volatility than that of the S&P 500 Index, by
investing in common stocks held in the S&P 500 Index, but taking a more
defensive posture when that Model signals a potential bear market, a prolonged
or significant downturn in stock prices.
* * * *
As with any mutual fund, there is no assurance that either Fund will achieve
its investment objective. Each Fund's net asset value fluctuates based upon
changes in the value of its portfolio securities.
----------
Prospectus Page 12
<PAGE>
- -------------------------------------------------------------------------------
-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
Investment Philosophy & Process
- -------------------------------------------------------------------------------
BALANCED FUND
Mitchell Hutchins believes that superior performance can be obtained by
reallocating assets from time to time before changes in the consensus outlook
of investors have been fully discounted by the market. Mitchell Hutchins also
believes that returns on stocks and bonds reflect the consensus expectations
for key economic variables, such as interest rates, profit growth and
inflation. To implement this strategy for Balanced Fund, Mitchell Hutchins:
. Regularly surveys key investment advisors and generates a consensus forecast
of economic variables affecting returns on equity securities, bonds and
money market instruments; and
. Applies fundamental valuation techniques to the consensus data to determine
the asset allocation it believes to be optimal.
Once Balanced Fund's asset allocation is determined, the portfolio managers
specializing in each asset class select individual securities for each portion
of the portfolio. Mitchell Hutchins regularly monitors the outlooks for key
economic variables and shifts the asset allocation mix when there are
significant changes in expected returns.
Balanced Fund uses the following investment process to determine the
individual securities for each portion of the Fund:
. EQUITY SECURITIES. Mitchell Hutchins uses its proprietary Factor Valuation
Model to identify stocks providing a combination of value and price
momentum. This Model screens a universe of small- to large-capitalization
companies in ten different business sectors to identify undervalued
companies with strong earnings momentum that rank well in three measures:
--VALUE: projected dividends, cash flow, earnings and book value;
--MOMENTUM: earnings and price to identify companies that could surprise on
the upside; and
--ECONOMIC SENSITIVITY: to forecast how different equity securities and
industries may perform under various economic scenarios.
The equity securities ranking in the top 20% of the Factor Valuation Model's
universe are screened twice a month. Then the portfolio managers take a closer
look at those equity securities that rank higher based on value and momentum.
Mitchell Hutchins applies traditional analysis and may speak to the management
of these companies, as well as those of their competitors.
. BONDS. Mitchell Hutchins selects these securities based on its analysis of
their maturity and risk structures (comparing yields on U.S. Treasury
securities to yields on riskier types of debt securities).
. MONEY MARKET INSTRUMENTS. Mitchell Hutchins' decision to use these
securities is based on its judgment of how they can further the Fund's
investment objective.
As of August 31, 1997, the Fund's net assets were allocated as follows: equity
securities, 62%; bonds, 32%; and cash and cash equivalents (including other
assets net of liabilities), 6%. At February 28, 1997, the net asset allocation
looked like this: equity securities, 59%; bonds, 33%; and cash and cash
equivalents (including other assets net of liabilities), 8%.
TACTICAL ALLOCATION FUND
Mitchell Hutchins allocates Tactical Allocation Fund's assets between stocks
and either bonds or cash, based on the Tactical Allocation Model's
quantitative assessment of the projected rates of return of each asset class.
The Tactical Allocation Model embraces the concept that incremental return to
the S&P 500 Index can be achieved through the tactical allocation of portfolio
assets across three main asset classes--stocks, bonds and cash. This
systematic approach to investing in stocks attempts to shift the asset mix in
anticipation of, not in response to, changing market trends. The emphasis of
this Model is to avoid or reduce exposure to the stock market during down
cycles and to track the S&P 500 Index in periods of strongly positive market
performance. In contrast to a typical S&P 500 Index fund that maintains a 100%
allocation to the Index at all times, the Fund is designed to take a more
defensive posture when the Tactical Allocation Model signals a potential bear
market, a prolonged or significant downturn in stock prices.
The basic premise of the Tactical Allocation Model is that investors accept
the risk of owning stocks, measured as volatility of return, because they
expect a
----------
Prospectus Page 13
<PAGE>
- -------------------------------------------------------------------------------
-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
return advantage. This expected return advantage of owning stocks is called
the equity risk premium ("ERP"). The Model projects the stock market's
expected ERP based on several factors including:
. current prices of stocks and their expected future dividends; and
. yield-to-maturity of the one-year U.S. Treasury bill.
When the stock market's ERP is high, the Tactical Allocation Model signals the
Fund to invest 100% in stocks. Conversely, when the ERP decreases below
certain threshold levels, the Model signals the Fund to reduce its exposure to
stocks. The Model can recommend stock allocations of 100%, 75%, 50%, 25% or
0%.
If the Tactical Allocation Model recommends a stock allocation of less than
100%, the Model also recommends a fixed income allocation for the remainder of
the Fund's assets. The Model will recommend either bonds (five-year U.S.
Treasury notes) or cash (30-day U.S. Treasury bills), but not both. To make
this determination, the Model calculates the risk premium available for the
notes. This "bond risk premium" ("BRP") is calculated based on the yield-to-
maturity of the five-year U.S. Treasury note and the one-year U.S. Treasury
bill.
Asset reallocations are made on the first business day of each month. In
addition to any reallocation of assets dictated by the Tactical Allocation
Model, any material amounts resulting from appreciation or receipt of
dividends, other distributions, interest payments and proceeds from securities
maturing in each of the asset classes are reallocated (or "rebalanced") to the
extent practicable to re-establish the Model's recommended asset allocation
mix.
The Fund deviates from the recommendations of the Tactical Allocation Model
only to the extent necessary to:
. Maintain an amount in cash, not expected to exceed 2% of its total assets
under normal market conditions, to pay Fund operating expenses, dividends
and other distributions on its shares and to meet anticipated sales of
shares by Fund investors; and
. Qualify as a regulated investment company for federal income tax purposes.
See "Dividends & Taxes."
As a result, even if the Tactical Allocation Model does not recommend an
allocation to cash, the Fund still may hold cash.
As of August 31, 1997 and February 28, 1997, 100% of the Fund's assets were
allocated to stocks.
DIFFERENCES BETWEEN BALANCED FUND AND TACTICAL ALLOCATION FUND
<TABLE>
-------------------------------------------------------------------------
<CAPTION>
BALANCED FUND TACTICAL ALLOCATION FUND
<S> <C> <C>
Investment Objective High total return with low Total return, consisting of long-
volatility. term capital appreciation and
current income.
- ---------------------------------------------------------------------------------------------
Asset Allocation Assets may be reallocated at any Assets may be reallocated only on
Decision time, based on Mitchell Hutchins' the first business day of each
fundamental valuations for each month based on the Mitchell
asset class using its consensus Hutchins Tactical Allocation
forecast for certain economic Model.
variables.
- ---------------------------------------------------------------------------------------------
Asset Mix Fixed income allocation (bonds Tactical Allocation Model signals
and cash): at least 25% at all a stock segment of 100%, 75%,
times. 50%, 25% or 0% and selects bonds
or cash for balance. Fund may
deviate from Model only to pay
its expenses, dividends and other
obligations.
- ---------------------------------------------------------------------------------------------
Stock Selection Discretionary, based on the When there is a stock allocation,
Mitchell Hutchins Factor invests in about 450 of the 500
Valuation Model, which evaluates common stocks that make up the
companies' potential for rapid S&P 500 Index.
earnings growth.
- ---------------------------------------------------------------------------------------------
Fixed Income Discretionary, may select from When there is a bond allocation,
Selection broad range of debt securities five-year U.S. Treasury notes.
with government or private When there is a cash allocation,
issuers. 30-day U.S. Treasury bills.
</TABLE>
----------
Prospectus Page 14
<PAGE>
- -------------------------------------------------------------------------------
-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
Performance
- -------------------------------------------------------------------------------
These charts show the total returns for the Funds. Sales charges have not been
deducted from total returns for Class A, B and C shares. Returns would be
lower if sales charges were deducted. Balanced Fund had no Class Y shares
outstanding during the periods shown. Past results are not a guarantee of
future results.
Average annual returns, both before and after deducting the maximum sales
charges, are shown below in the tables that follow the performance charts.
BALANCED FUND
[THE FOLLOWING CHART APPEARED AS A BAR GRAPH IN THE PRINTED MATERIAL]
<TABLE>
<CAPTION>
7/1/91 -
12/31/91 1992 1993 1994 1995 1996 1997
--------- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Class A 11.53 5.18 15.63 (9.88) 23.13 14.74 24.57
- -----------------------------------------------------------------------------
<CAPTION>
12/12/86 -
12/31/86 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
---------- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Class B (2.40) 1.21 11.34 10.84 1.95 18.52 4.46 14.66 (10.51) 22.23 13.81 23.63
- ---------------------------------------------------------------------------------------------------------------------------
<CAPTION>
7/2/92 -
12/31/92 1993 1994 1995 1996 1997
--------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Class C 5.08 14.79 (10.48) 22.15 13.86 23.61
- -----------------------------------------------------------------------
</TABLE>
The 1991 return for Class A shares represents the period from inception on
July 1, 1991 through December 31, 1991. The 1986 return for Class B shares
represents the period from inception on December 12, 1986 through December 31,
1986. The 1992 return for Class C shares represents the period from inception
on July 2, 1992 through December 31, 1992.
AVERAGE ANNUAL RETURNS
As of August 31, 1997
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES
-------------- -------------- --------------
<S> <C> <C> <C>
Inception Date.................... 7/1/91 12/12/86 7/2/92
ONE YEAR
Before deducting maximum sales
charges......................... 30.67% 29.70% 29.70%
After deducting maximum sales
charges......................... 24.84% 24.70% 28.70%
FIVE YEARS
Before deducting maximum sales
charges......................... 12.64% 11.81% 11.82%
After deducting maximum sales
charges......................... 11.60% 11.56% 11.82%
TEN YEARS OR LIFE OF CLASS
Before deducting maximum sales
charges......................... 12.34% 10.44% 11.73%
After deducting maximum sales
charges......................... 11.50% 10.44% 11.73%
</TABLE>
----------
Prospectus Page 15
<PAGE>
- -------------------------------------------------------------------------------
-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
TACTICAL ALLOCATION FUND
[THE FOLLOWING TABLE APPPEARED AS A BAR GRAPH IN THE PRINTED MATERIAL]
<TABLE>
<CAPTION>
5/10/93 -
12/31/93 1994 1995 1996 1997
--------- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Class A 6.48% (0.59) 35.12 21.53 32.00
- --------------------------------------------------------------------------------
<CAPTION>
1/30/96 -
12/31/96 1997
--------- ----
<S> <C> <C>
Class B 18.06 31.05
- -------------------------------------------------------------------------------
<CAPTION>
7/22/92 -
12/31/92 1993 1994 1995 1996 1997
--------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Class C 6.67 7.64 (1.28) 34.09 20.66 31.01
- ------------------------------------------------------------------------------
<CAPTION>
5/11/93 -
12/31/93 1994 1995 1996 1997
--------- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Class Y 6.65% (0.28) 35.48 21.79 32.29
</TABLE>
The 1993 returns for Class A shares and Class Y shares represent the period
from inception on May 10, 1993 through December 31, 1993. The 1996 return for
Class B shares represents the period from inception on January 30, 1996
through December 31, 1996. The 1992 return for Class C shares represents the
period from inception on July 22, 1992 through December 31, 1992. Investment
advisory functions for the Fund were transferred from Kidder Peabody Asset
Management, Inc. to Mitchell Hutchins on February 13, 1995.
AVERAGE ANNUAL RETURNS
As of August 31, 1997
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES CLASS Y SHARES
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Inception Date.......... 5/10/93 1/30/96 7/22/92 5/10/93
ONE YEAR
Before deducting maxi-
mum sales charges..... 39.26% 38.14% 38.20% 39.55%
After deducting maximum
sales charges......... 33.01% 33.14% 37.20% 39.55%
FIVE YEARS
Before deducting maxi-
mum sales charges..... N/A N/A 17.13% N/A
After deducting maximum
sales charges......... N/A N/A 17.13% N/A
LIFE
Before deducting maxi-
mum sales charges..... 19.06% 25.46% 16.96% 19.37%
After deducting maximum
sales charges......... 17.79% 23.24% 16.96% 19.37%
</TABLE>
PERFORMANCE INFORMATION
The Funds perform a standardized computation of annualized total return and
may show this return in advertisements or promotional materials. Standardized
return shows the change in value of an investment in a Fund as a steady
compound annual rate of return. Actual year-by-year returns fluctuate and may
be higher or lower than standardized return. Standardized returns for Class A
shares reflect deduction of the Funds' maximum initial sales charge of 4.5% at
the time of purchase, and standardized returns for Class B and Class C reflect
deduction of the applicable contingent deferred sales charge imposed on a sale
of shares held for the period. One-, five- and ten-year periods will be shown,
unless the Fund or class has been in existence for a shorter period. If so,
returns will be shown for the period since inception, known as "Life". Total
return calculations assume reinvestment of dividends and other distributions.
The Funds may use other total return presentations in conjunction with
standardized return. These may cover the same or different periods as those
used for standardized return and may include cumulative returns, average
annual rates, actual year-by-year rates or any combination thereof. Non-
standardized return does not reflect initial or contingent deferred sales
charges and would be lower if such charges were deducted.
Total return information reflects past performance and does not indicate
future results. The investment return and principal value of shares of the
Funds will fluctuate. The amount investors receive when selling shares may be
more or less than what they paid. Further information about each Fund's
performance is contained in its Annual Report to Shareholders, which may be
obtained without charge by contacting the Fund, your PaineWebber investment
executive or PaineWebber's correspondent firms or by calling toll-free
1-800-647-1568.
----------
Prospectus Page 16
<PAGE>
- -------------------------------------------------------------------------------
-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
The Funds' Investments
- -------------------------------------------------------------------------------
BALANCED FUND
EQUITY SECURITIES include common stocks, preferred stocks and securities that
are convertible into them, including convertible debentures and notes and
common stock purchase warrants and rights. Common stocks, the most familiar
type, represent an equity (ownership) interest in a corporation.
Preferred stock has certain fixed income features, like a bond, but is
actually equity in a company, like common stock. Convertible securities may
include debentures, notes and preferred equity securities, which are
convertible into common stock.
U.S. GOVERNMENT BONDS in which the Fund may invest include direct obligations
of the U.S. government (such as U.S. Treasury bills, notes and bonds) and
obligations issued or guaranteed by U.S. government agencies and
instrumentalities.
BONDS are fixed or variable rate debt obligations, including notes, debentures
and similar debt instruments and securities. Mortgage- and asset-backed
securities are types of bonds. Corporations, governments and other issuers use
bonds to borrow money from investors. The issuer pays the investor a fixed or
variable rate of interest and must repay the amount borrowed at or before
maturity. Bonds have varying degrees of investment risk and varying levels of
sensitivity to changes in interest rates.
MORTGAGE AND ASSET-BACKED SECURITIES are bonds backed by specific types of
assets. Mortgage-backed bonds, which represent a direct or indirect interest
(participation) in--or are secured by and payable from--a pool of mortgage
loans secured by real property. They are sold by U.S. government agencies,
such as Freddie Mac (also known as the Federal Home Loan Mortgage Corporation)
and Fannie Mae (also known as the Federal National Mortgage Association), and
private corporations. Investors typically receive payments out of the interest
and principal on the underlying mortgages. The growth of mortgage-backed
securities and the secondary mortgage market in which they are traded has
helped keep mortgage money available for home financing.
Mortgage-backed securities may be composed of one or more classes and may be
structured as either pass-through securities or collateralized debt
obligations. Multiple-class mortgage-backed securities are referred to in this
Prospectus as "CMOs." Some CMOs are directly supported by other CMOs, which in
turn are supported by mortgage pools. Investors typically receive payments out
of the interest and principal on the underlying mortgages. The portions of
these payments that investors receive, as well as the priority of their rights
to receive payments, are determined by the specific terms of the CMO class.
CMOs involve special risks; and evaluating them requires special knowledge.
When interest rates go down and homeowners refinance their mortgages,
mortgage-backed bonds may be paid off more quickly than investors expect. When
interest rates rise, mortgage-backed bonds may be paid off more slowly than
originally expected. Changes in the rate or "speed" of these prepayments can
cause the value of mortgage-backed securities to fluctuate rapidly.
Other asset-backed securities are similar to mortgage-backed securities,
except that the underlying assets are different. These underlying assets may
be nearly any type of financial asset or receivable, such as motor vehicle
installment sales contracts, home equity loans, leases of various types of
real and personal property and receivables from credit cards.
ZERO COUPON BONDS are securities that make no periodic interest payments but
instead are sold at a deep discount from their face value. The buyer of these
bonds receives a rate of return by the gradual appreciation of the security,
which is redeemed at face value on a specified maturity date. There are many
kinds of zero coupon bonds. Some are issued in zero-coupon form, including
stripped U.S. government securities issued through the U.S. Treasury. Others
are created by brokerage firms that strip (separate) the coupons (unmatured
interest payments) from interest-paying bonds and sell the principal and the
coupons separately.
----------
Prospectus Page 17
<PAGE>
- -------------------------------------------------------------------------------
-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
Because zero coupon bonds bear no interest and holders do not receive interest
payments, they are generally more sensitive to changes in interest rates than
other U.S. government bonds. For example, when interest rates fall, the value
of zero coupon bonds rises more rapidly than bonds paying out interest on a
current basis, because the zero coupon bonds have locked in a particular rate
of reinvestment that becomes more attractive the further rates fall. However,
when interest rates rise, their value falls more dramatically.
MONEY MARKET INSTRUMENTS in which the Fund may invest include:
. U.S. Treasury bills and other obligations issued or guaranteed as to
interest and principal by the U.S. government, its agencies and
instrumentalities;
. Obligations of U.S. banks (including certificates of deposit and bankers'
acceptances) with total assets in excess of $1.5 billion at the time of
purchase;
. Interest-bearing savings deposits in U.S. commercial and savings banks with
principal amounts that are fully insured by the Federal Deposit Insurance
Corporation (the aggregate amount of these deposits may not exceed 5% of the
value of the Fund's assets);
. Commercial paper and other short-term corporate obligations; and
. Variable and floating-rate securities and repurchase agreements.
In addition, the Fund may hold cash and may invest in participation interests
in the money market securities mentioned above without limitation. These
participation interests are the interests of securities held by others on a
pro-rata basis.
TACTICAL ALLOCATION FUND
STOCK PORTION. In its stock portion, the Fund attempts to duplicate, before
the deduction of operating expenses, the investment results of the S&P 500
Index by investing in approximately 450 of the 500 common stocks included in
that Index. The S&P 500 Index, which is chosen by S&P on a statistical basis
and may change from time to time, emphasizes large capitalization stocks and
is based on such factors as the market capitalization and trading activity of
each stock and its adequacy as a representative of stocks in a particular
industry sector. The Fund attempts to achieve a correlation between the
performance of the stock portion and that of the S&P 500 Index of at least
0.95, before the deduction of operating expenses (a correlation of 1.00 would
be perfect, which would mean that the net asset value of the stock portion
increased or decreased in exactly the same proportion as changes in the
Index).
BOND PORTION. In its bond portion, the Fund invests in U.S. Treasury notes
having five years remaining to maturity at the beginning of the then-current
calendar year or, if those instruments are unavailable at favorable prices, in
U.S. Treasury notes with remaining maturities as close as possible to five
years. The Fund does not invest in bonds and cash simultaneously, except as
noted below.
CASH PORTION. In its cash portion, the Fund invests in U.S. Treasury bills
with remaining maturities of 30 days or, if those instruments are unavailable
at favorable prices, in U.S. Treasury bills with remaining maturities as close
as possible to 30 days. Limited amounts of the Fund's assets are normally
invested in cash, generally to pay expenses.
RISKS
Under normal circumstances, Balanced Fund invests primarily in equity
securities, bonds, U.S. government securities, mortgage- and asset-backed
securities and money market instruments, and Tactical Allocation Fund invests
primarily in equity securities and U.S. government securities. Following is a
discussion of risks that are common to each Fund:
EQUITY SECURITIES. While past performance does not guarantee future results,
equity securities historically have provided the greatest long-term growth
potential in a company. However, their prices generally fluctuate more than
other securities and reflect changes in a company's financial condition and in
overall market and economic conditions. Common stocks generally represent the
riskiest investment in a company. It is possible that a Fund may experience a
substantial or complete loss on an individual equity investment.
INTEREST RATE RISK. Interest rate risk is the risk that interest rates will
rise and that, as a result, the prices of bonds, including U.S. government
securities will fall, lowering the value of the Funds' investments. In
general, long-term bonds are more sensitive to interest rate changes than
short-term or short duration bonds.
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<PAGE>
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PaineWebber Tactical Allocation Fund
Balanced Fund
"Duration" is a measure of the expected life of a fixed income security on a
present value basis.
CREDIT RISK is the risk the issuer or guarantor may be unable to pay interest
or repay principal on the bond. This can be affected by many factors,
including adverse changes in the issuer's own financial condition or in
economic conditions.
FOREIGN SECURITIES. Balanced Fund may invest in U.S. dollar-denominated
securities of foreign issuers that are traded on recognized U.S. exchanges or
in the U.S. over-the-counter ("OTC") market. Because the S&P 500 Index can
include common stocks of foreign issuers, Tactical Allocation Fund is also
subject to certain risks associated with investments in U.S. dollar-
denominated securities of foreign issuers.
Investing in securities of foreign companies can involve more risks than
investing in securities of U.S. companies. Their value is subject to economic
and political developments in the countries where the companies operate.
Values may also be affected by foreign tax laws, changes in foreign economic
or monetary policies, exchange control regulations and regulations involving
prohibitions on the repatriation of foreign currencies. In general, less
information may be available about foreign companies than about U.S.
companies, and they are generally not subject to the same accounting, auditing
and financial reporting standards as are U.S. companies.
DERIVATIVES. Some of the instruments in which the Funds may invest may be
referred to as "derivatives," because their value depends on (or "derives"
from) the value of an underlying asset, reference rate or index. These
instruments include options, futures contracts, swaps and similar instruments
that may be used in hedging and related strategies. There is only limited
consensus as to what constitutes a "derivative" security. However, in Mitchell
Hutchins' view, derivative securities also include "stripped" securities and
specially structured types of mortgage- and asset-backed securities, such as
interest only and principal only classes of securities. The market value of
derivative instruments and securities sometimes is more volatile than that of
other investments, and each type of derivative instrument may pose its own
special risks. Mitchell Hutchins takes these risks into account in its
management of the Funds.
COUNTERPARTIES. The Funds may be exposed to the risk of financial failure or
insolvency of another party. To help lessen those risks, Mitchell Hutchins,
subject to the supervision of the board of each Fund, monitors and evaluates
the creditworthiness of the parties with which each Fund does business.
YEAR 2000 RISKS. Like other mutual funds, financial and business organizations
around the world, each of the Funds could be adversely affected if the
computer systems used by Mitchell Hutchins, other service providers and
entities with computer systems that are linked to Fund records do not properly
process and calculate date-related information and data from and after January
1, 2000. This is commonly known as the "Year 2000 Issue." Mitchell Hutchins is
taking steps that it believes are reasonably designed to address the Year 2000
Issue with respect to the computer systems that it uses and to obtain
satisfactory assurances that comparable steps are being taken by each of the
Fund's other, major service providers. However, there can be no assurance that
these steps will be sufficient to avoid any adverse impact on the Funds.
In addition to these general risks, investments in each Fund are subject to
other risk considerations:
BALANCED FUND
BOND RATINGS. Balanced Fund invests in a broad range of investment grade
bonds. Investment grade quality means that the securities are rated within the
four highest categories by S&P or Moody's. Moody's fourth highest category
(Baa) includes securities which, in its opinion, have speculative features.
Balanced Fund may invest up to 10% of its total assets in convertible bonds
rated lower than investment grade, that is, below BBB by S&P or Baa by
Moody's, but no lower than B by S&P or Moody's. These bonds, which are
commonly referred to as "junk bonds," are considered to be predominantly
speculative with respect to the issuer's ability to pay interest and repay
principal and may be more sensitive to adverse conditions. The Fund's policy
of investing a portion of its assets in lower rated securities thus entails
greater risks than those associated with investment in higher rated
securities. The Fund also may invest in securities that are comparably rated
by another rating agency and unrated securities deemed by Mitchell Hutchins to
be of comparable quality.
Credit ratings attempt to evaluate the safety of principal and interest
payments and do not evaluate the volatility of the bond's value or its
liquidity and do not guarantee the performance of the issuer. The rating
agencies also may fail to make timely changes in credit ratings in response to
subsequent events, so that
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PaineWebber Tactical Allocation Fund
Balanced Fund
an issuer's current financial condition may be better or worse than the rating
indicates. There is a risk that rating agencies will downgrade bonds.
RISKS OF MORTGAGE- AND ASSET-BACKED SECURITIES. The yield characteristics of
the mortgage- and asset-backed securities in which Balanced Fund may invest
differ from those of traditional bonds. 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 assets generally may be prepaid at any time. Generally,
prepayments on fixed-rate mortgage loans will increase during a period of
falling interest rates and decrease during a period of rising interest rates.
Mortgage- and asset-backed securities may also decrease in value as a result
of increases in interest rates and, because of prepayments may benefit less
than other fixed income securities from declining interest rates.
Reinvestments of prepayments may occur at lower interest rates than the
original investment, thus adversely affecting the Fund's yield. Actual
prepayment experience may cause the yield of a mortgage-backed security to
differ from what was assumed when the Fund purchased the security.
The market for privately issued mortgage- and asset-backed securities is
smaller and less liquid than the market for U.S. government mortgage-backed
securities. CMO classes may be specially structured in a manner that provides
any of a wide variety of investment characteristics, such as yield, effective
maturity and interest rate sensitivity. As market conditions change, however,
and particularly during periods of rapid or unanticipated changes in market
interest rates, the attractiveness of the CMO classes and the ability of the
structure to provide the anticipated investment characteristics may be
significantly reduced. These changes can result in volatility in the market
value, and in some instances reduced liquidity, of the CMO class.
Certain classes of CMOs and other mortgage-backed securities are structured in
a manner that makes them extremely sensitive to changes in prepayment rates.
Interest-only ("IO") and principal-only ("PO") classes are examples of this.
IOs are entitled to receive all or a portion of the interest, but none (or
only a nominal amount) of the principal payments, from the underlying mortgage
assets. If the mortgage assets underlying an IO experience greater than
anticipated principal prepayments, then the total amount of interest payments
allocable to the IO class, and therefore the yield to investors, generally
will be reduced. In some instances, an investor in an IO may fail to recoup
all of his or her initial investment, even if the security is government
issued or guaranteed or is rated AAA or the equivalent. Conversely, PO classes
are entitled to receive all or a portion of the principal payments, but none
of the interest, from the underlying mortgage assets. PO classes are purchased
at substantial discounts from par, and the yield to investors will be reduced
if principal payments are slower than expected. Some IOs and POs, as well as
other CMO classes, are structured to have special protections against the
effects of prepayments. These structural protections, however, normally are
effective only within certain ranges of prepayment rates and thus will not
protect investors in all circumstances. Inverse floating rate CMO classes also
may be extremely volatile. These classes pay interest at a rate that decreases
when a specified index of market rates increases.
During 1994, the value and liquidity of many mortgage-backed securities
declined sharply due primarily to increases in interest rates. There can be no
assurance that such declines will not recur. The market value of certain
mortgage-backed securities in which the Fund may invest, including IO and PO
classes of mortgage-backed securities, can be extremely volatile and these
securities may become illiquid. Mitchell Hutchins seeks to manage the Fund's
investments in mortgage-backed securities so that the volatility of the Fund's
portfolio, taken as a whole, is consistent with the Fund's investment
objective. If market interest rates or other factors that affect the
volatility of securities held by the Fund change in ways that Mitchell
Hutchins does not anticipate, the Fund's ability to meet its investment
objective may be reduced.
RISKS OF ZERO COUPON BONDS. Zero coupon bonds pay no interest to holders prior
to maturity. However, a portion of the original issue discount on the zero
coupon securities must be included in Balanced Fund's income. Accordingly, to
continue to qualify for tax treatment as a regulated investment company and to
avoid certain excise taxes (see "Taxes" in the Statement of Additional
Information), the Fund may be required to distribute as dividends amounts that
are greater than the total amount of cash it actually receives. These
distributions must be made from the Fund's cash assets or, if necessary, from
the proceeds of sales of portfolio securities. The Fund will not be able to
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PaineWebber Tactical Allocation Fund
Balanced Fund
purchase additional income-producing securities with cash used to make such
distributions, and its current income ultimately may be reduced as a result.
Zero coupon bonds usually trade at a deep discount from their face or par
value and will be subject to greater fluctuations of market value in response
to changing interest rates than bonds of comparable maturities that make
current distributions of interest in cash.
DURATION. Duration is a measure of the expected life of a bond on a present
value basis. Duration incorporates a bond's yield, coupon interest payments,
final maturity and call features into one measure and is one of the
fundamental tools used by Mitchell Hutchins in selecting bonds for Balanced
Fund's portfolio.
Duration takes the length of the time intervals between the present time and
the time that the interest and principal payments are scheduled or, in the
case of a callable bonds, expected to be made, and weighs them by the present
values of the cash to be received at each future point in time. For any bond
with interest payments occurring prior to the payment of principal, duration
is always less than maturity.
Duration 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. 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 Mitchell Hutchins' initial calculation of its duration might
indicate. Moreover, in the case of mortgage-backed and other complex
securities, duration calculations are estimates and are not precise. This is
particularly true during periods of market volatility.
TACTICAL ALLOCATION FUND
LIMITS OF ASSET ALLOCATION STRATEGY. Although it seeks total return,
consisting of both long term capital appreciation and current income, in
following its asset allocation strategy, the Fund may not achieve as high a
level of either capital appreciation or current income as a fund that has only
one of those objectives as its primary objective. In addition, the need to
qualify as a regulated investment company for federal income tax purposes may
limit the Fund's ability to adhere rigidly to the recommendations of the
Tactical Allocation Model. See "Dividends & Taxes." In addition, the Fund is
also subject to the risk that the Tactical Allocation Model may not correctly
predict the appropriate times to shift the Fund's assets from one type of
investment to another.
INDEX INVESTING AND OPEN-END INVESTMENT COMPANIES. While Tactical Allocation
Fund's stock portion attempts to duplicate, before deduction of operating
expenses, the investment results of the S&P 500 Index, the investment results
of the stock portion generally are not identical to those of the S&P 500
Index. Deviations from the performance of the S&P 500 Index may result from
shareholder purchases and sales of shares that occur daily, as well as from
expenses borne by the Fund.
INVESTMENT TECHNIQUES AND STRATEGIES
HEDGING AND OTHER STRATEGIES USING DERIVATIVE INSTRUMENTS. Each Fund may use
derivative instruments, including options (on securities, futures and indices)
and futures contracts (on stock indices and debt securities) to reduce the
overall risk of its investments ("hedge") or to enhance income or return
(including maintaining an exposure to stocks while retaining a cash balance
for Fund management purposes, such as to provide liquidity to meet anticipated
sales by shareholders and for Fund operating expenses). New financial products
and risk management techniques continue to be developed and may be used if
consistent with the Funds' investment objectives and policies. Use of these
strategies solely to enhance income may be considered a form of speculation.
Balanced Fund also may enter into interest rate swaps and similar contracts to
preserve a return or spread on a particular investment or portion of its
portfolio or to protect against an increase in the price of securities the
Fund anticipates purchasing at a later date. The Funds' ability to use the
strategies may be limited by market conditions, regulatory limits and tax
considerations. The Statement of Additional Information contains further
information on these strategies.
The Funds might not use any of these derivative instruments, and there can be
no assurance that any strategy used will succeed. If Mitchell Hutchins is
incorrect in its judgment on interest rates, market values or other economic
factors in using a particular strategic investment, a Fund might have lower
net income and a net loss on the investment. Each of these strategies involves
certain risks, which include:
. the fact that the skills needed to use derivative instruments are different
from those needed to select securities for the Funds,
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PaineWebber Tactical Allocation Fund
Balanced Fund
. the possibility of imperfect correlation, or even no correlation, between
price movements of derivative instruments and price movements of the
securities being hedged,
. possible constraints on a Fund's ability to purchase or sell portfolio
investments at advantageous times due to the need for the Fund to "cover"
or to segregate securities, and
. the possibility that a Fund is unable to close out or liquidate its
position.
PORTFOLIO TURNOVER. Each Fund's portfolio turnover rate may vary greatly from
year to year and will not be a limiting factor when Mitchell Hutchins deems
portfolio changes appropriate. A higher turnover rate for a Fund (100% or
more) will involve correspondingly greater transaction costs, which will be
borne directly by that Fund, and may increase the potential for short-term
capital gains.
ILLIQUID SECURITIES. Each Fund may invest up to 10% of its net assets in
illiquid securities, including repurchase agreements maturing in more than
seven days, certain cover for OTC options and securities whose disposition is
restricted under the federal securities laws. The Funds do not consider
securities that are eligible for resale under SEC Rule 144A to be illiquid if
Mitchell Hutchins has determined them to be liquid, based upon the trading
markets for the securities under procedures approved by the Funds' boards.
LENDING PORTFOLIO SECURITIES. Each Fund may lend its securities to qualified
broker-dealers or institutional investors in an amount up to 33 1/3% of the
Fund's total assets taken at market value. Lending securities enables the
Funds to earn additional income, but could result in a loss or delay in
recovering these securities.
REPURCHASE AGREEMENTS. The Funds may enter into repurchase agreements. In a
typical repurchase agreement, a Fund buys a security and simultaneously agrees
to sell it back at an agreed-upon price and time, usually no more than seven
days after purchase. The time and price reflect a market rate of interest
unrelated to the coupon rate or maturity of the purchased securities. Risks
associated with repurchase agreements include a possible decline in the value
of the underlying securities and delays and costs to the Fund if the other
party to the repurchase agreement becomes insolvent.
OTHER INFORMATION. Each Fund may purchase securities on a when-issued basis or
may purchase or sell securities for delayed delivery. A Fund generally would
not pay for such securities or start earning interest on them until they are
delivered, but it would immediately assume the risks of ownership, including
the risk of price fluctuation. Each Fund may borrow money for temporary or
emergency purposes, but not in excess of 10% (Balanced Fund) or 20% (Tactical
Allocation Fund) of its total assets, including (in the case of Balanced Fund)
reverse repurchase agreements involving up to 5% of its net assets.
- -------------------------------------------------------------------------------
Flexible PricingSM
- -------------------------------------------------------------------------------
Each Fund offers four classes of shares that differ in terms of sales charges
and expenses. An investor can select from among Class A, B or C the class that
is best suited to his or her investment needs, based upon the holding period
and the amount of investment. Certain eligible investors may select Class Y.
CLASS A SHARES
HOW PRICE IS CALCULATED: The price is the net asset value plus the initial
sales charge (the maximum is 4.5% of the public offering price) next
calculated after PaineWebber's New York City headquarters or PFPC Inc., the
Funds' transfer agent ("Transfer Agent") receives the purchase order. Although
investors pay an initial sales charge when they buy Class A shares, the
ongoing expenses for this class are lower than those of Class B and Class C
shares. Class A shares sales charges are calculated as follows:
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PaineWebber Tactical Allocation Fund
Balanced Fund
<TABLE>
<CAPTION>
SALES CHARGE AS A PERCENTAGE OF: DISCOUNT TO SELECTED
---------------------------------- DEALERS AS PERCENTAGE OF
AMOUNT OF INVESTMENT OFFERING PRICE NET AMOUNT INVESTED OFFERING PRICE
- -------------------- -------------- ------------------- ------------------------
<S> <C> <C> <C>
Less than $50,000....... 4.50% 4.71% 4.25%
$50,000 to $99,999...... 4.00 4.17 3.75
$100,000 to $249,999.... 3.50 3.63 3.25
$250,000 to $499,999.... 2.50 2.56 2.25
$500,000 to $999,999.... 1.75 1.78 1.50
$1,000,000 and over (1). None None 1.00 (2)
</TABLE>
- -------
(1) A contingent deferred sales charge of 1% of the shares' offering price or
the net asset value at the time of sale by the shareholder, whichever is
less, is charged on sales of shares made within one year of the purchase
date. Class A shares representing reinvestment of any dividends or other
distributions are not subject to the 1% charge. Withdrawals under the
Systematic Withdrawal Plan are not subject to this charge. However,
investors may withdraw no more than 12% of the value of the Fund account
under the Plan in the first year after purchase.
(2) Mitchell Hutchins pays 1% to PaineWebber.
SALES CHARGE REDUCTIONS & WAIVERS
Investors purchasing Class A shares in more than one PaineWebber mutual fund
may combine those purchases to get a reduced sales charge. Investors who
already own Class A shares in one or more PaineWebber mutual funds may combine
the amount they are currently purchasing with the value of such previously
owned shares to qualify for a reduced sales charge. To determine the sales
charge reduction in either case, please refer to the chart above.
Investors may also qualify for a lower sales charge when they combine their
purchases with those of:
. their spouses, parents or children under age 21;
. their Individual Retirement Accounts (IRAs);
. certain employee benefit plans, including 401(k) plans;
. any company controlled by the investor;
. trusts created by the investor;
. Uniform Gifts to Minors Act/Uniform Transfers to Minors Act accounts created
by the investor or group of individuals for the benefit of the investors'
children; or
. accounts with the same adviser.
Employers who own Class A shares for one or more of their qualified retirement
plans may also qualify for the reduced sales charge.
The sales charge will not apply when the investor:
. is an employee, director, trustee or officer of PaineWebber, its affiliates
or any PaineWebber mutual fund;
. is the spouse, parent or child of any of the above;
. buys these shares through a PaineWebber investment executive who was
formerly employed as a broker with a competing brokerage firm that was
registered as a broker-dealer with the SEC; and
. was the investment executive's client at the competing brokerage firm;
. within 90 days of buying Class A shares in this Fund, the investor sells
shares of one or more mutual funds that (a) were principally underwritten
by the competing brokerage firm or its affiliates and (b) the investor
either paid a sales charge to buy those shares, paid a contingent
deferred sales charge when selling them or held those shares until the
contingent deferred sales charge was waived; and
. the amount that the investor purchases does not exceed the total amount
of money the investor received from the sale of the other mutual fund;
. is a certificate holder of unit investment trusts sponsored by PaineWebber
and has elected to have dividends and other distributions from that
investment automatically invested in Class A shares;
. is an employer establishing an employee benefit plan qualified under section
401, including a salary reduction plan qualified under section 401(k), or
section 403(b) of the Internal Revenue Code ("Code") (each a "qualified
plan"). (This waiver is subject to minimum requirements, with respect to the
number of employees and amount of plan assets, established by Mitchell
Hutchins. Currently, the plan must have 50 or more eligible employees and at
least $1 million in plan assets.) For investments made pursuant to this
waiver, Mitchell Hutchins
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PaineWebber Tactical Allocation Fund
Balanced Fund
may make a payment to PaineWebber out of its own resources in an amount not
to exceed 1% of the amount invested;
. is a participant in the PaineWebber Members Only Program(TM). For
investments made pursuant to this waiver, Mitchell Hutchins may make
payments out of its own resources to PaineWebber and to participating
membership organizations in a total amount not to exceed 1% of the amount
invested;
. is a variable annuity offered only to qualified plans. For investments made
pursuant to this waiver, Mitchell Hutchins may make payments out of its own
resources to PaineWebber and to the variable annuity's sponsor, adviser or
distributor in a total amount not to exceed 1% of the amount invested;
. acquires Class A shares through an investment program that is not sponsored
by PaineWebber or its affiliates and that charges participants a fee for
program services, provided that the program sponsor has entered into a
written agreement with PaineWebber permitting the sale of Class A shares at
net asset value to that program. For investments made pursuant to this
waiver, Mitchell Hutchins may make a payment to PaineWebber out of its own
resources in an amount not to exceed 1% of the amount invested. For
subsequent investments or exchanges made to implement a rebalancing feature
of such an investment program, the minimum subsequent investment requirement
is also waived; or
. acquires Class A shares in connection with a reorganization pursuant to
which a Fund acquires substantially all of the assets and liabilities of
another investment company in exchange solely for shares of the Fund.
For more information on how to get any reduced sales charge, investors should
contact a PaineWebber investment executive or a correspondent firm or call
1-800-647-1568. Investors must provide satisfactory information to PaineWebber
or the Fund if they seek any of these sales charge reductions or waivers.
CLASS B SHARES
HOW PRICE IS CALCULATED: The price is the net asset value next calculated
after PaineWebber's New York City headquarters or the Transfer Agent receives
the purchase order. The ongoing expenses investors pay for Class B shares are
higher than those of Class A shares. Because investors do not pay an initial
sales charge when they buy Class B shares, 100% of their purchase is
immediately invested.
Depending on how long they own their Fund investment, investors may have to
pay a sales charge when they sell their Fund shares. This sales charge is
called a "contingent deferred sales charge." The amount of the charge depends
on how long the investor owned the shares. The sales charge is calculated by
multiplying the offering price (net asset value of the shares at the time of
purchase) or the net asset value of the shares at the time of sale by the
shareholder, whichever is less, by the percentage shown on the following
table. Investors who own shares for more than six years do not have to pay a
sales charge when selling those shares.
<TABLE>
<CAPTION>
PERCENTAGE BY WHICH
THE SHARES' NET ASSET
IF THE INVESTOR SELLS SHARES WITHIN: VALUE IS MULTIPLIED:
- ------------------------------------ ---------------------
<S> <C>
1st year of purchase..................................... 5%
2nd year of purchase..................................... 4
3rd year of purchase..................................... 3
4th year of purchase..................................... 2
5th year of purchase..................................... 2
6th year of purchase..................................... 1
7th year of purchase..................................... None
</TABLE>
CONVERSION OF CLASS B SHARES
Class B shares automatically convert to the appropriate number of Class A
shares of equal dollar value after the investor has owned them for six years.
Dividends and other distributions paid to the investor by the Fund in the form
of additional Class B shares will also convert to Class A shares on a pro-rata
basis. This benefits shareholders because Class A shares have lower ongoing
expenses than Class B shares. If the investor has exchanged Class B shares
between PaineWebber funds, the Fund uses the purchase date at which the
initial investment was made to determine the conversion date.
MINIMIZING THE CONTINGENT DEFERRED SALES CHARGE
When investors sell Class B shares they have owned for less than six years,
the Fund automatically will minimize the sales charge by assuming they are
selling:
. First, Class B shares owned through reinvested dividends and capital gain
distributions; and
. Second, Class B shares held in the portfolio the longest.
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PaineWebber Tactical Allocation Fund
Balanced Fund
WAIVERS OF THE CONTINGENT DEFERRED SALES CHARGE
The contingent deferred sales charge will not apply to:
. sales of shares under a Fund's "Systematic Withdrawal Plan" (investors may
withdraw annually no more than 12% of the value of the Fund account under
the Plan);
. a distribution from an IRA, a self-employed individual retirement plan
("Keogh Plan") or a custodial account under section 403(b) of the Code
(after the investor reaches age 59 1/2);
. a tax-free return of an excess IRA contribution;
. a tax-qualified retirement plan distribution following retirement; or
. Class B shares sold within one year of an investor's death if the investor
owned the shares at the time of death either as the sole shareholder or with
his or her spouse as a joint tenant with the right of survivorship.
Investors must provide satisfactory information to PaineWebber or the Funds if
they seek any of these waivers.
CLASS C SHARES
HOW PRICE IS CALCULATED: The price of Class C shares is the net asset value
next calculated after PaineWebber's New York City headquarters or the Transfer
Agent receives the purchase order. Investors do not pay an initial sales
charge when they buy Class C shares, but the ongoing expenses of Class C
shares are higher than those of Class A shares. Because investors do not pay
an initial sales charge when they buy Class C shares, 100% of their purchase
is immediately invested. Class C shares never convert to any other class of
shares.
A contingent deferred sales charge of 1% of the offering price (net asset
value of at the time of purchase) or net asset value of the shares at the time
of sale by the shareholder, whichever is less, is charged on sales of shares
made within one year of the purchase date. Other PaineWebber mutual funds may
impose a different contingent deferred sales charge on Class C shares sold
within one year of the purchase date. A sale of Class C shares acquired
through an exchange and held less than one year will be subject to the same
contingent deferred sales charge that would have been imposed on the Class C
shares of the PaineWebber mutual fund originally purchased. Class C shares
representing reinvestment of any dividends or capital gains are not subject to
the 1% charge. Withdrawals under the Systematic Withdrawal Plan also are not
subject to this charge. However, investors may withdraw no more than 12% of
the value of the Fund account under the Plan in the first year after purchase.
CLASS Y SHARES
HOW PRICE IS CALCULATED: Eligible investors may purchase Class Y shares at the
net asset value next calculated after PaineWebber's New York City headquarters
or the Transfer Agent receives the purchase order. Because investors do not
pay an initial sales charge when they buy Class Y shares, 100% of their
purchase is immediately invested. No contingent deferred sales charge is
imposed on Class Y shares, and the ongoing expenses for Class Y shares are
lower than for the other classes because Class Y shares are not subject to
12b-1 distribution or service fees.
LIMITED GROUP OF INVESTORS. Only the following investors are eligible to buy
Class Y shares:
. a participant in one of the PW Programs listed below when Class Y shares are
purchased through that PW Program;
. an investor who buys $10 million or more at any one time in any combination
of PaineWebber mutual funds in the Flexible Pricing SM System;
. as qualified plan that has either
5,000 or more eligible employees or
$50 million or more in assets; and
. an investment company advised by PaineWebber or an affiliate of PaineWebber.
. for Tactical Allocation Fund, the trustee of the PaineWebber Savings
Investment Plan ("PW SIP")
PACE MULTI-ADVISOR PROGRAM. An investor who participates in PACE Multi-Advisor
Program is eligible to purchase Class Y shares. The PACE Multi-Advisor Program
is an advisory program sponsored by PaineWebber that provides comprehensive
investment services, including investor profiling, a personalized asset
allocation strategy using an appropriate combination of funds, and a quarterly
investment performance review. Participation in the PACE Multi-Advisor Program
is subject to payment of an advisory fee at the maximum annual rate of 1.5% of
assets. Employees of PaineWebber and its affiliates are entitled to a waiver
of this fee.
Please contact your PaineWebber investment executive or PaineWebber's
correspondent firms for more
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Prospectus Page 25
<PAGE>
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PaineWebber Tactical Allocation Fund
Balanced Fund
information concerning mutual funds that are available to the PACE Multi-
Advisor Program.
INSIGHT. An investor who participates in the INSIGHT Advisory Program
("INSIGHT"), a total portfolio asset allocation program sponsored by
PaineWebber, is eligible to purchase Class Y shares. Participation in INSIGHT
is subject to payment of an advisory fee to PaineWebber at the maximum annual
rate of 1.5% of assets held through the program. Employees of PaineWebber and
its affiliates are entitled to a 50% reduction in the fee otherwise payable
for participation in INSIGHT.
PURCHASES BY THE TRUSTEE OF THE PW SIP
The Class Y shares of Tactical Allocation Fund also are offered for sale to
the trustee of the PW SIP, a defined contribution plan sponsored by Paine
Webber Group Inc. ("PW Group"). The trustee of the PW SIP purchases and
redeems these Class Y shares to implement the investment choices of individual
plan participants with respect to their PW SIP contributions. Individual plan
participants should consult the Summary Plan Description and other plan
material of the PW SIP (collectively, the "Plan Documents") for a description
of the procedures and limitations applicable to making and changing investment
choices.
Copies of the Plan Documents are available from the Benefits Connection, 100
Halfday Road, Lincolnshire, IL 60069 or by calling 1-888-PWebber (1-999-793-
2237).
As described in the Plan Documents, the average net asset value per share at
which Class Y shares of Tactical Allocation Fund are purchased or redeemed by
the trustee of the PW SIP for the accounts of individual participants might be
more or less than the net asset value per share prevailing at the time that
such participants made their investment choices or made their contributions to
the PW SIP.
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How to Buy Shares
- -------------------------------------------------------------------------------
Prices are calculated for each class of a Fund's shares once each Business
Day, at the close of regular trading on the New York Stock Exchange (currently
4:00 p.m., Eastern time). A "Business Day" is any day, Monday through Friday,
on which the New York Stock Exchange is open for business.
The Funds and Mitchell Hutchins reserve the right to reject any purchase order
and to suspend the offering of Fund shares for a period of time.
When placing an order to buy shares, investors should specify which class of
shares they want to buy. If investors fail to specify the class, they will
automatically receive Class A shares, which include an initial sales charge.
Investors in Class Y shares must provide satisfactory information to
PaineWebber or an individual Fund that they are eligible to purchase Class Y
shares.
PAINEWEBBER CLIENTS
Investors who are PaineWebber clients may buy shares through PaineWebber
investment executives or its correspondent firms. Investors may buy shares in
person, by mail, by telephone or by wire (the minimum wire purchase is $1
million). PaineWebber investment executives and correspondent firms are
responsible for promptly sending investors' purchase orders to PaineWebber's
New York City headquarters. Investors may pay for their purchases with checks
drawn on U.S. banks or with funds they have in their brokerage accounts at
PaineWebber or its correspondent firms.
OTHER INVESTORS
Investors who are not PaineWebber clients may purchase Fund shares and set up
an account through the Transfer Agent (PFPC Inc.) by completing an account
application, which can be obtained by calling 1-800-647-1568. The application
and check must be mailed to PFPC Inc., Attn: PaineWebber Mutual Funds, P.O.
Box 8950, Wilmington, DE 19899.
New investors to PaineWebber may complete and sign an account application and
mail it along with a check. Investors also may open an account in person.
Investors who already have money invested in a PaineWebber mutual fund, and
want to invest in another PaineWebber mutual fund, can:
. mail an application with a check; or
. open an account by exchanging from another PaineWebber mutual fund.
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Prospectus Page 26
<PAGE>
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PaineWebber Tactical Allocation Fund
Balanced Fund
Investors do not have to send an application when making additional
investments in the Fund.
MINIMUM INVESTMENTS
<TABLE>
<S> <C>
To open an account....................................................... $1,000
To add to an account..................................................... $ 100
</TABLE>
A Fund may waive or reduce these minimums for:
. employees of PaineWebber or its affiliates; or
. participants in certain pension plans, retirement accounts, unaffiliated
investment programs or the Fund's automatic investment plan.
HOW TO EXCHANGE SHARES
As shareholders, investors have the privilege of exchanging Class A, B and C
shares for the same class of other PaineWebber mutual fund shares. For classes
of shares where no initial sales charge is imposed, a contingent deferred
sales charge may apply if the investor sells the shares acquired through the
exchange. Class Y shares are not exchangeable.
Exchanges may be subject to minimum investment requirements of the fund into
which exchanges are made.
. Investors who purchased their shares through an investment executive at
PaineWebber or one of its correspondent firms may exchange their shares by
contacting their investment executive in person or by telephone, mail or
wire.
. Investors who do not have an account with an investment executive at
PaineWebber or one of its correspondent firms may exchange their shares by
writing a "letter of instruction" to the Transfer Agent. The letter of
instruction must include:
. the investor's name and address;
. the Fund's name;
. the Fund account number;
. the dollar amount or number of shares to be sold; and
. a guarantee of each registered owner's signature by an eligible
institution, such as a commercial bank, trust company or stock exchange
member.
The letter must be mailed to PFPC Inc., Attn: PaineWebber Mutual Funds, P.O.
Box 8950, Wilmington, DE 19899.
No contingent deferred sales charge is imposed when shares are exchanged for
the corresponding class of shares of other PaineWebber mutual funds. A Fund
will use the purchase date of the initial investment to determine any
contingent deferred sales charge due when the acquired shares are sold. Fund
shares may be exchanged only after the settlement date has passed and payment
for the shares has been made. The exchange privilege is available only in
those jurisdictions where the sale of the fund shares to be acquired is
authorized. This exchange privilege may be modified or terminated at any time
and, when required by SEC rules, upon 60 days' notice. See the back cover of
this Prospectus for a listing of other PaineWebber mutual funds.
- -------------------------------------------------------------------------------
How to Sell Shares
- -------------------------------------------------------------------------------
Investors can sell (redeem) shares at any time. Shares will be sold at the
share price for that class as next calculated after the order is received and
accepted (less any applicable contingent deferred sales charge). Share prices
are normally calculated at the close of regular trading on the New York Stock
Exchange (currently 4:00 p.m., Eastern time).
Investors who own more than one class of shares should specify which class
they are selling. If they do not, the Fund will assume they are first selling
their Class A shares, then Class C, then Class B and last, Class Y.
If a shareholder wants to sell shares which were purchased recently, the Fund
may delay payment until it verifies that good payment was received. In the
case of purchases by check, this can take up to 15 days.
Investors who have an account with PaineWebber or one of PaineWebber's
correspondent firms can sell their shares by contacting their investment
executive. Investors who do not have an account and have bought their shares
through the Funds' Transfer Agent (PFPC Inc.), may sell shares by writing a
"letter of instruction," as detailed in "How to Exchange Shares."
Prospectus Page 27
<PAGE>
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-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
Because the Funds incur certain fixed costs in maintaining shareholder
accounts, each Fund reserves the right to purchase back all of its shares in
any shareholder account with a net asset value of less than $500. If a Fund
elects to do so, it will notify the shareholder of the opportunity to increase
the amount invested to $500 or more within 60 days of the notice. A Fund will
not purchase back accounts that fall below $500 solely due to a reduction in
net asset value per share.
SALES BY PARTICIPANTS IN PW SIP
The trustee of the PW SIP sells Class Y shares of Tactical Allocation Fund to
implement the investment choices of individual plan participants with respect
to their PW SIP contributions, as described in the Plan Documents referenced
under "How to Buy Shares" above. The price at which Class Y shares are sold by
the trustee of the PW SIP might be more or less than the price per share at
the time the participants made their investment choices.
REINSTATEMENT PRIVILEGE
Shareholders who sell their Class A shares may reinstate their Fund account
without a sales charge up to the dollar amount sold by purchasing the Fund's
Class A shares within 365 days after the sale. To take advantage of this
reinstatement privilege, shareholders must notify their investment executive
at PaineWebber or one of its correspondent firms at the time of purchase.
- -------------------------------------------------------------------------------
Other Services
- -------------------------------------------------------------------------------
Investors should consult their investment executive at PaineWebber or one of
its correspondent firms to learn more about the following services available
with respect to the Funds' Class A, B and C shares.
AUTOMATIC INVESTMENT PLAN
Investing on a regular basis helps investors meet their financial goals.
PaineWebber offers an Automatic Investment Plan Service with a minimum initial
investment of $1,000 through which the Funds will, on a monthly, quarterly,
semiannual or annual basis, deduct $50 or more from the investor's bank
account to invest directly in the Fund. In addition to providing a convenient
and disciplined manner of investing, participation in the Automatic Investment
Plan enables the investor to use the technique of "dollar cost averaging."
SYSTEMATIC WITHDRAWAL PLAN
The Systematic Withdrawal Plan allows investors to set up monthly, quarterly
(March, June, September and December), semiannual (June and December), or
annual (December) withdrawals from their PaineWebber Mutual Fund accounts.
Minimum balances and withdrawals vary according to the class of shares:
. CLASS A AND CLASS C SHARES. Minimum value of Fund shares is $5,000; minimum
withdrawals of $100.
. CLASS B SHARES. Minimum value of Fund shares is $20,000; minimum monthly,
quarterly, semiannual and annual withdrawals of $200, $400, $600, and $800,
respectively.
Withdrawals under the Systematic Withdrawal Plan are not subject to a
contingent deferred sales charge. Investors may withdraw no more than 12% of
the value of the Fund account when the investor signed up for the Plan (for
Class B shares annually; for Class A and Class C shares, during the first year
under the Plan). Shareholders who elect to receive dividends or other
distributions in cash may not participate in the Plan.
INDIVIDUAL RETIREMENT ACCOUNTS
Self-Directed IRAs are available through PaineWebber in which purchases of
PaineWebber funds and other investments may be made. Investors considering
establishing an IRA should review applicable tax laws and should consult their
tax advisers.
TRANSFER OF ACCOUNTS
If investors holding shares of a Fund in a PaineWebber brokerage account
transfer their brokerage accounts to another firm, the Fund shares will be
moved to an account with the Transfer Agent. However, if the other firm has
entered into a selected dealer agreement with Mitchell Hutchins relating to
the Fund, the shareholder may be able to hold Fund shares in an account with
the other firm.
----------
Prospectus Page 28
<PAGE>
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-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
Management
- -------------------------------------------------------------------------------
Balanced Fund is a series of PaineWebber Master Series, Inc. ("Corporation")
and Tactical Allocation Fund is a series of PaineWebber Investment Trust
("Trust"). The board of directors of the Corporation and the board of trustees
of the Trust (each a "board") oversee the Funds' operations and, as part of
this overall management responsibility, oversee various organizations
responsible for the day-to-day management of each Fund. Each board has
appointed Mitchell Hutchins as investment adviser and administrator
responsible for the Fund's operations (subject to the authority of the board).
In accordance with procedures adopted by each board, brokerage transactions
for the Funds may be conducted through PaineWebber or its affiliates and the
Funds may pay fees to PaineWebber for its services as lending agent in their
portfolio securities lending programs.
ABOUT THE INVESTMENT ADVISER
Mitchell Hutchins, located at 1285 Avenue of the Americas, New York, New York,
10019, is a wholly owned asset management subsidiary of PaineWebber
Incorporated, which is wholly owned by Paine Webber Group Inc., a publicly
owned financial services holding company. On November 30, 1997, Mitchell
Hutchins was adviser or sub-adviser of 29 investment companies with
64 separate portfolios and aggregate assets of approximately $36.2 billion.
As investment adviser and administrator for Balanced Fund and Tactical
Allocation Fund, Mitchell Hutchins makes and implements all investment
decisions and supervises all aspects of each Fund's operations.
T. Kirkham Barneby is responsible for the asset allocation decisions for both
Balanced Fund and Tactical Allocation Fund. He has been responsible for the
day-to-day management of Tactical Allocation Fund since February 1995. Mr.
Barneby is a managing director and chief investment officer of quantitative
investments of Mitchell Hutchins. Mr. Barneby rejoined Mitchell Hutchins in
1994, after being with Vantage Global Management for one year. During the
eight years that Mr. Barneby was previously with Mitchell Hutchins, he was a
senior vice president responsible for quantitative management and asset
allocation models.
Mark A. Tincher is responsible for the day-to-day management of the equity
portion of Balanced Fund. Mr. Tincher is a managing director and chief
investment officer of equities of Mitchell Hutchins, responsible for
overseeing the management of equity investments. From March 1988 to March
1995, Mr. Tincher worked for Chase Manhattan Private Bank where he was a vice
president. Mr. Tincher directed the U.S. funds management and equity research
area at Chase and oversaw the management of all Chase U.S. equity funds (the
Vista Funds and Trust Investment Funds).
Dennis L. McCauley is responsible for the day-to-day management of the debt
securities portion of Balanced Fund. Mr. McCauley is a managing director and
chief investment officer of fixed income investments of Mitchell Hutchins,
responsible for overseeing all active fixed income investments, including
domestic and global taxable and tax-exempt mutual funds. Prior to joining
Mitchell Hutchins in 1994, Mr. McCauley worked for IBM Corporation, where he
was director of fixed income investments responsible for developing and
managing investment strategy for all fixed income and cash management
investments of IBM's pension fund and self-insured medical funds. Mr. McCauley
has also served as vice president of IBM Credit Corporation's mutual funds and
as a member of the retirement fund investment committee.
Nirmal Singh and Craig M. Varrelman, CFA, assist Mr. McCauley in managing
Balanced Fund's debt securities. Mr. Singh and Mr. Varrelman are both senior
vice presidents of Mitchell Hutchins. Prior to joining Mitchell Hutchins in
September 1993, Mr. Singh was with Merrill Lynch Asset Management, Inc., where
he was a member of the portfolio management team. From 1990 to 1993, Mr. Singh
was a senior portfolio manager at Nomura Mortgage Fund Management Corporation.
Mr. Varrelman has been with Mitchell Hutchins as a portfolio manager since
1988 and manages fixed income portfolios with an emphasis on U.S. government
securities.
Susan Ryan is responsible for the day-to-day management of the portion of
Balanced Fund's assets
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Prospectus Page 29
<PAGE>
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-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
invested in money market instruments. Ms. Ryan has been with Mitchell Hutchins
since 1982 and is a senior vice president of Mitchell Hutchins.
Each of these managers first assumed responsibilities with respect to Balanced
Fund in August 1995.
Other members of Mitchell Hutchins' domestic equity and domestic fixed income
investments groups provide input on market outlook, interest rate forecasts,
investment research and other considerations pertaining to each Fund's
investments.
Mitchell Hutchins personnel may engage in securities transactions for their
own accounts pursuant to a code of ethics that establishes procedures for
personal investing and restricts certain transactions.
MANAGEMENT FEES & OTHER EXPENSES
Each Fund pays Mitchell Hutchins a monthly fee for its services. For the
fiscal year ended August 31, 1997, Balanced Fund paid advisory fees to
Mitchell Hutchins at the annual rate of 0.75% of its average daily net assets
and Tactical Allocation Fund paid advisory fees to Mitchell Hutchins at the
annual rate of 0.50% of its average daily net assets.
DISTRIBUTION ARRANGEMENTS
Mitchell Hutchins is the distributor of each Fund's shares and has appointed
PaineWebber as the exclusive dealer for the sale of those shares. There is no
distribution plan with respect to the Funds' Class Y shares. Under
distribution plans for Class A, Class B and Class C shares ("Class A Plan,"
"Class B Plan" and "Class C Plan," collectively, "Plans"), each Fund pays
Mitchell Hutchins:
. Monthly service fees at the annual rate of 0.25% of the average daily net
assets of each class of shares.
. Monthly distribution fees at the annual rate of 0.75% of the average daily
net assets of Class B shares and Class C Shares.
Under the Plans, Mitchell Hutchins primarily uses the service fees to pay
PaineWebber for shareholder servicing, currently at the annual rate of 0.25%
of the aggregate investment amounts maintained in each Fund's Class A, Class B
and Class C shares by PaineWebber clients. PaineWebber then compensates its
investment executives for shareholder servicing that they perform and offsets
its own expenses in servicing and maintaining shareholder accounts.
Mitchell Hutchins uses the distribution fees under the Class B and Class C
Plans to:
. Offset the commissions it pays to PaineWebber for selling each Fund's Class
B and Class C shares, respectively.
. Offset each Fund's marketing costs attributable to such classes, such as
preparation, printing and distribution of sales literature, advertising and
prospectuses to prospective investors and related overhead expenses, such as
employee salaries and bonuses.
PaineWebber compensates investment executives when Class B and Class C shares
are purchased by investors, as well as on an ongoing basis. Mitchell Hutchins
receives no special compensation from either Fund or investors at the time
Class B or C shares are purchased.
Mitchell Hutchins receives the proceeds of the initial sales charge paid when
Class A shares are bought and of the contingent deferred sales charge paid
upon sales of shares. These proceeds may be used to cover distribution
expenses.
The Plans and the related distribution contracts for Class A, Class B and
Class C shares ("Distribution Contracts") specify that each Fund must pay
service and distribution fees to Mitchell Hutchins for its activities, not as
reimbursement for specific expenses incurred. Therefore, even if Mitchell
Hutchins' expenses exceed the service or distribution fees it receives, the
Funds will not be obligated to pay more than those fees. On the other hand, if
Mitchell Hutchins' expenses are less than such fees, it will retain its full
fees and realize a profit. Expenses in excess of service and distribution fees
received or accrued through the termination date of any Plan will be Mitchell
Hutchins' sole responsibility and not that of the Funds. Annually, the board
of each Fund reviews each Plan and Mitchell Hutchins' corresponding expenses
for each class separately from the Plans and expenses of the other classes.
----------
Prospectus Page 30
<PAGE>
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-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
- -------------------------------------------------------------------------------
Determining the Shares' Net Asset Value
- -------------------------------------------------------------------------------
The net asset value of a Fund's shares fluctuates and is determined separately
for each class as of the close of regular trading on the New York Stock
Exchange (currently 4:00 p.m., Eastern time) each Business Day. Each Fund's
net asset value per share is determined by dividing the value of the
securities held by the Fund, plus any cash or other assets, minus all
liabilities, by the total number of Fund shares outstanding.
Each Fund values its assets based on their current market value when market
quotations are readily available. If market quotations are not readily
available, assets are valued at fair value as determined in good faith by or
under the direction of its board. The amortized cost method of valuation
generally is used to value debt obligations with 60 days or less remaining to
maturity, unless its board determines that this does not represent fair value.
It should be recognized that judgment plays a greater role in valuing lower-
rated corporate bonds because there is less reliable, objective data
available.
- -------------------------------------------------------------------------------
Dividends & Taxes
- -------------------------------------------------------------------------------
DIVIDENDS
Balanced Fund pays dividends semiannually from its net investment income and
also may distribute net short-term capital gain, if any, with a periodic
dividend. While Balanced Fund will not declare any distribution in excess of
the amount of its net investment income and net short-term capital gain
available at the time of declaration, it is possible that net capital losses
sustained after the declaration of a distribution including net short-term
capital gain could convert a portion of such a distribution to a non-taxable
return of capital. Tactical Allocation Fund pays an annual dividend from its
net investment income and net short-term capital gain, if any. Net investment
income includes dividend income, accrued interest and discount, less
amortization of premium and accrued expenses. Substantially all of each Fund's
net capital gain (the excess of net long-term capital gain over net short-term
capital loss), if any, and any undistributed net short-term capital gain, is
distributed at least annually. Each Fund may make additional distributions if
necessary to avoid income or excise taxes.
Dividends and other distributions paid on each class of shares of a Fund are
calculated at the same time and in the same manner.Dividends on Class A, B and
C shares of a Fund are expected to be lower than those on its Class Y shares
because the other shares have higher expenses resulting from their service
fees, and, in the case of Class B and Class C shares, their distribution fees.
Dividends on Class B and Class C shares of a Fund are expected to be lower
than those on its Class A shares because Class B and Class C shares have
higher expenses resulting from their distribution fees. Dividends on each
class also might be affected differently by the allocation of other class-
specific expenses. See "General Information."
A Fund's dividends and other distributions are paid in additional Fund shares
of the same class at net asset value, unless the shareholder has requested
cash payments. Shareholders who wish to receive dividends and other
distributions in cash, either mailed to them by check or credited to their
PaineWebber accounts, should contact their investment executives at
PaineWebber or one of its correspondent firms or complete the appropriate
section of the account application. For PW SIP participants, Tactical
Allocation Fund's Class Y dividends and other distributions are paid in
additional Class Y shares at net asset value unless the Transfer Agent is
instructed otherwise.
TAXES
Each Fund intends to continue to qualify for treatment as a regulated
investment company under the Code so that it will not have to pay federal
income tax on the part of its investment company taxable income (generally
consisting of net investment income
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Prospectus Page 31
<PAGE>
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-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
and net short-term capital gain) and net capital gain that it distributes to
its shareholders.
Dividends from each Fund's investment company taxable income (whether paid in
cash or in additional Fund shares) generally are taxable to its shareholders
as ordinary income. Distributions of each Fund's net capital gain (whether
paid in cash or in additional Fund shares) are taxable to its shareholders as
long-term capital gain, regardless of how long they have held their Fund
shares. Under the Taxpayer Relief Act of 1997, different maximum tax rates
apply to a non-corporate taxpayer's net capital gain depending on the
taxpayer's holding period and marginal rate of federal income tax--generally,
28% for gain recognized on securities held for more than one year but not more
than 18 months and 20% (10% for taxpayers in the 15% marginal tax bracket) for
gain recognized on securities held for more than 18 months. Pursuant to an
Internal Revenue Service notice, each Fund may divide each net capital gain
distribution into a 28% rate gain distribution and a 20% rate gain
distribution (in accordance with the Fund's holding periods for the securities
it sold that generated the distributed gain) and its shareholders must treat
those portions accordingly. Shareholders not subject to tax on their income
generally will not be required to pay tax on distributions from the Funds.
YEAR-END TAX REPORTING
Each Fund notifies its shareholders following the end of each calendar year of
the amounts of dividends and capital gain distributions paid (or deemed paid)
that year and any portion of those dividends that qualifies for special
treatment. The information regarding capital gain distributions designates the
portions thereof subject to the different maximum rates of tax applicable to
non-corporate taxpayers' net capital gain indicated above.
WITHHOLDING REQUIREMENTS
Each Fund is required to withhold 31% of all dividends, capital gain
distributions and redemption proceeds payable to individuals and certain other
non-corporate shareholders who do not provide the Fund with a correct taxpayer
identification number. Withholding at that rate also is required from
dividends and capital gain distributions payable to such shareholders who
otherwise are subject to backup withholding.
TAX ON THE SALE OR EXCHANGE OF FUND SHARES
A shareholder's sale (redemption) of Fund shares may result in a taxable gain
or loss. This depends upon whether the shareholder receives more or less than
the adjusted basis for the shares (which normally includes any initial sales
charge paid on Class A shares). An exchange of a Fund's shares for shares of
another PaineWebber mutual fund generally will have similar tax consequences.
In addition, if a Fund's shares are bought within 30 days before or after
selling other shares of the Fund (regardless of class) at a loss, all or a
portion of that loss will not be deductible and will increase the basis of the
newly purchased shares.
SPECIAL TAX RULES FOR CLASS A SHAREHOLDERS
Special tax rules apply when a shareholder sells (redeems) or exchanges Class
A shares within 90 days of purchase and subsequently purchases Class A shares
of the same or another PaineWebber mutual fund without paying a sales charge
due to the 365-day reinstatement privilege or the exchange privilege. In these
cases, any gain on the sale or exchange of the original Class A shares would
be increased, or any loss thereon would be decreased, by the amount of the
sales charge paid when those shares were bought, and that amount would
increase the basis of the PaineWebber mutual fund shares subsequently
acquired.
No gain or loss will be recognized to a shareholder as a result of conversion
of Class B shares into Class A shares.
* * * *
Because the foregoing only summarizes some of the important federal income tax
considerations affecting the Funds and their shareholders, please see the
further discussion in the Statement of Additional Information. Prospective
shareholders are urged to consult their tax advisors.
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Prospectus Page 32
<PAGE>
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-------------------
PaineWebber Tactical Allocation Fund
Balanced Fund
- -------------------------------------------------------------------------------
General Information
- -------------------------------------------------------------------------------
ORGANIZATION
BALANCED FUND
Balanced Fund is a diversified series of the Corporation, an open-end
management investment company that was incorporated in Maryland on October 29,
1985. The Corporation has authority to issue 10 billion shares of common stock
of separate series, par value $.001 per share; four billion of these shares
are classified as shares of Balanced Fund. Shares of one other series have
been authorized.
TACTICAL ALLOCATION FUND
Tactical Allocation Fund is a diversified series of the Trust, an open-end
management investment company that was formed on March 28, 1991, as a business
trust under the laws of the Commonwealth of Massachusetts. The trustees have
authority to issue an unlimited number of shares of beneficial interest of
separate series, with a par value of $.001 per share. Shares of one other
series have been authorized.
SHARES
The shares of each Fund are divided into four classes, designated Class A,
Class B, Class C and Class Y shares. Each class represents an identical
interest in the respective Fund's investment portfolio and has the same
rights, privileges and preferences. However, each class may differ with
respect to sales charges, if any, distribution and/or service fees, if any,
other expenses allocable exclusively to each class, voting rights on matters
exclusively affecting that class, and its exchange privilege. The different
sales charges and other expenses applicable to the different classes of shares
of the Funds will affect the performance of those classes.
Each share of a Fund is entitled to participate equally in dividends, other
distributions and the proceeds of any liquidation of that Fund. However, due
to the differing expenses of the classes, dividends on each Fund's Class A, B,
C and Y shares will differ.
Although each Fund is offering only its own shares, it is possible that a Fund
could become liable for misstatements in the Prospectus about the other Fund.
The boards of the Corporation and the Trust have considered this factor in
approving the use of a single, combined Prospectus.
VOTING RIGHTS
Shareholders of each Fund are entitled to one vote for each full share held
and fractional votes for fractional shares held. Voting rights are not
cumulative and, as a result, the holders of more than 50% of all the shares of
the Corporation or the Trust may elect all of its board members. The shares of
a Fund will be voted together except that only the shareholders of a
particular class of a Fund may vote on matters affecting only that class, such
as the terms of a Plan as it relates to that class. The shares of each series
of the Corporation or the Trust will be voted separately, except when an
aggregate vote of all the securities is required by law.
SHAREHOLDER MEETING
The Funds do not hold annual meetings.
Shareholders of record of no less than two-thirds of the outstanding shares of
the Corporation or the Trust may remove a board member through a declaration
in writing or by vote cast in person or by proxy at a meeting called for that
purpose. A meeting will be called to vote on the removal of a board member at
the written request of holders of 10% of the Corporation's or Trust's
outstanding shares.
REPORTS TO SHAREHOLDERS
Each Fund sends its shareholders audited annual and unaudited semiannual
reports, each of which includes a list of the investment securities held by
the Fund as of the end of the period covered by the report. The Statement of
Additional Information is available to shareholders upon request.
CUSTODIAN & RECORDKEEPING AGENT; TRANSFER & DIVIDEND DISBURSING AGENT
State Street Bank and Trust Company, located at One Heritage Drive, North
Quincy, Massachusetts 02171, serves as the Funds' custodian and recordkeeping
agent. PFPC Inc., a subsidiary of PNC Bank, N.A., serves as the Funds'
transfer and dividend disbursing agent. It is located at 400 Bellevue Parkway,
Wilmington, DE 19809.
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Prospectus Page 33
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PaineWebber Balanced Fund
PaineWebber Tactical Allocation Fund
Prospectus -- January 1, 1998
- --------------------------------------------------------------------------------
. PAINEWEBBER BOND FUNDS . PAINEWEBBER STOCK FUNDS
High Income Fund Capital Appreciation Fund
Investment Grade Income Financial Services Growth Fund
Fund Growth Fund
Low Duration U.S. Growth and Income Fund
Government Income Fund Small Cap Value Fund
Strategic Income Fund Utility Income Fund
U.S. Government Income
Fund
. PAINEWEBBER TAX-FREE . PAINEWEBBER GLOBAL FUNDS
BOND FUNDS
Asia Pacific Growth Fund
California Tax-Free Emerging Markets Equity Fund
Income Fund Global Equity Fund
Municipal High Income Global Income Fund
Fund
National Tax-Free
Income Fund
New York Tax-Free
Income Fund
. PAINEWEBBER MONEY MARKET FUND
. PAINEWEBBER ASSET
ALLOCATION FUNDS
Balanced Fund
Tactical Allocation
Fund
A prospectus containing more complete information for any of the above
funds, including charges and expenses, can be obtained from a PaineWebber
investment executive or correspondent firm. Please read it carefully before
investing. It is important you have all the information you need to make a
sound investment decision.
---------
- --------------------------------------------------------------------------------
<PAGE>
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" and, collectively, "Funds") 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,
investment grade 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 January 1,
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 January 1, 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 debt obligations. A
description of the range of ratings assigned to 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 securities, 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 mortgagors 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.
<PAGE>
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 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 convertible debt 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. These securities are below
investment grade, 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. Lower rated debt
securities 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 lower rated debt securities has expanded rapidly in recent
years, and its growth generally paralleled a long economic expansion. 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 lower rated 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
lower rated securities, especially in a thinly traded market.
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<PAGE>
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 the Government National Mortgage Association ("Ginnie Mae"), 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 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 or private
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
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<PAGE>
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, RTC and Similar 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.
The Resolution Trust Corporation ("RTC"), which was organized by the U.S.
government in connection with the savings and loan crisis, held assets of
failed savings associations as either a conservator or receiver for such
associations, or it acquired such assets in its corporate capacity. These
assets included, among other things, single family and multi-family mortgage
loans, as well as commercial mortgage loans. In order to dispose of such
assets in an orderly manner, RTC established a vehicle registered with the
Securities and Exchange Commission ("SEC") through which it sold mortgage-
backed securities. RTC mortgage-backed securities represent pro rata interests
in pools of mortgage loans that RTC held or had acquired, as described above,
and are supported by one or more of the types of private credit enhancements
used by Private Mortgage Lenders.
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, 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
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<PAGE>
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"
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(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.
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.
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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 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"
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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 option shave durations roughly equal to the
negative duration of the securities that underlie these positions, and have
the effect of 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 sometimes referred to as 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
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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 exempt
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.
However, 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. Such markets might 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). 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 from a bank or recognized securities dealer and
simultaneously commits to resell the securities to the bank or dealer 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 securities.
Each Fund maintains custody of the underlying securities prior to their
repurchase; thus, the obligation of the bank or dealer to pay the repurchase
price on the date agreed to or upon demand is, in effect, secured by such
securities. If the value of such securities is less than the repurchase price,
plus any agreed-upon additional amount, the other party to the agreement 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
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received upon repurchase of the securities 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.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to a Fund if the other party to
a repurchase agreement becomes insolvent. Each Fund intends to enter into
repurchase agreements only with banks and dealers in transactions believed by
Mitchell Hutchins to present minimal credit risks in accordance with
guidelines established by the applicable board. Mitchell Hutchins reviews and
monitors the creditworthiness of those institutions under the 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 its 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."
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. 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 "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,
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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, 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 over-the-counter ("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. While no
securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock, although
the extent to which such risk is reduced depends in large measure upon the
degree to which the convertible security sells above its value as a fixed
income security. 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 value and generally the conversion value decreases as the
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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 that
involve obligations to make future payments to third parties, including the
purchase of securities on a when-issued or delayed delivery basis, swaps, or
reverse repurchase agreements, 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 "Hedging and Other 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. The 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. As a result of the Taxpayer Relief Act of 1997,
short sales "against the box" no longer may be used to defer the recognition
of gain for federal income tax purposes. See "Taxes."
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, marked to market daily, in an
amount 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. In determining whether to lend
securities to a particular broker-dealer or
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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 loan at any time. A Fund may pay reasonable fees in connection with a loan
and may pay a negotiated portion of the interest earned on the cash or money
market instruments held as collateral to the borrower or placing broker. A
Fund will receive reasonable interest on the loan or a flat fee from the
borrower and 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, the applicable board has approved retention of PaineWebber to
serve as lending agent for each Fund. The 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 which PaineWebber acted as
lending agent. PaineWebber received $2,585 and $4,200 in compensation from
Balanced Fund and Tactical Allocation Fund, respectively, for the fiscal year
ended August 31, 1997.
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
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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, a term
that 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, repurchase
agreements maturing in more than seven days.
(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.
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HEDGING AND OTHER STRATEGIES USING DERIVATIVE INSTRUMENTS
As discussed in the Prospectus, 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. 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
other 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. 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.
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--An index assigns relative values to the securities
included in the index and fluctuates with changes in the market values of
these securities. Index options operate in the same way as more traditional
options, except that the exercise of an index option is effected with cash
payment and does not involve delivery of securities. Thus, upon exercise of
an 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 index.
INDEX FUTURES CONTRACT--An 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 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.
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
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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 HEDGING STRATEGIES. 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 less than or equal to the exercise price of
the call. The Fund might enter into a long straddle when Mitchell Hutchins
believes it likely that interest rates 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 less than or equal to the exercise price of the
call. A Fund might enter into a short straddle when Mitchell Hutchins believes
it unlikely that interest rates 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 or debt
securities, in contrast, may be used to hedge either individual securities or
broad equity market sectors. 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.
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 will be limited by tax considerations.
See "Taxes."
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In addition to the products, strategies and risks described below and in the
Prospectus, Mitchell Hutchins expects to discover additional opportunities in
connection with options, futures contracts and other derivative contracts and
hedging techniques. These new opportunities may become available as Mitchell
Hutchins develops new techniques, as regulatory authorities broaden the range
of permitted transactions and as new options, futures contracts or other
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 unrelated to the value of the
investments being hedged, such as speculative or other pressures on the
markets in which Derivative Instruments are traded. 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 such 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 contra party to enter
17
<PAGE>
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 DERIVATIVES. 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 obligations to the extent not
covered as provided in (1) above. The Funds will comply with SEC guidelines
regarding cover for hedging 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 or 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. 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. If the covered call option is an OTC option, the securities or
other assets used as cover 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.
18
<PAGE>
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 contra party (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 contra party
to make or take delivery of the underlying investment upon exercise of the
option. Failure by the contra party 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 will enter into OTC option transactions only with
contra parties that have a net worth of at least $20 million.
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 contra party, or by a
transaction in the secondary market if any such market exists. Although the
Funds will enter into OTC options only with contra parties 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 option position
at a favorable price prior to expiration. In the event of insolvency of the
contra party, 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 common stock
indices or indices of debt securities 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 debt securities market (or
market sectors) rather than anticipated increases or decreases in the value of
a particular security.
GUIDELINES FOR 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, stock indices and indices of debt securities 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 debt securities 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
19
<PAGE>
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.
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
20
<PAGE>
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.
GUIDELINES FOR 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, stock indices and indices of debt securities 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.
INTEREST RATE PROTECTION TRANSACTIONS. Balanced Fund may enter into interest
rate protection transactions, including interest rate swaps and interest rate
caps, collars and floors. Interest rate swap transactions involve an agreement
between two parties to 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
21
<PAGE>
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, collars and floors
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 interest
rate swaps that are not entered into on a net basis and with respect to any
interest rate caps, collars and floors 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.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. Caps, collars and floors are more
recent innovations for which documentation is less standardized, and
accordingly, they are less liquid than swaps.
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 BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
---------------------- ---------------------- --------------------
<S> <C> <C>
Margo N. Alexander**; 50 Director/Trustee and Mrs. Alexander is president, chief
President executive officer and a director of
Mitchell Hutchins (since January
1995) and an executive vice presi-
dent and a director of PaineWebber.
Mrs. Alexander is president and a
director or trustee of 29 invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
---------------------- ---------------------- --------------------
<S> <C> <C>
Richard Q. Armstrong; 62 Director/Trustee Mr. Armstrong is chairman and prin-
78 West Brother Drive cipal of RQA Enterprises (manage-
Greenwich, CT 06830 ment consulting firm) (since April
1991 and princi-
pal occupation since March 1995).
Mr.
Armstrong is also a director of Hi
Lo
Automotive, Inc. He was chairman of
the board, chief executive officer
and co-owner of Adirondack Bever-
ages (producer and distributor of
soft drinks and sparkling/still wa-
ters) (October 1993-March 1995).
Mr. Armstrong was a part-
ner 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,
Luis Vuitton Moet Hennessey Corpo-
ration) (1987-1991) and chairman of
its wine
and spirits subsidiary, Schieffelin
&
Somerset Company (1987-1991). Mr.
Armstrong is a director or trustee
of
28 investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
E. Garrett Bewkes, Director/Trustee and Mr. Bewkes is a director of Paine
Jr.**; 71 Chairman of the Board of Webber Group Inc. ("PW Group")
Directors/Trustees (holding company of PaineWebber and
Mitchell Hutchins). Prior to Decem-
ber 1995, he was a consultant to PW
Group. Prior to 1988, he was chair-
man of the board, president and
chief executive officer of American
Bakeries Company. Mr. Bewkes is
also a director of Interstate Bak-
eries Corporation and NaPro
BioTherapeutics, Inc. Mr. Bewkes is
a director or trustee of 29 invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Richard R. Burt; 50 Director/Trustee Mr. Burt is chairman of IEP Advi-
1275 Pennsylvania Ave- sors, Inc. (international invest-
nue, N.W. ments and consulting firm) (since
Washington, D.C. 20004 March 1994) and a partner of
McKinsey & Company (management con-
sulting firm) (since 1991). He is
also a di-
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
NAME AND ADDRESS*; POSITION BUSINESS EXPERIENCE;
AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
------------------ ---------------------- --------------------
<S> <C> <C>
rector of American Publishing Com-
pany and Archer-Daniels-Midland Co.
(agricultural commodities). He was
the chief negotiator in the Strate-
gic Arms Reduction 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 28 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Mary C. Farrell**; 48 Director/Trustee Ms. Farrell is a managing director,
senior investment strategist and
member of the Investment 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 di-
rector or trustee of 28 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Meyer Feldberg; 55 Director/Trustee Mr. Feldberg is Dean and Professor
Columbia University of Management of the Graduate
101 Uris Hall School of Business, Columbia Uni-
New York, New York versity. Prior to 1989, he was
10027 president of the Illinois Institute
of Technology. Dean Feldberg is
also a director of K-III Communica-
tions Corporation, Federated De-
partment Stores, Inc. and Revlon
Inc. Dean Feldberg is a director or
trustee of 28 investment companies
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
George W. Gowen; 68 Director/Trustee Mr. Gowen is a partner in the law
666 Third Avenue firm of Dunnington, Bartholow &
New York, New York Miller. Prior to May 1994, he was a
10017 partner in the law firm of Fryer,
Ross & Gowen. Mr. Gowen is a direc-
tor of Columbia Real Estate Invest-
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
---------------------- ---------------------- --------------------
<S> <C> <C>
ments, Inc. Mr. Gowen is a director
or trustee of 28 investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Frederic V. Malek; 61 Director/Trustee Mr. Malek is chairman of Thayer Cap-
1455 Pennsylvania Avenue, N.W. ital Partners (merchant bank). From
Suite 350 January 1992 to November 1992, he
Washington, D.C. 20004 was campaign manager 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 (ho-
tels, restaurants, airline catering
and contract feeding), where he
most recently was an executive vice
president and president of Marriott
Hotels and Resorts. Mr. Malek is
also a director of American Manage-
ment Systems, Inc. (management con-
sulting and computer-related serv-
ices), Automatic Data Processing,
Inc., CB Commercial Group, Inc.
(real estate services), Choice Ho-
tels International (hotel and hotel
franchising), FPL Group, Inc.
(electric services), Integra, Inc.
(bio-medical), Manor Care, Inc.
(healthcare), National Education
Corporation and Northwest Airlines
Inc. Mr. Malek is a director or
trustee of 28 investment companies
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Carl W. Schafer; 61 Director/Trustee Mr. Schafer is president of the At-
P.O. Box 1164 lantic Foundation (charitable foun-
Princeton, New Jersey 08542 dation supporting mainly oceano-
graphic exploration and research).
He also is a director of Roadway
Express, Inc. (trucking), The
Guardian Group of Mutual Funds,
Evans Systems, Inc. (a motor fuels,
convenience store and diversified
company), Electronic Clearing
House, Inc. (financial transactions
processing), Wainoco
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
---------------------- ---------------------- --------------------
<S> <C> <C>
Oil Corporation and Nutraceutix
Inc. (biotechnology). Prior to Jan-
uary 1993, he was chairman of the
Investment Advisory Committee of
the Howard Hughes Medical Insti-
tute. Mr. Schafer is a director
or trustee of 28 investment compa-
nies for which Mitchell Hutchins
or PaineWebber serves as investment
adviser.
T. Kirkham Barneby; 51 Vice President Mr. Barneby is a managing director
and chief investment officer--quan-
titative investments of Mitchell
Hutchins. Prior to September 1994,
he was a senior vice president at
Vantage Global Management. Prior to
June 1993, he was a senior vice
president at Mitchell Hutchins. Mr.
Barneby is a vice president of six
investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Dennis McCauley; 51 Vice President Mr. McCauley is a managing director
(Master Series, Inc.) and chief investment officer--fixed
income of Mitchell Hutchins. Prior
to December 1994, he was director
of fixed income investments of IBM
Corporation. Mr. McCauley is a vice
president of 18 investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Ann E. Moran; 40 Vice President Ms. Moran is a vice president and a
and Assistant Treasurer manager of the mutual fund finance
division of Mitchell Hutchins. Ms.
Moran is a vice president and as-
sistant treasurer of 29 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Dianne E. O'Donnell; 45 Vice President and Ms. O'Donnell is a senior vice pres-
Secretary ident and deputy general counsel of
Mitchell Hutchins. Ms. O'Donnell is
a vice president and secretary of
28 investment companies and a vice
president and assistant secretary
of one investment company for which
Mitchell Hutchins or PaineWebber
serves as investment
adviser.
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
- ---------------------- ---------------------- --------------------
<S> <C> <C>
Emil Polito; 37 Vice President Mr. Polito is a senior vice
president and director of
operations and control for Mitchell
Hutchins. From March 1991 to
September 1993 he was director of
the mutual funds sales support and
service center for Mitchell
Hutchins and PaineWebber. Mr.
Polito is also vice president of 29
investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Susan P. Ryan; 37 Vice President Ms. Ryan is a senior vice president
(Master Series, Inc.) and portfolio 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 or PaineWebber serves as
investment adviser.
Victoria E. Schonfeld; Vice President Ms. Schonfeld is a managing director
47 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 28 invest-
ment companies and a vice president
and secretary of one investment
company for which Mitchell Hutchins
or PaineWebber serves as investment
adviser.
Paul H. Schubert; 34 Vice President Mr. Schubert is a first vice presi-
and Treasurer dent and the director of the mutual
fund finance division of Mitchell
Hutchins. From August 1992 to Au-
gust 1994, he was a vice president
of BlackRock Financial Management,
Inc. Prior to August 1992, he was
an audit manager with Ernst & Young
LLP. Mr. Schubert is a vice presi-
dent and treasurer of 29 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Nirmal Singh; 41 Vice President Mr. Singh is a senior vice president
(Master Series, Inc.) and a portfolio manager of Mitchell
Hutchins. Prior to September 1993,
he was a member of the portfolio
management team at
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
---------------------- ---------------------- --------------------
<S> <C> <C>
Merrill Lynch Asset Management,
Inc. Mr. Singh is a vice president
of four investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Barney A. Taglialatela; Vice President and Mr. Taglialatela is a vice president
36 Assistant Treasurer and a manager of the mutual fund
finance di- vision of Mitchell
Hutchins. Prior to February 1995,
he was a manager of the mutual fund
finance division of Kidder Peabody
Asset Management, Inc. Mr.
Taglialatela is a vice president
and assistant treasurer of 29 in-
vestment companies for which Mitch-
ell Hutchins or PaineWebber serves
as investment adviser.
Mark A. Tincher; 42 Vice President Mr. Tincher is a managing director
(Investment Trust) and chief investment officer--U.S.
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 or PaineWebber serves as
investment adviser.
Craig M. Varrelman; 39 Vice President Mr. Varrelman is a senior vice pres-
(Master Series, Inc.) ident and a portfolio manager of
Mitchell Hutchins. Mr. Varrelman is
a vice president of four investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Keith A. Weller; 36 Vice President and Mr. Weller is a first vice president
Assistant Secretary and associate general counsel of
Mitchell Hutchins. Prior to May
1995, he was an attorney in private
practice. Mr. Weller is a vice
president and assistant secretary
of 28 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
NAME AND ADDRESS*; POSITION BUSINESS EXPERIENCE;
AGE WITH CORPORATION/TRUST OTHER DIRECTORSHIPS
------------------ ---------------------- --------------------
<S> <C> <C>
Ian W. Williams; 40 Vice President and Mr. Williams is a vice president and
Assistant Treasurer a manager of the mutual fund fi-
nance division of Mitchell
Hutchins. Prior to June 1992, he
was an audit senior accountant with
Price Waterhouse LLP. Mr. Williams
is a vice president and assistant
treasurer of 29 investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves 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 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 annual compensation, aggregating $15,000 each 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.
29
<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
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
FROM THE
AGGREGATE CORPORATION,
COMPENSATION AGGREGATE THE TRUST
FROM THE COMPENSATION AND THE
NAME OF PERSON, POSITION CORPORATION*++ FROM THE TRUST*++ COMPLEX+
- ------------------------ -------------- ----------------- ------------
<S> <C> <C> <C>
Richard Q. Armstrong, $4,300 $4,300 $ 94,885
Director/Trustee...............
Richard R. Burt, 4,000 4,000 87,085
Director/Trustee...............
Meyer Feldberg, 4,300 6,190 117,853
Director/Trustee...............
George W. Gowen, 4,423 4,300 101,567
Director/Trustee...............
Frederic V. Malek, 4,300 4,300 95,845
Director/Trustee...............
Carl W. Schafer, 4,300 4,300 94,885
Director/Trustee...............
</TABLE>
- --------
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, 1997 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 November 29, 1997
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.
30
<PAGE>
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, and, for
Tactical Allocation Fund, substantially similar prior contracts, each Fund
pays Mitchell Hutchins an annual fee, computed daily and paid monthly,
according to the schedule set forth below:
BALANCED FUND
<TABLE>
<CAPTION>
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
</TABLE>
TACTICAL ALLOCATION FUND
<TABLE>
<CAPTION>
ANNUAL
AVERAGE DAILY NET ASSETS RATE
------------------------ ------
<S> <C>
Up to $250 million................................................. 0.500%
Over $250 million.................................................. 0.450
</TABLE>
During the fiscal year ended August 31, 1997, the period March 1, 1996
through August 31, 1996 and the fiscal years ended February 29, 1996 and
February 28, 1995 the Corporation paid (or accrued) to Mitchell Hutchins
investment advisory and administrative fees of $1,465,166, $739,209,
$1,584,083 and $1,934,650 respectively, with respect to Balanced Fund.
For the fiscal years ended August 31, 1997, August 31, 1996, and August 31,
1995, the Trust paid (or accrued) to Mitchell Hutchins and a prior investment
adviser and administrator management fees of $1,756,146, $402,466, and
$279,950, 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 and February 28, 1995, PaineWebber
earned fees in the amounts of $54,420, $32,992, $77,050, and $100,272,
respectively. Subsequent to August 1, 1997, PFPC (not the Funds) pays
PaineWebber for certain transfer agency related services that PFPC has
delegated to PaineWebber.
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
31
<PAGE>
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.
The following table shows the approximate net assets as of November 30,
1997, 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).............................. $6,441.3
Global......................................................... 3,312.6
Equity/Balanced................................................ 4,903.2
Fixed Income (excluding Money Market).......................... 4,850.7
Taxable Fixed Income......................................... 3,285.4
Tax-Free Fixed Income........................................ 1,565.3
Money Market Funds............................................. 26,428.7
</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 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,
32
<PAGE>
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"). Each
distribution contract requires 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, 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 the Class B shares. Under the 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 the Class C
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.
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,
1997:
<TABLE>
<CAPTION>
TACTICAL
BALANCED FUND ALLOCATION FUND
------------- ---------------
<S> <C> <C>
Class A..................................... $413,824 $ 213,818
Class B..................................... 220,684 1,071,964
Class C..................................... 77,568 1,403,684
</TABLE>
33
<PAGE>
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,
1997.
CLASS A
<TABLE>
<CAPTION>
TACTICAL
BALANCED FUND ALLOCATION FUND
------------- ---------------
<S> <C> <C>
Marketing and advertising........................ $ 99,486 $ 27,693
Amortization of commissions...................... N/A N/A
Printing of prospectuses and statements of
additional information for other than current
shareholders.................................... 5,207 2,239
Branch network costs allocated and interest ex-
pense........................................... 431,585 71,653
Service fees paid to PaineWebber investment exec-
utives.......................................... 156,240 81,064
CLASS B
Marketing and advertising........................ $ 13,171 $ 34,086
Amortization of commissions...................... 66,820 338,457
Printing of prospectuses and statements of
additional information for other than current
shareholders.................................... 689 2,756
Branch network costs allocated and interest ex-
pense........................................... 62,929 158,953
Service fees paid to PaineWebber investment exec-
utives.......................................... 20,825 101,594
CLASS C
Marketing and advertising........................ $ 4,701 $ 48,783
Amortization of commissions...................... 21,971 398,445
Printing of prospectuses and statements of
additional information for other than current
shareholders.................................... 246 3,945
Branch network costs allocated and interest ex-
pense........................................... 20,658 112,723
Service fees paid to PaineWebber investment exec-
utives.......................................... 7,322 132,815
</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 PricingSM 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
34
<PAGE>
PaineWebber investment executives and correspondent firms, resulting in a
greater growth of the Funds than 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.
35
<PAGE>
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 YEARS ENDED
------------------- FOR THE PERIOD FISCAL YEAR
FEBRUARY 28 OR 29, MARCH 1, 1996 ENDED
------------------- THROUGH AUGUST 31, AUGUST 31,
1995 1996 1996 1997
--------- --------- ------------------ -----------
<S> <C> <C> <C> <C>
Earned..................... $ 33,533 $82,272 $7,576 $61,774
Retained................... 2,003 3,365 459 2,215
</TABLE>
TACTICAL ALLOCATION FUND
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
AUGUST 31,
---------------------------
1995 1996 1997
------- -------- ----------
<S> <C> <C> <C>
Earned........................................... $17,000 $474,448 $2,887,643
Retained......................................... 8,737 166,202 182,132
</TABLE>
For the fiscal year ended August 31, 1997, 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 BALANCED
ALLOCATION FUND FUND
--------------- --------
<S> <C> <C>
Class A.............................................. $ 0 $ 0
Class B.............................................. 197,879 27,504
Class C.............................................. 71,931 567
</TABLE>
36
<PAGE>
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. Generally, bonds are traded on
the OTC market on a "net" basis without a stated commission through dealers
acting for their own account and not as brokers. Prices paid to dealers in
principal transactions 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 year ended August 31,
1997, for the period March 1, 1996 through August 31, 1996 and for the fiscal
years ended February 29, 1996 and February 28, 1995, paid $249,609, $134,453,
$335,166, and $495,853 respectively, in aggregate brokerage commissions.
Tactical Allocation Fund, for the fiscal years ended August 31, 1997, August
31, 1996 and August 31, 1995, paid $211,116, $41,271 and $82,091,
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 years ended February 29, 1996 and February 28,
1995, Balanced Fund paid $1,350 and $7,266 in brokerage commissions to
PaineWebber. For the period March 1, 1996 through August 31, 1996, Balanced
Fund paid $2,220 in brokerage commissions to PaineWebber. For the fiscal year
ended August 31, 1997, Balanced Fund paid $15,564 in brokerage commissions
which represented 6% of the total commissions paid by that fund and 0.28% of
the aggregate dollar amount of transactions involving commission payments. For
the fiscal year ended August 31, 1997, Tactical Allocation Fund paid $2,422
commissions to PaineWebber. For the fiscal years ended August 31, 1996 and
August 31, 1995, Tactical Allocation Fund paid no brokerage commissions to
PaineWebber.
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 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 the Fund with research,
analysis, advice and similar services. In return for such services, the 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, 1997 Mitchell Hutchins directed $35,441,492 in
portfolio transactions to brokers chosen because they provided research
services, for which Balanced Fund paid $40,886 in commissions.
37
<PAGE>
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.
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 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 were one year or less) by the monthly average value of
the securities in the portfolio during the year. For the fiscal year ended
August 31, 1997, the period March 1, 1996 through August 31, 1996 and the
fiscal year ended February 29, 1996, the portfolio turnover rates for Balanced
Fund were 188%, 103%, and 188%, respectively. For the fiscal years ended
August 31, 1997 and August 31, 1996, the portfolio turnover rates for Tactical
Allocation Fund were 6% and 6%, respectively.
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<PAGE>
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 most 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.
AUTOMATIC INVESTMENT PLAN. Participation in the Automatic Investment Plan
enables an investor to use the technique of "dollar cost averaging." When the
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
low 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
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<PAGE>
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").
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(SM);
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(R) (RMA(R))
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.
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<PAGE>
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
low 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.
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:
. monthly Premier account statements that itemize all account activity,
including investment transactions, checking activity and Gold MasterCard(R)
transactions during the period, and provide unrealized and realized gain
and loss estimates for most securities held in the account;
. comprehensive preliminary 9-month and year-end summary statements that
provide information on account activity for use in tax planning and tax
return preparation;
. 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. Each money market fund attempts to maintain a stable price per share
of $1.00, although there can be no assurance that it will be able to do so.
Investments in the money market funds are not insured or guaranteed by the
U.S. government;
. 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;
. 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;
. 24-hour access to account information through toll-free numbers, and more
detailed personal assistance during business hours from the RMA Service
Center;
. 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
. 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.
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<PAGE>
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 value of each class, 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 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 be
met.
VALUATION OF SHARES
Each Fund determines the net asset value per share separately for each class
of shares as of the close of regular trading (currently 4:00 p.m., Eastern
time) on the NYSE on each Business Day, which is defined as each Monday
through Friday when the NYSE is open. 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 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 at 4:00 p.m., Eastern time; other OTC
securities are valued at the last bid price available prior to valuation.
Where market quotations are readily available, debt securities are valued
based upon those quotations, provided such quotations adequately reflect, in
Mitchell Hutchins' judgment, the fair value of the security. Where such market
quotations are not readily available, such securities are valued based upon
appraisals received from a pricing service using a computerized matrix system,
or based upon appraisals derived from information concerning the security or
similar securities received from recognized dealers in those securities. All
other securities or assets will be valued at fair value as determined in good
faith by or under the direction of the applicable board. 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. All other assets are valued at fair value
as determined in good faith by or under the direction of each board.
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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>
<S> <C> <C> <C>
P(1 + T)n = ERV
a hypothetical initial payment of $1,000 to purchase shares of a
where: P = 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.
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<PAGE>
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
------- ------- -------
<S> <C> <C> <C>
Fiscal year ended August 31, 1997:
Standardized Return*.................................. 24.84% 24.70% 28.70%
Non-Standardized Return............................... 30.67% 29.70% 29.70%
Five years ended August 31, 1997:
Standardized Return*.................................. 11.60% 11.56% 11.82%
Non-Standardized Return............................... 12.64% 11.81% 11.82%
Inception** to August 31, 1997:
Standardized Return*.................................. 11.50% 9.59% 11.73%
Non-Standardized Return............................... 12.34% 9.59% 11.73%
</TABLE>
<TABLE>
TACTICAL ALLOCATION FUND
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
<S> <C> <C> <C> <C>
Fiscal year ended August 31, 1997:
Standardized Return*.......................... 33.01% 33.14 37.20% 39.55%
Non-Standardized Return....................... 39.26% 38.14 38.20% 39.55%
Five years ended August 31, 1997:
Standardized Return*.......................... N/A N/A 17.13% N/A
Non-Standardized Return....................... N/A N/A 17.13% N/A
Inception*** to August 31, 1997:
Standardized Return*.......................... 17.79% 23.24% 16.96% 19.37%
Non-Standardized Return....................... 19.06% 25.46% 16.96% 19.37%
</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. (a) 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 the Class B shares of Balanced Fund was December
12, 1986. The inception dates for Class A shares and Class C shares of
Balanced Fund were July 1, 1991 and July 2, 1992, respectively.
*** The inception date for Class C shares of Tactical Allocation Fund was July
22, 1992. The inception dates for Class A shares, Class B and Class Y
shares of Tactical Allocation Fund were May 10, 1993, January 30, 1996 and
May 10, 1993, respectively.
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") for flexible portfolio funds; 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, the Dow Jones Industrial Average, the Morgan Stanley International
Capital World Index, the Lehman Brothers 20+ Year Treasury Bond Index, the
Lehman
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<PAGE>
Brothers Government/Corporate Bond Index, 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 Investment Technologies,
Inc. Certificate of Deposit Index, the Bank Rate Monitor National Index and
the averages of yields of CDs of major banks published by Banxquote (R) 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 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 generally have
longer maturities than most CDs and may reflect interest rate fluctuations for
longer term 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. With respect to 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.
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
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<PAGE>
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 U.S. shareholder
(effective for its taxable year beginning September 1, 1998)--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 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 such 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 that income is distributed to its shareholders. If the 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 will 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 the Fund may have to distribute
to satisfy the Distribution Requirement and avoid imposition of the Excise
Tax--even if those earnings and gain are 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.
Effective for its taxable year beginning September 1, 1998, 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
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makes this election will be adjusted to reflect the amounts of income included
and deductions taken under the election. Regulations proposed in 1992 would
provide a similar election with respect to the stock of certain PFICs.
The use of hedging and option income strategies, 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 or forward contract, or
short sales) 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 futures or forward 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.
Balanced Fund may acquire zero coupon securities or other securities issued
with original issue discount. As a holder of such securities, the Fund must
include in its gross income the portion of the original issue discount 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 original issue discount, 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.
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
48
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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.
INDEPENDENT ACCOUNTANTS AND AUDITORS. Price Waterhouse 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.
49
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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.
A-1
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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.
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.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Investment Policies and Restrictions..................................... 1
Hedging and Other Strategies Using Derivative Instruments................ 15
Directors, Trustees and Officers; Principal Holders of Securities........ 22
Investment Advisory and Distribution Arrangements........................ 31
Portfolio Transactions................................................... 37
Reduced Sales Charges, Additional Exchange and Redemption Information and
Other Services.......................................................... 39
Conversion of Class B Shares............................................. 43
Valuation of Shares...................................................... 43
Performance Information.................................................. 44
Taxes.................................................................... 46
Other Information........................................................ 48
Financial Statements..................................................... 49
Appendix ................................................................ A-1
</TABLE>
(C)1998 PaineWebber Incorporated
PAINEWEBBER
BALANCED FUND
PAINEWEBBER
TACTICAL ALLOCATION FUND
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Statement of Additional Information January 1, 1998
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PAINEWEBBER
