As filed with the Securities and Exchange Commission on November 1, 2000
1933 Act: Registration No. 33-2524
1940 Act: Registration No. 811-4448
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [ X ]
---
Pre-Effective Amendment No. [ ]
Post-Effective Amendment No. 42 [ X ]
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [ X ]
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Amendment No. 35 [ X ]
(Check appropriate box or boxes.)
PAINEWEBBER MASTER SERIES, INC.
(Exact name of registrant as specified in charter)
51 West 52nd Street
New York, New York 10019-6114
(Address of principal executive offices)
Registrant's telephone number, including area code: (212) 713-2000
AMY DOBERMAN, ESQ.
Mitchell Hutchins Asset Management Inc.
1285 Avenue of the Americas
New York, New York 10019-6028
(Name and address of agent for service)
Copies to:
ELINOR W. GAMMON, ESQ.
Kirkpatrick & Lockhart LLP
1800 Massachusetts Avenue, N.W.
Second Floor
Washington, D.C. 20036-1800
Telephone: (202) 778-9000
Approximate Date of Proposed Public Offering: Effective Date of this Post
Effective Amendment.
It is proposed that this filing will become effective:
[ ] Immediately upon filing pursuant to Rule 485(b)
[ ] On __________________ pursuant to Rule 485(b)
[ ] 60 days after filing pursuant to Rule 485(a)(1)
[ X ] On DECEMBER 31, 2000 pursuant to Rule 485(a)(1)
[ ] 75 days after filing pursuant to Rule 485(a)(2)
[ ] On __________________ pursuant to Rule 485(a)(2)
Title of Securities Being Registered: Class A, B and C Shares of Common Stock of
PaineWebber Balanced Fund.
<PAGE>
PAINEWEBBER
BALANCED FUND
--------------------
PROSPECTUS
DECEMBER 31, 2000
--------------------
This prospectus offers Class A, Class B, Class C and Class Y shares in one of
PaineWebber's asset allocation funds. Each class has different sales charges and
ongoing expenses. You can choose the class that is best for you based on how
much you plan to invest and how long you plan to hold your fund shares. Class Y
shares are available only to certain types of investors.
As with all mutual funds, the Securities and Exchange Commission has not
approved or disapproved either fund's shares or determined whether this
prospectus is complete or accurate. To state otherwise is a crime.
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On October 6, 2000, the board of directors for PaineWebber Balanced Fund
approved the submission to its shareholders of an Agreement and Plan of
Reorganization and Termination under which the fund would transfer substantially
all of its assets and liabilities to PaineWebber Tactical Allocation Fund, a
series of PaineWebber Investment Trust, another open-end mutual fund. If the
fund's shareholders approve its proposed merger, you will receive shares of
Tactical Allocation Fund in exchange for your fund shares and the fund will
cease operations.
The merger is expected to be a tax-free reorganization, which means that you
will not realize any gain or loss on your receipt of Tactical Allocation Fund
shares in the merger and neither fund will realize any gain or loss. The proxy
solicitation materials previously mailed to the fund's shareholders provide more
information about the proposed merger.
You may continue to buy, sell and exchange your fund shares as described in this
prospectus prior to the shareholder meetings. When you sell or exchange your
fund shares, however, you generally will be subject to federal income tax on any
gain you realize. If the merger proposal is approved, the fund expects to close
to new purchases and exchange purchases approximately five business days prior
to the date on which the merger is to be effected.
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PaineWebber Balanced Fund
CONTENTS
THE FUND
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What every investor 3 Investment Objective, Strategies and Risks
should know about
the fund 4 Performance
5 Expenses and Fee Tables
6 More About Risks and Investment Strategies
YOUR INVESTMENT
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Information for 8 Managing Your Fund Account
managing your fund -- Flexible Pricing
account -- Buying Shares
-- Selling Shares
-- Exchanging Shares
-- Pricing and Valuation
ADDITIONAL INFORMATION
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Additional important 13 Management
information about
the fund 14 Dividends and Taxes
16 Financial Highlights
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Where to learn more 18 Back cover
about PaineWebber
mutual funds
-----------------------------
The fund is not a complete or
balanced investment program.
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Prospectus Page 2
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PaineWebber Balanced Fund
BALANCED FUND
INVESTMENT OBJECTIVE, STRATEGIES AND RISKS
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FUND OBJECTIVE
High total return with low volatility.
PRINCIPAL INVESTMENT STRATEGIES
The fund allocates its investments among three asset classes:
o stocks
o bonds
o cash (money market instruments)
The fund normally has investments in each asset class but it always keeps at
least 25% of its total assets in a combination of bonds and cash. This is
intended to limit changes in the value of fund shares compared to funds that
invest solely in stocks.
The fund's bonds are primarily investment grade, but it may invest, to a lesser
extent, in lower quality bonds. The fund may invest in U.S. dollar-denominated
securities of foreign issuers. The fund may (but is not required to) use
options, futures contracts and other derivatives to adjust its exposure to
different asset classes, to manage the "duration" of its bond investments and to
maintain exposure to stocks or bonds while maintaining a cash balance for fund
management purposes. "Duration" is a measure of the fund's exposure to interest
rate risk.
Mitchell Hutchins Asset Management Inc., the fund's investment adviser, believes
investors tend to reach a consensus as to the likely effect of changes in key
economic variables (for example, interest rates, profits and inflation) on each
asset class. Mitchell Hutchins also believes that prices of securities in each
asset class tend to move toward a level that reflects that consensus, but that
this takes time. By using fundamental valuation techniques, Mitchell Hutchins
attempts to adjust the allocation of the fund's assets among asset classes
before prices fully reflect the consensus view.
In buying and selling individual securities for the fund, Mitchell Hutchins uses
the following criteria:
o STOCKS. The fund's stock portion is designed to track the performance of
the Standard & Poor's 500 Composite Stock Price Index.
o BONDS. The fund's bond portion is designed to track the performance of the
Lehman Brothers Aggregate Bond Index.
PRINCIPAL RISKS
An investment in the fund is not guaranteed; investors may lose money by
investing in the fund.
The principal risks presented by the fund are:
o ASSET ALLOCATION RISK - Mitchell Hutchins may not be successful in
choosing the best allocation of the fund's assets among the three asset
classes.
o EQUITY RISK - Stocks and other equity securities generally fluctuate in
value more than bonds. The fund could lose all of its investment in
company's stock.
o INTEREST RATE RISK - The value of the fund's investments generally will
fall when interest rates rise.
o CREDIT RISK - Bond issuers may fail to make payments when due, or they may
become less willing or less able to do so.
o INDEX TRACKING RISKS - The fund expects a close correlation between the
performance of the portion of its assets allocated to stocks and bonds,
respectively, and that of the designated index in both rising and falling
markets. The performance of the fund's stock and bond investments,
however, generally will not be identical to that of the corresponding
index because of the fees and expenses borne by the fund and investor
purchases and sales of fund shares, which can occur daily.
o FOREIGN INVESTING RISK - The value of the fund's investments in foreign
securities may fall due to adverse political, social and economic
developments abroad. However, because the fund's foreign investments must
be denominated U.S. dollars, it generally is not subject to the risk of
changes in currency valuations.
o DERIVATIVES RISKS - The fund's investments in derivatives may rise or fall
more rapidly than other investments.
More information about risks of an investment in the fund is provided below in
"More About Risks and Investment Strategies."
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Prospectus Page 3
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PaineWebber Balanced Fund
PERFORMANCE
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RISK/RETURN BAR CHART AND TABLE
The following bar chart and table provide information about the fund's
performance and thus give some indication of the risks of an investment in the
fund.
The bar chart shows how the fund's performance has varied from year to year. The
chart shows Class B shares because they have a longer performance history than
any other class of fund shares. The chart does not reflect the effect of sales
charges; if it did, the total returns shown would be lower.
The table that follows the chart shows the average annual returns over several
time periods for each class of the fund's shares. The table does reflect fund
sales charges. The table compares fund returns to returns on a broad-based
market index. The index is unmanaged and, therefore, does not reflect any sales
charges or expenses.
The fund's past performance does not necessarily indicate how the fund will
perform in the future.
TOTAL RETURN ON CLASS B SHARES
[The following was represented as a bar chart in the printed material.]
CALENDAR YEAR TOTAL RETURNS
1990 1.95%
1991 18.52
1992 4.46
1993 14.66
1994 -10.51
1995 22.23
1996 13.81
1997 23.63
1998 18.02
1999
Total return January 1, 2000 to September 30, 2000: ( )%
Best quarter during years shown-- quarter, : %
Worst quarter during years shown-- quarter, : ( )%
AVERAGE ANNUAL TOTAL RETURNS
as of December 31, 1999
CLASS CLASS A CLASS B* CLASS C CLASS Y S&P 500
(INCEPTION DATE) (7/1/91) (12/12/86) (7/2/92) (3/26/98) INDEX
---------------- -------- ---------- -------- --------- -------
One Year................... % % -- %
Five Years ................ % % N/A %
Ten Years ................. % N/A %
Life of Class ............. % % -- **
* Assumes conversion of Class B shares to Class A after six years.
** Average annual total returns for the S&P 500 Index for the life of each
class shown were as follows: Class A -- %, Class B -- %, Class
C -- % and Class Y -- %.
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Prospectus Page 4
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PaineWebber Balanced Fund
EXPENSES AND FEE TABLES
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FEES AND EXPENSES These tables describe the fees and expenses that you may pay
if you buy and hold shares of the fund.
SHAREHOLDER TRANSACTION EXPENSES (fees paid directly from your investment)
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
<S> <C> <C> <C> <C>
Maximum Sales Charge (Load) Imposed on Purchases
(as a % of offering price) ............................ 4.5% None None None
Maximum Contingent Deferred Sales Charge (Load) (CDSC)
(as a % of offering price)` .......................... None 5% 1% None
Exchange Fee ........................................... None None None None
</TABLE>
ANNUAL FUND OPERATING EXPENSES (expenses that are deducted from fund assets)
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
<S> <C> <C> <C> <C>
Management Fees ........................................ 0.75% 0.75% 0.75% 0.75%
Distribution and/or Service (12b-1) Fees ............... 0.25 1.00 1.00 None
Other Expenses .........................................
---- ---- ---- ----
Total Annual Fund Operating Expenses ...................
==== ==== ==== ====
</TABLE>
EXAMPLE
This example is intended to help you compare the cost of investing in the fund
with the cost of investing in other mutual funds.
The example assumes that you invest $10,000 in the fund for the time periods
indicated and then sell all of your shares at the end of those periods unless
otherwise stated. The example also assumes that your investment has a 5% return
each year and that the fund's operating expenses remain the same. Although your
actual costs may be higher or lower, based on these assumptions your costs would
be:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Class A ....................................................... $ $ $ $
Class B (assuming sale of all shares at end of period)
Class B (assuming no sale of shares)...........................
Class C (assuming sale of all shares at end of period)
Class C (assuming no sale of shares)...........................
Class Y........................................................
</TABLE>
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Prospectus Page 5
<PAGE>
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PaineWebber Balanced Fund
MORE ABOUT RISKS AND INVESTMENT
STRATEGIES
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PRINCIPAL RISKS
The main risks of investing in the fund are described below.
Other risks of investing in the fund, along with further detail about some of
the risks described below, are discussed in the fund's Statement of Additional
Information ("SAI"). Information on how you can obtain the SAI is on the back
cover of this prospectus.
ASSET ALLOCATION RISK. Mitchell Hutchins may not be successful in choosing the
best allocation among different asset classes. A fund that allocates its assets
among different asset classes is more dependent on Mitchell Hutchins' ability to
successfully assess the relative values in each asset class than are funds that
do not do so.
EQUITY RISK. The prices of common stocks and other equity securities generally
fluctuate more than those of other investments. They reflect changes in the
issuing company's financial condition and changes in the overall market.
The fund may lose a substantial part, or even all, of its investment in a
company's stock.
INTEREST RATE RISK. The value of bonds can be expected to fall when interest
rates rise and to rise when interest rates fall. Interest rate risk is the risk
that interest rates will rise, so that the value of the fund's investments in
bonds will fall. Because interest rate risk is the primary risk presented by
U.S. government and other very high quality bonds, changes in interest rates may
actually have a larger effect on the value of those bonds than on lower quality
bonds.
CREDIT RISK. Credit risk is the risk that the issuer of a bond will not make
principal or interest payments when they are due. Even if an issuer does not
default on a payment, a bond's value may decline if the market believes that the
issuer has become less able, or less willing, to make payments on time. Even
high quality bonds are subject to some credit risk. However, credit risk is
higher for lower quality bonds. Bonds that are not investment grade involve high
credit risk and are considered speculative.
FOREIGN INVESTING RISK. Foreign investing involves risks relating to political,
social and economic developments abroad to a greater extent than investing in
the securities of U.S. issuers. In addition, there are differences between U.S.
and foreign regulatory requirements and market practices.
DERIVATIVES RISK. The value of "derivatives" - so-called because their value
"derives" from the value of an underlying asset, reference rate or index - may
rise or fall more rapidly than other investments. For some derivatives, it is
possible for the fund to lose more than the amount it invested in the
derivative. Options and futures contracts are examples of derivatives. The
fund's use of derivatives may not succeed for various reasons, including
unexpected changes in the values of the derivatives or the assets underlying
them. Also, if the fund uses derivatives to adjust or "hedge" the overall risk
of its portfolio, the hedge may not succeed if changes in the values of the
derivatives are not matched by opposite changes in the values of the assets
being hedged.
ADDITIONAL INVESTMENT STRATEGIES
Defensive Positions; Cash Reserves. In order to protect itself from adverse
market conditions, the fund may take a temporary defensive position that is
different from its normal investment strategy. This means that the fund may
temporarily invest a larger-than-normal part, or even all, of its assets in cash
or money market instruments. Since these investments provide relatively low
income, a defensive position may not be consistent with achieving the fund's
investment objective. The fund may invest in money market instruments on an
unlimited basis as part of its ordinary investment strategy. The fund normally
maintains a limited amount of cash for liquidity purposes.
PORTFOLIO TURNOVER. The fund may engage in frequent trading to achieve its
investment objective. Frequent trading can result in portfolio turnover in
excess of 100% (high portfolio turnover).
Frequent trading may increase the portion of the fund's capital gains that are
realized for tax purposes in any given year. This may increase the fund's
taxable dividends in that year. Frequent trading also may increase the portion
of the fund's realized capital gains that are considered "short-term" for tax
purposes. Shareholders will pay higher taxes on dividends that represent
short-term capital gains than they would pay on dividends that represent
long-term
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Prospectus Page 6
<PAGE>
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PaineWebber Balanced Fund
capital gains. Frequent trading also may result in higher fund expenses due to
transaction costs.
The fund does not restrict the frequency of trading to limit expenses or the tax
effect that the fund's dividends may have on shareholders.
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Prospectus Page 7
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PaineWebber Balanced Fund
MANAGING YOUR FUND ACCOUNT
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FLEXIBLE PRICING
The fund offers four classes of shares - Class A, Class B, Class C and Class Y.
Each class has different sales charges and ongoing expenses. You can choose the
class that is best for you, based on how much you plan to invest and how long
you plan to hold your fund investment. Class Y shares are only available to
certain types of investors.
The fund has adopted a plan under rule 12b-1 for its Class A, Class B and Class
C shares that allows it to pay service and (for Class B and Class C shares)
distribution fees for the sale of its shares and services provided to
shareholders. Because the 12b-1 distribution fees for Class B and Class C shares
are paid out of a fund's assets on an ongoing basis, over time they will
increase the cost of your investment and may cost you more than if you paid a
front-end sales charge.
CLASS A SHARES
Class A shares have a front-end sales charge that is included in the offering
price of the Class A shares. This sales charge is not invested in the fund.
Class A shares pay an annual 12b-1 service fee of 0.25% of average net assets,
but they pay no 12b-1 distribution fees. The ongoing expenses for Class A shares
are lower than for Class B and Class C shares.
The Class A sales charges for the fund are described in the following table.
CLASS A SALES CHARGES
<TABLE>
<CAPTION>
SALES CHARGE AS A PERCENTAGE OF: DISCOUNT TO SELECTED DEALERS AS
AMOUNT OF INVESTMENT OFFERING PRICE NET AMOUNT INVESTED PERCENTAGE OF 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 dividends are not
subject to this 1% charge. Withdrawals in the first year after purchase of
up to 12% of the value of the fund account under the funds' Systematic
Withdrawal Plan are not subject to this charge.
(2) Mitchell Hutchins pays 1% to PaineWebber.
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Prospectus Page 8
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PaineWebber Balanced Fund
Sales Charge Reductions and Waivers. You may qualify for a lower sales charge if
you already own Class A shares of a PaineWebber mutual fund. You can combine the
value of Class A shares that you own in other PaineWebber funds and the purchase
amount of the Class A shares of the PaineWebber fund that you are buying.
You may also qualify for a lower sales charge if you combine your purchases with
those of:
o your spouse, parents or children under age 21;
o your Individual Retirement Accounts (IRAs);
o certain employee benefit plans, including 401(k) plans;
o a company that you control;
o a trust that you created;
o Uniform Gifts to Minors Act/Uniform Transfers to Minors Act accounts
created by you or by a group of investors for your children; or
o accounts with the same adviser.
You may qualify for a complete waiver of the sales charge if you:
o Are an employee of PaineWebber or its affiliates or the spouse, parent or
child under age 21 of a PaineWebber employee;
o Buy these shares through a PaineWebber Financial Advisor who was formerly
employed as an investment executive with a competing brokerage firm that
was registered as a broker-dealer with the SEC, and
-- you were the Financial Advisor's client at the competing brokerage
firm;
-- within 90 days of buying shares in a fund, you sell shares of one or
more mutual funds that were principally underwritten by the
competing brokerage firm or its affiliates, and you either paid a
sales charge to buy those shares, pay a contingent deferred sales
charge when selling them or held those shares until the contingent
deferred sales charge was waived; and
-- you purchase an amount that does not exceed the total amount of
money you received from the sale of the other mutual fund;
o Acquire these shares through the reinvestment of dividends of a
PaineWebber unit investment trust;
o Are a 401(k) or 403(b) qualified employee benefit plan with 50 or more
eligible employees in the plan or at least $1 million in assets; or
o Are a participant in the PaineWebber Members Only(SM) Program. 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; or
o Acquire fund shares through a PaineWebber InsightOne(SM) Program brokerage
account.
CLASS B SHARES
Class B shares have a contingent deferred sales charge. When you purchase Class
B shares, we invest 100% of your purchase in fund shares. However, you may have
to pay the deferred sales charge when you sell your fund shares, depending on
how long you own the shares.
Class B shares pay an annual 12b-1 distribution fee of 0.75% of average net
assets, as well as an annual 12b-1 service fee of 0.25% of average net assets.
If you hold your Class B shares for six years, they will automatically convert
to Class A shares, which have lower ongoing expenses.
If you sell Class B shares before the end of six years, you will pay a deferred
sales charge. We calculate the deferred sales charge by multiplying the lesser
of the net asset value of the Class B shares at the time of purchase or the net
asset value at the time of sale by the percentage shown below:
PERCENTAGE BY WHICH THE
IF YOU SELL SHARES' NET ASSET
SHARES WITHIN: VALUE IS MULTIPLIED:
-------------- -----------------------
1st year since purchase 5%
2nd year since purchase 4
3rd year since purchase 3
4th year since purchase 2
5th year since purchase 2
6th year since purchase 1
7th year since purchase None
We will not impose the deferred sales charge on Class B shares representing
reinvestment of dividends or on withdrawals in any year of up to 12% of the
value of your Class B shares under the Systematic Withdrawal Plan.
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Prospectus Page 9
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PaineWebber Balanced Fund
To minimize your deferred sales charge, we will assume that you are selling:
o First, Class B shares representing reinvested dividends, and
o Second, Class B shares that you have owned the longest.
Sales Charge Waivers. You may qualify for a waiver of the deferred sales charge
on a sale of shares if:
o You participate in the Systematic Withdrawal Plan;
o You are older than 591/2 and are selling shares to take a distribution
from certain types of retirement plans;
o You receive a tax-free return of an excess IRA contribution;
o You receive a tax-qualified retirement plan distribution following
retirement;
o The shares are sold within one year of your death and you owned the shares
either (1) as the sole shareholder or (2) with your spouse as a joint
tenant with the right of survivorship; or
o The shares are held in trust and the death of the trustee requires
liquidation of the trust.
CLASS C SHARES
Class C shares have a level load sales charge in the form of ongoing 12b-1
distribution fees. When you purchase Class C shares, we will invest 100% of your
purchase in fund shares.
Class C shares pay an annual 12b-1 distribution fee of 0.75% of average net
assets, as well as an annual 12b-1 service fee of 0.25% of average net assets.
Class C shares do not convert to another class of shares. This means that you
will pay the 12b-1 fees for as long as you own your shares.
Class C shares also have a contingent deferred sales charge. You may have to pay
the deferred sales charge if you sell your shares within one year of the date
you purchased them. We calculate the deferred sales charge on sales of Class C
shares by multiplying 1.00% by the lesser of the net asset value of the Class C
shares at the time of purchase or the net asset value at the time of sale. We
will not impose the deferred sales charge on Class C shares representing
reinvestment of dividends or on withdrawals in the first year after purchase, of
up to 12% of the value of your Class C shares under the Systematic Withdrawal
Plan.
You may be eligible to sell your Class C shares without paying a contingent
deferred sales charge if you are a 401(k) or 403(b) qualified employee benefit
plan with fewer than 100 employees or less than $1 million in assets.
NOTES ON SALES CHARGE WAIVERS FOR CLASS A, CLASS B AND CLASS C SHARES
If you think you qualify for any of the sales charge waivers described above,
you will need to provide documentation to PaineWebber or the fund. For more
information, you should contact your PaineWebber Financial Advisor or
correspondent firm or call 1-800-647-1568. If you want information on the fund's
Systematic Withdrawal Plan, see the SAI or contact your PaineWebber Financial
Advisor or correspondent firm.
CLASS Y SHARES
Class Y shares have no sales charge. Only specific types of investors can
purchase Class Y shares. You may be eligible to purchase Class Y shares if you:
o Buy shares through PaineWebber's PACE(SM) Multi Advisor Program;
o Buy $10 million or more of PaineWebber fund shares at any one time;
o Are a qualified retirement plan with 5,000 or more eligible employees or
$50 million in assets; or
o A corporation, bank, trust company, insurance company, pension fund,
employee benefit plan, professional firm, trust, estate or educational,
religious or charitable organization with 5,000 or more employees or with
over $50 million in investable asset.
The trustee of PaineWebber's 401(k) Plus Plan for its employees is also eligible
to purchase Class Y shares.
Class Y shares do not pay ongoing distribution or service fees or sales charges.
The ongoing expenses for Class Y shares are the lowest for all the classes.
BUYING SHARES
If you are a PaineWebber client, or a client of a PaineWebber correspondent
firm, you can purchase fund shares through your Financial Advisor. Otherwise,
you can invest in the fund through the fund's transfer agent,
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Prospectus Page 10
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PaineWebber Balanced Fund
PFPC Inc. You can obtain an application by calling 1-800-647-1568. You must
complete and sign the application and mail it, along with a check, to:
PFPC Inc.
Attn.: PaineWebber Mutual Funds
P.O. Box 8950
Wilmington, DE 19899.
If you wish to invest in other PaineWebber funds, you can do so by:
o Contacting your Financial Advisor (if you have an account at PaineWebber
or at a PaineWebber correspondent firm);
o Mailing an application with a check; or
o Opening an account by exchanging shares from another PaineWebber fund.
You do not have to complete an application when you make additional investments
in the same fund.
The fund and Mitchell Hutchins reserve the right to reject a purchase order or
suspend the offering of shares.
MINIMUM INVESTMENTS
-------------------
To open an account........... $1,000
To add to an account......... $ 100
The fund may waive or reduce these amounts for:
o Employees of PaineWebber or its affiliates; or
o Participants in certain pension plans, retirement accounts, unaffiliated
investment programs or the funds' automatic investment plans.
FREQUENT TRADING. The interests of the fund's long-term shareholders and its
ability to manage its investments may be adversely affected when its shares are
repeatedly bought and sold in response to short-term market fluctuations -- also
known as "market timing." When large dollar amounts are involved, the fund may
have difficulty implementing long-term investment strategies, because it cannot
predict how much cash it will have to invest. Market timing also may force the
fund to sell portfolio securities at disadvantageous times to raise the cash
needed to buy a market timer's fund shares. These factors may hurt the fund's
performance and its shareholders. When Mitchell Hutchins believes frequent
trading would have a disruptive effect on the fund's ability to manage its
investments, Mitchell Hutchins and the fund may reject purchase orders and
exchanges into the fund by any person, group or account that Mitchell Hutchins
believes to be a market timer. The fund may notify the market timer that a
purchase order or an exchange has been rejected after the day the order is
placed.
SELLING SHARES
You can sell your fund shares at any time. If you own more than one class of
shares, you should specify which class you want to sell. If you do not, the fund
will assume that you want to sell shares in the following order: Class A, then
Class C, then Class B and last, Class Y.
If you want to sell shares that you purchased recently, the fund may delay
payment until it verifies that it has received good payment. If you purchased
shares by check, this can take up to 15 days.
If you have an account with PaineWebber or a PaineWebber correspondent firm, you
can sell shares by contacting your Financial Advisor.
If you do not have an account at PaineWebber or a correspondent firm, and you
bought your shares through the transfer agent, you can sell your shares by
writing to the fund's transfer agent. Your letter must include:
o Your name and address;
o The fund's name;
o The fund account number;
o The dollar amount or number of shares you want to sell; and
o A guarantee of each registered owner's signature. A signature guarantee
may be obtained from a financial institution, broker, dealer or clearing
agency that is a participant in one of the medallion programs recognized
by the Securities Transfer Agents Association. These are: Securities
Transfer Agents Medallion Program (STAMP), Stock Exchanges Medallion
Program (SEMP) and the New York Stock Exchange Medallion Signature Program
(MSP). The fund will not accept signature guarantees that are not a part
of these programs.
Mail the letter to:
PFPC Inc.
Attn.: PaineWebber Mutual Funds
P.O. Box 8950
Wilmington, DE 19899.
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Prospectus Page 11
<PAGE>
--------------------------------------------------------------------------------
PaineWebber Balanced Fund
If you sell Class A shares and then repurchase Class A Shares of the same fund
within 365 days of the sale, you can reinstate your account without paying a
sales charge.
It costs the fund money to maintain shareholder accounts. Therefore, the fund
reserves the right to repurchase all shares in any account that has a net asset
value of less than $500. If the fund elects to do this with your account, it
will notify you that you can increase the amount invested to $500 or more within
60 days. The fund will not repurchase shares in accounts that fall below $500
solely because of a decrease in the fund's net asset value.
EXCHANGING SHARES
You may exchange Class A, Class B or Class C shares of the fund for shares of
the same class of most other PaineWebber funds. You may not exchange Class Y
shares.
You will not pay either a front-end sales charge or a deferred sales charge when
you exchange shares. However, you may have to pay a deferred sales charge if you
later sell the shares you acquired in the exchange. The fund will use the date
that you purchased the shares in the first fund to determine whether you must
pay a deferred sales charge when you sell the shares in the acquired fund.
Other PaineWebber funds may have different minimum investment amounts. You may
not be able to exchange your shares if your exchange is not as large as the
minimum investment amount in that other fund.
You may exchange shares of one fund for shares of another fund only after the
first purchase has settled and the first fund has received your payment.
PAINEWEBBER AND CORRESPONDENT FIRM CLIENTS. If you bought your shares through
PaineWebber or a correspondent firm, you may exchange your shares by placing an
order with your Financial Advisor.
OTHER INVESTORS. If you are not a PaineWebber or correspondent firm client, you
may exchange your shares by writing to the fund's transfer agent. You must
include:
o Your name and address;
o The name of the fund whose shares you are selling and the name of the fund
whose shares you want to buy;
o Your account number;
o How much you are exchanging (by dollar amount or by number of shares to be
sold); and
o A guarantee of your signature. (See "Selling Shares" for information on
obtaining a signature guarantee.)
Mail the letter to:
PFPC Inc.
Attn.: PaineWebber Mutual Funds
P.O. Box 8950
Wilmington, DE 19899.
A fund may modify or terminate the exchange privilege at any time.
PRICING AND VALUATION
The price at which you may buy, sell or exchange fund shares is based on net
asset value per share. The fund calculates net asset value on days that the New
York Stock Exchange is open. The fund calculates net asset value separately for
each class as of the close of regular trading on the NYSE (generally, 4:00 p.m.,
Eastern time). The NYSE normally is not open, and the funds do not price their
shares, on most national holidays and on Good Friday. If trading on the NYSE is
halted for the day before 4:00 p.m., Eastern time, the fund's net asset value
per share will be calculated as of the time trading was halted.
Your price for buying, selling or exchanging shares will be based on the net
asset value that is next calculated after the fund accepts your order. If you
place your order through PaineWebber, your PaineWebber Financial Advisor is
responsible for making sure that your order is promptly sent to the fund.
You should keep in mind that a front-end sales charge may be applied to your
purchase if you buy Class A shares. A deferred sales charge may be applied when
you sell Class B or Class C shares.
The fund calculates its net asset value based on the current market value for
its portfolio securities. The fund normally obtains market values for its
securities from independent pricing services that use reported last sales
prices, current market quotations or valuations from computerized "matrix"
systems that derive values based on comparable securities. If a market value is
not available from an independent pricing source for a particular security, that
security is valued at a fair value determined by or under the direction of the
fund's board. The fund normally uses the amortized cost method to value bonds
that will mature in 60 days or less.
Judgment plays a greater role in valuing thinly traded securities, including
many lower-rated bonds, because there is less reliable, objective data
available.
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Prospectus Page 12
<PAGE>
--------------------------------------------------------------------------------
PaineWebber Balanced Fund
MANAGEMENT
--------------------------------------------------------------------------------
INVESTMENT ADVISER
Mitchell Hutchins Asset Management Inc. is the investment adviser and
administrator of the funds. Mitchell Hutchins is located at 51 West 52nd Street,
New York, New York 10019-6114. It is a wholly owned asset management subsidiary
of PaineWebber Incorporated, which is a wholly owned indirect subsidiary of UBS
AG, an internationally diversified organization with headquarters in Switzerland
and operations in many areas of the financial services industry. On October 31,
2000, Mitchell Hutchins was adviser or sub-adviser of investment companies
with separate portfolios and aggregate assets of approximately
$ billion.
PORTFOLIO MANAGERS
BALANCED FUND. T. Kirkham Barneby and Joe Baggett are responsible for the asset
allocation decisions for Balanced Fund. Mr. Barneby is a managing director and
chief investment officer for quantitative investments of Mitchell Hutchins. Mr.
Baggett is a first vice president of Mitchell Hutchins and a member of its
quantitative investments group. Prior to joining Mitchell Hutchins in 1996, Mr.
Baggett worked at PaineWebber in its economics group. Mr. Barneby first assumed
responsibility for the fund's asset allocation decisions in August 1995. Mr.
Baggett assumed his fund responsibilities on October 10, 2000.
Mr. Barneby and Frank Vallario assumed responsibility for the day-to-day
management of the fund's stock investments on October 10, 2000. Mr. Vallario is
a first vice president of Mitchell Hutchins and a member of its quantitative
investments group. Prior to joining Mitchell Hutchins in March 1996, Mr.
Vallario worked at PaineWebber in its capital markets group.
Heidi Kirmaier assumed responsibility for the day-to-day management of the
fund's bond investments on October 10, 2000. Ms. Kirmaier is a first vice
president of Mitchell Hutchins and a member of its quantitative investments
group. Ms. Kirmaier first joined Mitchell Hutchins in 1982.
Susan Ryan is responsible for the day-to-day management of the portion of
Balanced Fund's assets invested in money market instruments. Ms. Ryan has been
with Mitchell Hutchins since 1982 and is a senior vice president of Mitchell
Hutchins. She has held her fund responsibilities since August 1995.
ADVISORY FEES
The fund paid advisory and administration fees to Mitchell Hutchins for the most
recent fiscal year ended August 31, 2000 at the annual rate of 0.75% of average
daily net assets:
--------------------------------------------------------------------------------
Prospectus Page 13
<PAGE>
--------------------------------------------------------------------------------
PaineWebber Balanced Fund
DIVIDENDS AND TAXES
--------------------------------------------------------------------------------
DIVIDENDS
The fund normally declares and pays dividends semi-annually and distributes any
gains annually.
Classes with higher expenses are expected to have lower dividends. For example,
Class B and Class C shares are expected to have the lowest dividends of any
class of the fund's shares, while Class Y shares are expected to have the
highest.
You will receive dividends in additional shares of the same class unless you
elect to receive them in cash. Contact your Financial Advisor at PaineWebber or
one of its correspondent firms if you prefer to receive dividends in cash.
TAXES
The dividends that you receive from the fund generally are subject to federal
income tax regardless of whether you receive them in additional fund shares or
in cash. If you hold fund shares through a tax-exempt account or plan, such as
an IRA or 401(k) plan, dividends on your shares generally will not be subject to
tax.
When you sell fund shares, you generally will be subject to federal income tax
on any gain you realize. If you exchange the fund's shares for shares of another
PaineWebber mutual fund, the transaction will be treated as a sale of the fund's
shares, and any gain will be subject to federal income tax.
The fund expects that its dividends will include capital gain distributions.
However, a portion of the fund's dividends will be taxed as ordinary income. A
distribution of capital gains will be taxed at a lower rate than ordinary income
if the fund held the assets that generated the gains for more than 12 months.
The fund will tell you annually how you should treat its dividends for tax
purposes.
--------------------------------------------------------------------------------
Prospectus Page 14
<PAGE>
--------------------------------------------------------------------------------
PaineWebber Balanced Fund
--------------------------------------------------------------------------------
[This page intentionally left blank.]
--------------------------------------------------------------------------------
Prospectus Page 15
<PAGE>
--------------------------------------------------------------------------------
PaineWebber Balanced Fund
FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------
The following financial highlights tables are intended to help you understand
the fund's financial performance for the past 5 years. Shorter periods are shown
for classes of fund shares that have existed for less than 5 years. Certain
information reflects financial results for a single fund share. In the tables,
"total investment return" represents the rate that an investor would have earned
(or lost) on an investment in the fund (assuming reinvestment of all dividends).
This information in the financial highlights has been audited by
PricewaterhouseCoopers LLP, independent accountants, whose report, along with
the fund's financial statements, are included in the funds' Annual Report to
Shareholders. The Annual Report may be obtained without charge by calling
1-800-647-1568.
PAINEWEBBER BALANCED FUND
<TABLE>
<CAPTION>
Class A
--------------------------------------------------------------------------------------
For the
Six For the
For the Years Ended Months Year
August 31, Ended Ended
------------------------------------------------------- August 31, February 29,
2000 1999 1998 1997 1996 (2) 1996
--------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period ..... $ 11.27 $ 12.50 $ 10.27 $ 10.85 $ 9.80
--------- ----------- ----------- ----------- ----------- -----------
Net investment income .................... 0.22++ 0.23++ 0.23++ 0.12++ 0.27++
Net realized and unrealized gains (losses)
from investments, futures and options . 1.56++ 0.31++ 2.79++ (0.12)++ 1.84++
--------- ----------- ----------- ----------- ----------- -----------
Net increase (decrease) from investment
operations ............................. 1.78 0.54 3.02 0.00 2.11
--------- ----------- ----------- ----------- ----------- -----------
Dividends from net investment income ..... (0.22) (0.22) (0.24) (0.10) (0.31)
Distributions from net realized gains
from investment transactions ........... (1.23) (1.55) (0.55) (0.48) (0.75)
--------- ----------- ----------- ----------- ----------- -----------
Total dividends and distributions to
shareholders ........................... (1.45) (1.77) (0.79) (0.58) (1.06)
--------- ----------- ----------- ----------- ----------- -----------
Net asset value, end of period ........... $ 11.60 $ 11.27 $ 12.50 $ 10.27 $ 10.85
========= =========== =========== =========== =========== ===========
Total investment return (1) .............. 16.20% 4.69% 30.67% 0.03% 22.08%
========= =========== =========== =========== =========== ===========
Ratios/supplemental data:
Net assets, end of period (000's) ........ $ 196,684 $ 182,362 $ 176,403 $ 157,525 $ 171,609
Expenses to average net assets,
net of waivers from adviser (3) ........ 1.22% 1.26% 1.46% 1.34%* 1.29%
Net investment income to average net
assets, net of waivers from adviser (3) 1.81% 1.88% 2.02% 2.19%* 2.55%
Portfolio turnover rate .................. 234% 190% 188% 103% 188%
</TABLE>
----------
* Annualized.
+ Commencement of issuance of shares.
++ Calculated using the average shares outstanding for the period.
(1) Total investment return is calculated assuming a $10,000 investment on the
first day of each period reported, reinvestment of all dividends and
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 any applicable sales charges or program fees. Results would be
lower if they were included. Total investment return for periods less than
one year has not been annualized.
(2) Fiscal year changed to August 31.
(3) During the years ended August 31, 2000 and August 31, 1999 Mitchell
Hutchins waived a portion of its advisory and administration fees. The
ratios excluding the waiver would be the same since the fee waiver
represents less than 0.005%.
--------------------------------------------------------------------------------
Prospectus Page 16
<PAGE>
--------------------------------------------------------------------------------
PaineWebber Balanced Fund
FINANCIAL HIGHLIGHTS
(continued)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class B
--------------------------------------------------------------------------------------
For the
Six For the
For the Years Ended Months Year
August 31, Ended Ended
------------------------------------------------------- August 31, February 29,
2000 1999 1998 1997 1996 (2) 1996
--------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
$ 11.48 $ 12.70 $ 10.42 $ 11.00 $ 9.90
--------- ----------- ----------- ----------- ----------- -----------
0.13++ 0.14++ 0.14++ 0.08++ 0.19++
1.59++ 0.31++ 2.84++ (0.11)++ 1.86++
--------- ----------- ----------- ----------- ----------- -----------
1.72 0.45 2.98 (0.03) 2.05
--------- ----------- ----------- ----------- ----------- -----------
(0.13) (0.12) (0.15) (0.07) (0.20)
(1.23) (1.55) (0.55) (0.48) (0.75)
--------- ----------- ----------- ----------- ----------- -----------
(1.36) (1.67) (0.70) (0.55) (0.95)
--------- ----------- ----------- ----------- ----------- -----------
$ 11.84 $ 11.48 $ 12.70 $ 10.42 $ 11.00
========= =========== =========== =========== =========== ===========
15.28% 3.87% 29.70% (0.30)% 21.20%
========= =========== =========== =========== =========== ===========
$ $ 28,719 $ 26,425 $ 22,768 $ 22,307 $ 26,627
1.98% 2.03% 2.22% 2.09%* 2.05%
1.04% 1.13% 1.27% 1.43%* 1.81%
234% 190% 188% 103% 188%
</TABLE>
<TABLE>
<CAPTION>
Class C Class Y
--------------------------------------------------------------------------------------- -------------------------------------------
For the For the
Six For the For the Period
For the Years Ended Months Year Year March 26, 1998+
August 31, Ended Ended Ended through
------------------------------------------------------- August 31, February 29, August 31, August 31,
2000 1999 1998 1997 1996 (2) 1996 2000 1999 1998
--------- ----------- ----------- ----------- ----------- ----------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$ 11.28 $ 12.52 $ 10.29 $ 10.88 $ 9.82 $ 11.27 $ 12.55
--------- ----------- ----------- ----------- ----------- ----------- --------- ----------- -----------
0.14++ 0.14++ 0.14++ 0.08++ 0.19++ 0.26++ 0.11++
1.56++ 0.31++ 2.80++ (0.12)++ 1.84++ 1.55++ (1.28)++
--------- ----------- ----------- ----------- ----------- ----------- --------- ----------- -----------
1.70 0.45 2.94 (0.04) 2.03 1.81 (1.17)
--------- ----------- ----------- ----------- ----------- ----------- --------- ----------- -----------
(0.15) (0.14) (0.16) (0.07) (0.22) (0.26) (0.11)
(1.23) (1.55) (0.55) (0.48) (0.75) (1.23) --
--------- ----------- ----------- ----------- ----------- ----------- --------- ----------- -----------
(1.38) (1.69) (0.71) (0.55) (0.97) (1.49) (0.11)
--------- ----------- ----------- ----------- ----------- ----------- --------- ----------- -----------
$ 11.60 $ 11.28 $ 12.52 $ 10.29 $ 10.88 $ 11.59 $ 11.27
========= =========== =========== =========== =========== =========== ========= =========== ===========
15.34% 3.89% 29.70% (0.38)% 21.12% 16.42% (9.41)%
========= =========== =========== =========== =========== =========== ========= =========== ===========
$ 19,894 $ 14,581 $ 8,736 $ 6,979 $ 7,469 $ $ 519 $ 175
1.95% 2.00% 2.21% 2.09%* 2.08% 0.96% 0.89%*
1.08% 1.18% 1.27% 1.44%* 1.77% 2.11% 2.48%*
234% 190% 188% 103% 188% 234% 190%
</TABLE>
--------------------------------------------------------------------------------
Prospectus Pages 17
<PAGE>
--------------------------------------------------------------------------------
PaineWebber Balanced Fund
TICKER SYMBOL: Balanced Fund Class A: PASAX
B: PASBX
C: PASCX
Y: None
--------------------------------------------------------------------------------
If you want more information about the fund, the following documents are
available free upon request:
ANNUAL/SEMI-ANNUAL REPORTS
Additional information about the fund's investments is available in the fund's
annual and semi-annual reports to shareholders. In the fund's annual reports,
you will find a discussion of the market conditions and investment strategies
that significantly affected the fund's performance during the last fiscal year.
STATEMENT OF ADDITIONAL INFORMATION (SAI)
The SAI provides more detailed information about the fund and is incorporated by
reference into this prospectus.
You may discuss your questions about the fund by contacting your Financial
Advisor. You may obtain free copies of annual and semi-annual reports and the
SAI by contacting the fund directly at 1-800-647-1568.
You may review and copy information about the fund, including shareholder
reports and the SAI, at the Public Reference Room of the Securities and Exchange
Commission. You may obtain information about the operations of the SEC's Public
Reference Room by calling the SEC at 1-202-942-8090.
o For a fee, by electronic request at [email protected] or by writing the
SEC's Public Reference Section, Washington, D.C. 20549-0102; or
o Free from the EDGAR Database on the SEC's Internet website at
http://www.sec.gov
Paine Webber Master Series, Inc.
- Paine Webber Balanced Fund
Investment Company Act File No. 811-4448
(C) 2000 PaineWebber Incorporated. All rights reserved.
--------------------------------------------------------------------------------
Prospectus Page 18
<PAGE>
PaineWebber Balanced Fund
51 West 52nd Street
New York, New York 10019-6114
STATEMENT OF ADDITIONAL INFORMATION
PaineWebber Balanced Fund is a diversified series of PaineWebber Master
Series, Inc., ("Corporation"), a professionally managed, open-end management
investment company, organized as a Maryland corporation.
The investment adviser, administrator and distributor for the fund is
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly owned
asset management subsidiary of PaineWebber Incorporated ("PaineWebber"). As
distributor for the fund, Mitchell Hutchins has appointed PaineWebber to serve
as dealer for the sale of fund shares.
Portions of the fund's Annual Report to Shareholders are incorporated by
reference into this Statement of Additional Information ("SAI"). The Annual
Report accompanies this SAI. You may obtain an additional copy of the fund's
Annual Report without charge by calling toll-free 1-800-647-1568.
This SAI is not a prospectus and should be read only in conjunction with
the fund's current Prospectus, dated December 31, 2000. A copy of the Prospectus
may be obtained by calling any PaineWebber Financial Advisor or correspondent
firm or by calling toll-free 1-800-647-1568. This SAI is dated December 31,
2000.
TABLE OF CONTENTS
Page
----
The Fund and Its Investment Policies...................................... 2
The Fund's Investments, Related Risks and Limitations..................... 2
Strategies Using Derivative Instruments................................... 17
Organization of the Corporation; Board Members and Officers; Principal
Holders and Management Ownership of Securities........................... 25
Investment Advisory, Administration and Distribution Arrangements......... 31
Portfolio Transactions.................................................... 36
Reduced Sales Charges, Additional Exchange and Redemption
Information and Other Services .......................................... 38
Conversion of Class B Shares.............................................. 43
Valuation of Shares....................................................... 44
Performance Information................................................... 44
Taxes..................................................................... 47
Other Information......................................................... 50
Financial Statements...................................................... 51
Appendix ................................................................. A-1
<PAGE>
THE FUND AND ITS INVESTMENT POLICIES
The fund's investment objective may not be changed without shareholder
approval. Except where noted, the other investment policies of the fund may be
changed by its board without shareholder approval. As with other mutual funds,
there is no assurance that the fund will achieve its investment objective.
The fund's investment objective is high total return with low volatility.
The fund invests primarily in a combination of three asset classes: stocks
(equity securities), bonds (investment grade bonds) and cash (money market
instruments) and maintains a fixed income allocation (including bonds and cash)
of at least 25%.
For its stock investments, the fund seeks to replicate (before fees and
expenses) the total return of the Standard & Poor's Composite Stock Price Index.
For its bond investments, the fund seeks to replicate (before fees and expenses)
the total return of the Lehman Brothers Aggregate Bond Index. To the extent
necessary to track the performances of these benchmark indices, the 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 market. The fund
also may invest up to 10% of its assets in bonds and other securities (including
convertible securities) rated below investment grade but rated at least B by
Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's, a division of
The McGraw-Hill Companies, Inc. ("S&P"), comparably rated by another rating
agency or, if unrated, determined by Mitchell Hutchins to be of comparable
quality. The fund's bond investments may include zero coupon bonds and other
original issue discount securities.
The 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) having total assets at the time of purchase in excess of $1.5
billion; commercial paper and other short-term corporate obligations; variable
and floating rate securities and repurchase agreements; participation interests
in these money market instruments; and the securities of other investment
companies that invest exclusively in money market instruments. The fund may also
hold cash.
The commercial paper and other short-term corporate obligations purchased
by the fund will consist only of obligations of U.S. corporations that are (1)
rated at least Prime-2 by Moody's or A-2 by S&P, (2) comparably rated by another
rating agency or (3) unrated and determined by Mitchell Hutchins to be of
comparable quality. These obligations may include variable amount master demand
notes, which are unsecured obligations redeemable upon notice that permit
investment of fluctuating amounts at varying rates of interest pursuant to
direct arrangements with the issuer of the instrument. Such obligations are
usually unrated by a rating agency.
The fund may invest up to 10% of its net assets in illiquid securities.
The fund may purchase securities on a when-issued or delayed delivery basis. The
fund may lend its portfolio securities to qualified broker-dealers or
institutional investors in an amount up to 33 1/3% of its total assets. The fund
may borrow from banks or through reverse repurchase agreements for temporary or
emergency purposes, but not in excess of 10% of its total assets. The costs
associated with borrowing may reduce the fund's net income. The fund may invest
in the securities of other investment companies and may sell short "against the
box."
THE FUND'S INVESTMENTS, RELATED RISKS AND LIMITATIONS
The following supplements the information contained in the Prospectus and
above concerning the fund's investments, related risks and limitations. Except
as otherwise indicated in the Prospectus or SAI, the fund has established no
policy limitations on its ability to use the investments or techniques discussed
in these documents.
EQUITY SECURITIES. Equity securities include common stocks, most preferred
stocks and securities that are convertible into them, including common stock
purchase warrants and rights, equity interests in trusts, partnerships, joint
ventures or similar enterprises and depository receipts. Common stocks, the most
familiar type, represent an equity (ownership) interest in a corporation.
2
<PAGE>
Preferred stock has certain fixed income features, like a bond, but is
actually equity that is senior to a company's common stock. Convertible bonds
may include debentures and notes 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. Some preferred stock
also may be converted into or exchanged for common stock. Depositary receipts
typically are issued by banks or trust companies and evidence ownership of
underlying 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. While this is possible with
bonds, it is less likely.
BONDS are fixed or variable rate debt obligations, including bills, notes,
debentures, money market instruments and similar instruments and securities.
Mortgage- and asset-backed securities are types of bonds, and certain types of
income-producing, non-convertible preferred stocks may be treated as bonds for
investment purposes. Bonds generally are used by corporations and governments to
borrow money from investors. The issuer pays the investor a fixed or variable
rate of interest and normally must repay the amount borrowed on or before
maturity. Many preferred stocks and some bonds are "perpetual" in that they have
no maturity date.
Bonds are subject to interest rate risk and credit risk. Interest rate
risk is the risk that interest rates will rise and that, as a result, bond
prices will fall, lowering the value of a fund's investments in bonds. In
general, bonds having longer durations are more sensitive to interest rate
changes than are bonds with shorter durations. Credit risk is the risk that an
issuer may be unable or unwilling to pay interest and/or principal on the bond.
Credit risk can be affected by many factors, including adverse changes in the
issuer's own financial condition or in economic conditions.
CREDIT RATINGS; NON-INVESTMENT GRADE BONDS. Moody's, S&P, and other rating
agencies are private services that provide ratings of the credit quality of
bonds and certain other securities. The fund may use these ratings in
determining whether to buy, sell or hold a security. A description of the
ratings assigned to corporate bonds by Moody's and S&P is included in the
Appendix to this SAI. The process by which Moody's and S&P determine ratings for
mortgage-backed securities includes consideration of the likelihood of the
receipt by security holders of all distributions, the nature of the underlying
assets, the credit quality of the guarantor, if any, and the structural, legal
and tax aspects associated with these securities. Not even the highest such
rating represents an assessment of the likelihood that principal prepayments
will be made by obligors on the underlying assets or the degree to which such
prepayments may differ from that originally anticipated, nor do such ratings
address the possibility that investors may suffer a lower than anticipated yield
or that investors in such securities may fail to recoup fully their initial
investment due to prepayments.
Credit ratings attempt to evaluate the safety of principal and interest
payments, but they do not evaluate the volatility of a bond's value or its
liquidity and do not guarantee the performance of the issuer. Rating agencies
may fail to make timely changes in credit ratings in response to subsequent
events, so that an issuer's current financial condition may be better or worse
than the rating indicates. There is a risk that rating agencies may downgrade a
bond's rating. Subsequent to a bond's purchase by the fund, it may cease to be
rated or its rating may be reduced below the minimum rating required for
purchase by the fund. It should be emphasized that ratings are general and are
not absolute standards of quality. Consequently, bonds with the same maturity,
interest rate and rating may have different market prices.
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 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
3
<PAGE>
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.
Investment grade bonds are rated in one of the four highest rating
categories by Moody's or S&P, comparably rated by another rating agency or, if
unrated, determined by Mitchell Hutchins to be of comparable quality. Moody's
considers bonds rated Baa (its lowest investment grade rating) to have
speculative characteristics. This means that changes in economic conditions or
other circumstances are more likely to lead to a weakened capacity to make
principal and interest payments than is the case for higher rated debt
securities. Bonds rated D by S&P are in payment default or such rating is
assigned upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized. Bonds rated C by Moody's
are in the lowest rated class and can be regarded as having extremely poor
prospects of attaining any real investment standing. References to rated bonds
in the Prospectus or this SAI include bonds that are not rated by a rating
agency but that Mitchell Hutchins determines to be of comparable quality.
Non-investment grade bonds (commonly known as "junk bonds" and sometimes
referred to as "high yield bonds") are rated Ba or lower by Moody's, BB or lower
by S&P, comparably rated by another rating agency or, if unrated, determined by
Mitchell Hutchins to be of comparable quality. The fund's investments in
non-investment grade bonds entail greater risk than its investments in higher
rated bonds. Non-investment grade bonds, which are sometimes referred to as
"high yield bonds," are considered predominantly speculative with respect to the
issuer's ability to pay interest and repay principal and may involve significant
risk exposure to adverse conditions. Non-investment grade bonds generally offer
a higher current yield than that available for investment grade issues; however,
they involve greater risks, in that they are especially sensitive 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 that 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 by collateral and will not receive
payment until more senior claims are paid in full.
The market for non-investment grade bonds has expanded rapidly in recent
years, which has been a period of generally expanding growth and lower
inflation. These securities will be susceptible to greater risk when economic
growth slows or reverses and when inflation increases or deflation occurs. In
the past, many lower rated bonds experienced substantial price declines
reflecting an expectation that many issuers of such securities might experience
financial difficulties. As a result, the yields on lower rated bonds rose
dramatically. However, those higher yields did not reflect the value of the
income stream that holders of such securities expected. Rather, they reflected
the risk that holders of such securities could lose a substantial portion of
their value due to the issuers' financial restructurings or defaults by the
issuers. There can be no assurance that those declines will not recur.
The market for non-investment grade bonds generally is thinner and less
active than that for higher quality securities, which may limit the fund's
ability to sell such securities at fair value in response to changes in the
economy or financial markets. Adverse publicity and investor perceptions,
whether or not based on fundamental analysis, may also decrease the values and
liquidity of non-investment grade bonds, especially in a thinly traded market.
U.S. GOVERNMENT SECURITIES. U.S. government securities include direct
obligations of the U.S. Treasury (such as Treasury bills, notes or bonds) and
obligations issued or guaranteed as to principal and interest (but not as to
market value) by the U.S. government, its agencies or its instrumentalities.
U.S. government securities include mortgage-backed securities issued or
guaranteed by government agencies or government-sponsored enterprises. Other
U.S. government securities may be backed by the full faith and credit of the
U.S. government or supported primarily or solely by the creditworthiness of the
government-related issuer or, in the case of mortgage-backed securities, by
pools of assets.
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U.S. government securities also include separately traded principal and
interest components of securities issued or guaranteed by the U.S. Treasury,
which are traded independently under the Separate Trading of Registered Interest
and Principal of Securities ("STRIPS") program. Under the STRIPS programs, the
principal and interest components are individually numbered and separately
issued by the U.S. Treasury.
Treasury inflation-protected securities ("TIPS") (also known as
"inflation-indexed securities") are Treasury bonds on which the principal value
is adjusted daily in accordance with changes in the Consumer Price Index.
Interest on TIPS is payable semi-annually on the adjusted principal value. The
principal value of TIPS would decline during periods of deflation, but the
principal amount payable at maturity would not be less than the original par
amount. If inflation is lower than expected while the fund holds TIPS, the fund
may earn less on the TIPS than it would on conventional Treasury bonds. Any
increase in the principal value of TIPS is taxable in the year the increase
occurs, even though holders do not receive cash representing the increase at
that time. See "Taxes--Other Information," below.
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 sales
contracts, other installment sales 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. See "The Fund's Investments, Related Risks and Limitations --
Mortgage-Backed Securities -- Types of Credit Enhancements.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent direct or
indirect interests in pools of underlying mortgage loans that are secured by
real property. The U.S. government mortgage-backed securities in which the fund
may invest include mortgage-backed securities issued or guaranteed as to the
payment of principal and interest (but not as to market value) by Ginnie Mae
(also known as the Government National Mortgage Association), Fannie Mae (also
known as the Federal National Mortgage Association), Freddie Mac (also known as
the Federal Home Loan Mortgage Corporation) or other government sponsored
enterprises. Other domestic mortgage-backed securities are sponsored or issued
by private entities, generally originators of and investors in mortgage loans,
including savings associations, mortgage bankers, commercial banks, investment
bankers and special purposes 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. Foreign mortgage-backed
securities may be issued by mortgage banks and other private or governmental
entities outside the United States and are supported by interests in foreign
real estate.
Mortgage-backed securities may be composed of one or more classes and may
be structured either as pass-through securities or collateralized debt
obligations. Multiple-class mortgage-backed securities are referred to herein 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 risk and evaluating them requires special knowledge.
A major difference between mortgage-backed securities and traditional
bonds is that interest and principal payments are made more frequently (usually
monthly) and that principal may be repaid at any time because the underlying
mortgage loans may be prepaid at any time. When interest rates go down and
homeowners refinance their mortgages, mortgage-backed securities may be paid off
more quickly than investors expect. When interest rates rise, mortgage-backed
securities 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.
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Mortgage-backed securities also may decrease in value as a result of
increases in interest rates and, because of prepayments, may benefit less than
other bonds from declining interest rates. Reinvestments of prepayments may
occur at lower interest rates than the original investment, thus adversely
affecting a 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. Prepayments at a slower rate than expected may lengthen the
effective life of a mortgage-backed security. The value of securities with
longer effective lives generally fluctuates more widely in response to changes
in interest rates than the value of securities with shorter effective lives.
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.
The market for privately issued mortgage-backed securities is smaller and
less liquid than the market for U.S. government mortgage-backed securities.
Foreign mortgage-backed securities markets are substantially smaller than U.S.
markets but have been established in several countries, including Germany,
Denmark, Sweden, Canada and Australia, and may be developed elsewhere. Foreign
mortgage-backed securities generally are structured differently than domestic
mortgage-backed securities, but they normally present substantially similar
investment risks as well as the other risks normally associated with foreign
securities.
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, 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 its portfolio, taken as a whole, is
consistent with its investment objective. Management of portfolio duration is an
important part of this. However, computing the duration of mortgage-backed
securities is complex. See, "The Fund's Investments, Related Risks and
Limitations -- Duration." If Mitchell Hutchins does not compute the duration of
mortgage-backed securities correctly, the value of the fund's portfolio may be
either more or less sensitive to changes in market interest rates than intended.
In addition, 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.
More information concerning these mortgage-backed securities and the
related risks of investments therein is set forth below. New types of
mortgage-backed securities are developed and marketed from time to time and,
consistent with its investment limitations, the fund expects to invest in those
new types of mortgage-backed securities that Mitchell Hutchins believe may
assist the fund in achieving its investment objective. Similarly, the
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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 certificate holders such as the 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 interest and principal
payments made and owed on the underlying pools. Fannie Mae guarantees timely
payment of interest and principal on Fannie Mae certificates. The Fannie Mae
guarantee is not backed by the full faith and credit of the U.S. government.
FREDDIE MAC CERTIFICATES -- Freddie Mac also facilitates a national
secondary market for conventional residential and U.S. government-insured
mortgage loans through its mortgage purchase and mortgage-backed securities
sales activities. Freddie Mac issues two types of mortgage pass-through
securities: mortgage participation certificates ("PCs") and guaranteed mortgage
certificates ("GMCs"). Each PC represents a pro rata share of all interest and
principal payments made and owed on the underlying pool. Freddie Mac generally
guarantees timely monthly payment of interest on PCs and the ultimate payment of
principal, but it also has a PC program under which it guarantees timely payment
of both principal and interest. GMCs also represent a pro rata interest in a
pool of mortgages. These instruments, however, pay interest semi-annually and
return principal once a year in guaranteed minimum payments. The Freddie Mac
guarantee is not backed by the full faith and credit of the U.S. government.
PRIVATE MORTGAGE-BACKED SECURITIES -- Mortgage-backed securities issued by
Private Mortgage Lenders are structured similarly to CMOs issued or guaranteed
by Ginnie Mae, Fannie Mae and Freddie Mac. Such mortgage-backed securities may
be supported by pools of U.S. government or agency insured or guaranteed
mortgage loans or by other mortgage-backed securities issued by a government
agency or instrumentality, but they generally are supported by pools of
conventional (i.e., non-government guaranteed or insured) mortgage loans. Since
such mortgage-backed securities normally are not guaranteed by an entity having
the credit standing of Ginnie Mae, Fannie Mae and Freddie Mac, they normally are
structured with one or more types of credit enhancement. See "The Fund's
Investments, Related Risks and Limitations -- Mortgage-Backed Securities --
Types of Credit Enhancement." These credit enhancements do not protect investors
from changes in market value.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS MORTGAGE PASS-THROUGHS
-- CMOs are debt obligations that are collateralized by mortgage loans or
mortgage pass-through securities (collectively, "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 the debt service on the
CMOs or to make scheduled distributions on the multi-class mortgage pass-through
securities.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMO, also referred to as a "tranche," is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the Mortgage Assets may cause CMOs to be retired
substantially earlier than their
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stated maturities or final distribution dates. Interest is paid or accrued on
all classes of a CMO (other than any PO class) on a monthly, quarterly or
semi-annual 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 class, 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) loss protection. Loss protection
relates to 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. Loss protection 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. The fund will not pay any additional fees for such credit
enhancement, although the existence of credit enhancement may increase the price
of a security. Credit enhancements do not provide protection against changes in
the market value of the security. Examples of credit enhancement arising out of
the structure of the transaction include "senior-subordinated securities"
(multiple class securities with one or more classes subordinate to other classes
as to the payment of principal thereof and interest thereon, with the result
that defaults on the underlying assets are borne first by the holders of the
subordinated class), creation of "spread accounts" or "reserve funds" (where
cash or investments, sometimes funded from a portion of the payments on the
underlying assets, are held in reserve against future losses) and
"over-collateralization" (where the scheduled payments on, or the principal
amount of, the underlying assets exceed that required to make payment of the
securities and pay any servicing or other fees). The degree of credit
enhancement provided for each issue generally is based on historical information
regarding the level of credit risk associated with the underlying assets.
Delinquency or loss in excess of that anticipated could adversely affect the
return on an investment in such a security.
SPECIAL CHARACTERISTICS OF MORTGAGE- AND ASSET-BACKED SECURITIES -- The
yield characteristics of mortgage- and asset-backed securities differ from those
of traditiona1 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.
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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 was 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-related 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. Reinvestment of prepayments may
occur at lower interest rates than the original investment, thus adversely
affecting a fund's yield.
ADJUSTABLE RATE MORTGAGE AND FLOATING RATE MORTGAGE-BACKED SECURITIES --
Adjustable rate mortgage ("ARM") securities are mortgage-backed securities
(sometimes referred to as ARMs) 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. 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. ARMs represent a right to receive interest payments at a
rate that is adjusted to reflect the interest earned on a pool of ARM loans.
These mortgage loans 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 ARM loans specify
limitations on the maximum amount by which the mortgage interest rate may adjust
for any single adjustment period. These mortgage loans also may limit changes in
the maximum amount by which the borrower's monthly payment may adjust for any
single adjustment period. If a monthly payment is not sufficient to pay the
interest accruing on the ARM, any such excess interest is
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added to the mortgage loan ("negative amortization"), which is repaid through
future 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
loan. Borrowers under these mortgage loans experiencing negative amortization
may take longer to build up their equity in the underlying property and may be
more likely to default.
ARM loans 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 these mortgage loans 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 ARM loans might decrease. The rate of
prepayments with respect to ARM loans has fluctuated in recent years.
The rates of interest payable on certain ARM loans, and therefore on
certain ARM 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 securities supported by ARM loans 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
securities still tend to be less sensitive to interest rate fluctuations than
fixed-rate securities.
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. As with ARM
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 bond on a
present value basis. Duration incorporates the bond's yield, coupon interest
payments, final maturity and call features into one measures and is one of the
fundamental tools used by Mitchell Hutchins in portfolio selection and yield
curve positioning of the fund's investments in debt securities. Duration was
developed as a more precise alternative to the concept "term to maturity."
Traditionally, a debt security's "term to maturity" has been used as a proxy for
the sensitivity of the security's price to changes in interest rates (which is
the "interest rate risk" or "volatility" of the security). However, "term to
maturity" measures only the time until the scheduled a final payment on the
bond, taking no account of the pattern of payments prior to maturity.
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 debt security, expected to be made, and weights them by the
present values of the cash to be received at each future point in time. For any
debt security with interest payments occurring prior to the payment of
principal, duration is always less than maturity. For example, depending on 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 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 the
fund's portfolio of debt securities. For example, when the level of interest
rates increases by 1%, a debt 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 of bonds 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
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interest rates than indicated in the above example. 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. Accordingly, the net asset value of a fund's portfolio of
bonds may vary in relation to interest rates by a greater or lesser percentage
than indicated by 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 will lengthen portfolio duration
by approximately the same amount as would holding an equivalent amount of the
underlying securities. Short futures or put options have durations roughly equal
to the negative duration of the securities that underlie these positions, and
have the effect of 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.
INVESTING IN FOREIGN SECURITIES. The 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 market. Securities of foreign issuers
may not be registered with the Securities and Exchange Commission ("SEC"), and
the issuers thereof may not be subject to its reporting requirements.
Accordingly, there may be less publicly available information concerning foreign
issuers of securities held by the fund than is available concerning U.S.
companies. Foreign companies are not generally subject to uniform accounting,
auditing and financial reporting standards or to other regulatory requirements
comparable to those applicable to U.S. companies.
The fund may invest in foreign securities by purchasing American
Depositary Receipts ("ADRs"). ADRs are receipts typically issued by a U.S. bank
or trust company evidencing ownership of the underlying securities. They
generally are in registered form, are denominated in U.S. dollars and are
designed for use in the U.S. securities markets. For purposes of the fund's
investment policies, ADRs generally are deemed to have the same classification
as the underlying securities they represent. Thus, an ADR representing ownership
of common stock will be treated as common stock.
ADRs are publicly traded on exchanges or over-the-counter 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 and gains on certain foreign securities in which the
fund 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 certain foreign countries, however, may reduce or eliminate the amount of
foreign taxes to which the fund would be subject.
ZERO COUPON AND OTHER OID SECURITIES. Zero coupon securities are
securities on which no periodic interest payments are made but instead are sold
at a deep discount from their face value. The buyer of these securities receives
a rate of return by the gradual appreciation of the security, which results from
the fact that it will be paid at face value on a specified maturity date. There
are many types of zero coupon securities. Some are issued in zero coupon form,
including Treasury bills, notes and bonds that have been stripped of (separated
from) their unmatured interest coupons (unmatured interest payments) and
receipts or certificates representing interests in
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such stripped debt obligations and coupons. Others are created by brokerage
firms that strip the coupons from interest-paying bonds and sell the principal
and the coupons separately.
Other securities are sold with original issue discount ("OID") (i.e., the
difference between the issue price and the value at maturity) may provide for
some interest to be paid make prior to maturity. OID securities usually trade at
a discount from their face value.
Zero coupon securities are generally more sensitive to changes in interest
rates than debt obligations of comparable maturities that make current interest
payments. This means that when interest rates fall, the value of zero coupon
securities rises more rapidly than securities paying interest on a current
basis. However, when interest rates rise, their value falls more dramatically.
Other OID securities also are subject to greater fluctuations in market value in
response to changing interest rates than bonds of comparable maturities that
make current distributions of interest in cash.
Federal tax law requires that a fund that holds a zero coupon security or
other OID security include in gross income each year the OID that accrues on the
security for the year, even though the fund receives no interest payment on the
security during the year. These distributions would have to be made from the
fund's cash assets or, if necessary, from the proceeds of sales of portfolio
securities. The fund would not be able to purchase additional securities with
cash used to make such distributions and its current income and the value of its
shares would ultimately be reduced as a result.
Certain zero coupon securities are U.S. Treasury notes and bonds that have
been stripped of their unmatured interest coupon receipts or interests in such
U.S. Treasury securities or coupons. This technique is frequently used with U.S.
Treasury bonds to create CATS (Certificate of Accrual Treasury Securities),
TIGRs (Treasury Income Growth Receipts) and similar securities.
CONVERTIBLE SECURITIES. A convertible security is a bond, 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 or dividends until the convertible security
matures or is redeemed, converted or exchanged. 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. While
no securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock. However,
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.
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 the 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.
WARRANTS. Warrants are securities permitting, but not obligating, holders
to subscribe for other securities. Warrants do not carry with them the right to
dividends or voting rights with respect to the securities that they entitle
their holder to purchase, and they do not represent any rights in the assets of
the issuer. As a result, warrants may be considered more speculative than
certain other types of investments. In addition, the value of a warrant does not
necessarily change with the value of the underlying securities, and a warrant
ceases to have value if it is not exercised prior to its expiration date.
TEMPORARY AND DEFENSIVE INVESTMENTS; MONEY MARKET INVESTMENTS. The fund
may invest in money market investments for temporary or defensive purposes to
reinvest cash collateral from its securities lending activities or as part of
its normal investment program. Such investments
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include, among other things, (1) securities issued or guaranteed by the U.S.
government or one of its agencies or instrumentalities, (2) debt obligations of
banks, savings and loan institutions, insurance companies and mortgage bankers,
(3) commercial paper and notes, including those with variable and floating rates
of interest, (4) debt obligations of foreign branches of U.S. banks, U.S.
branches of foreign banks, and foreign branches of foreign banks, (5) debt
obligations issued or guaranteed by one or more foreign governments or any of
their foreign political subdivisions, agencies or instrumentalities, including
obligations of supranational entities, (6) bonds issued by foreign issuers, (7)
repurchase agreements and (8) securities of other investment companies that
invest exclusively in money market instruments and similar private investment
vehicles.
INVESTMENTS IN OTHER INVESTMENT COMPANIES. The fund may invest in
securities of other investment companies, subject to limitations imposed by the
Investment Company Act of 1940, as amended ("Investment Company Act"). Among
other things, these limitations currently restrict the fund's aggregate
investments in other investment companies to no more than 10% of its total
assets. The fund's investment in certain private investment vehicles are not
subject to this restriction. The shares of other investment companies are
subject to the management fees and other expenses of those companies, and the
purchase of shares of some investment companies requires the payment of sales
loads and (in the case of closed-end investment companies) sometime substantial
premiums above the value of such companies' portfolio securities. At the same
time, the fund would continue to pay its own management fees and expenses with
respect to all its investments, including shares of other investment companies.
The fund may invest in the shares of other investment companies when, in the
judgement of Mitchell Hutchins, the potential benefits of the investment
outweigh the payment of any management fees and expenses and, where appplicable,
premium or sales load.
ILLIQUID SECURITIES. The term "illiquid securities" 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 options, repurchase
agreements maturing in more than seven days and restricted securities other than
those Mitchell Hutchins has determined are liquid pursuant to guidelines
established by the board. The assets used as cover for over-the-counter options
written by the fund will be considered illiquid unless the over-the-counter
options are sold to qualified dealers who agree that the fund may repurchase any
over-the-counter options it writes at a maximum price to be calculated by a
formula set forth in the option agreements. The cover for an over-the-counter
option written subject to this procedure would be considered illiquid only to
the extent that the maximum repurchase price under the formula exceeds the
intrinsic value of the option. Under current SEC guidelines, interest-only and
principal-only classes of mortgage-backed securities generally are considered
illiquid. However, interest only and principal only 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.
The fund may not be able to readily liquidate its investments in illiquid
securities and may have to sell other investments if necessary to raise cash to
meet its obligations. The lack of a liquid secondary market for illiquid
securities may make it more difficult for the fund to assign a value to those
securities for purposes of valuing its portfolio and calculating its net asset
value.
Restricted securities are not registered under the Securities Act of 1933,
as amended ("Securities Act"), and may be sold only in privately negotiated or
other exempted transactions or after a Securities Act registration statement has
become effective. Where registration is required, the fund may be obligated to
pay all or part of the registration expenses and a considerable period may
elapse between the time of the decision to sell and the time the fund may be
permitted to sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop, the fund might
obtain a less favorable price than prevailed when it decided to sell.
Not all restricted securities are illiquid. A large institutional market
has developed for many U.S. and foreign securities that are not registered under
the Securities 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.
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Institutional markets for restricted securities also have developed as a
result of Rule 144A under the Securities Act, which establishes a "safe harbor"
from the registration requirements of the Securities Act for resales of certain
securities to qualified institutional buyers. Such markets include automated
systems for the trading, clearance and settlement of unregistered securities of
domestic and foreign issuers, such as the PORTAL System sponsored by the
National Association of Securities Dealers, Inc. An insufficient number of
qualified institutional buyers interested in purchasing Rule 144A-eligible
restricted securities held by the fund, however, could affect adversely the
marketability of such portfolio securities, and the fund might be unable to
dispose of them promptly or at favorable prices.
The 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 bids 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 board.
Mitchell Hutchins also monitors the fund's overall holdings of illiquid
securities. If the fund's holdings of illiquid securities exceed its limitation
on investments in illiquid securities for any reason (such as a particular
security becoming illiquid, changes in the relative market values of liquid and
illiquid portfolio securities or shareholder redemptions), Mitchell Hutchins
will consider what action would be in the best interests of the fund and its
shareholders. Such action may include engaging in an orderly disposition of
securities to reduce the fund's holdings of illiquid securities. However, the
fund is not required to dispose of illiquid securities under these
circumstances.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which the
fund purchases securities or other obligations from a bank or securities dealer
(or its affiliate) and simultaneously commits to resell them to the counterparty
at an agreed-upon date or upon demand and at a price reflecting a market rate of
interest unrelated to the coupon rate or maturity of the purchased obligations.
The fund maintains custody of the underlying obligations prior to their
repurchase, either through its regular custodian or through a special
"tri-party" custodian or sub-custodian that maintains separate accounts for both
the fund and its counterparty. Thus, the obligation of the counterparty to pay
the repurchase price on the date agreed to or upon demand is, in effect, secured
by such obligations.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including a possible decline in the market value of
the underlying obligations. If their value becomes less than the repurchase
price, plus any agreed-upon additional amount, the counterparty must provide
additional collateral so that at all times the collateral is at least equal to
the repurchase price plus any agreed-upon additional amount. The difference
between the total amount to be received upon repurchase of the obligations and
the price that was paid by a fund upon acquisition is accrued as interest and
included in its net investment income. Repurchase agreements involving
obligations other than U.S. government securities (such as commercial paper and
corporate bonds) may be subject to special risks and may not have the benefit of
certain protections in the event of the counterparty's insolvency. If the seller
or guarantor becomes insolvent, the fund may suffer delays, costs and possible
losses in connection with the disposition of collateral. The fund intends to
enter into repurchase agreements only in transactions with counterparties
believed by Mitchell Hutchins to present minimum credit risks.
REVERSE REPURCHASE AGREEMENTS. Reverse repurchase 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. Reverse repurchase agreements are subject to the fund's
limitation on borrowings and may be entered into only with banks or securities
dealers or their affiliates. While a reverse repurchase agreement is
outstanding, the fund will maintain, in a segregated account with its custodian,
cash or liquid securities, marked to market daily, in an amount at least equal
to its obligations under the reverse repurchase agreement. See "The Fund's
Investments, Related Risks and Limitations -- Segregated Accounts."
Reverse repurchase agreements involve the risk that the buyer of the
securities sold by the fund might be unable to deliver them when the fund seeks
to repurchase. If the buyer of securities under a reverse repurchase agreement
files for bankruptcy or becomes insolvent, the buyer or trustee or receiver may
receive an extension of
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time to determine whether to enforce the fund's obligation to repurchase the
securities, and the fund's use of the proceeds of the reverse repurchase
agreement may effectively be restricted pending such decision.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The fund may purchase
securities on a "when-issued" basis or may purchase or sell securities for
delayed delivery, i.e. , for issuance or delivery to the fund later than the
normal settlement date for such securities at a stated price and yield. When
issued securities include TBA ("to be announced") securities. TBA securities,
which are usually mortgage-backed securities, are purchased on a forward
commitment basis with an approximate principal amount and no defined maturity
date. The actual principal amount and maturity date are determined upon
settlement when the specific mortgage pools are assigned. The fund generally
would not pay for such securities or start earning interest on them until they
are received. However, when the fund undertakes a when-issued or
delayed-delivery obligation, it immediately assumes the risks of ownership,
including the risks of price fluctuation. Failure of the issuer to deliver a
security purchased by the fund on a when-issued or delayed-delivery basis may
result in the fund's incurring or missing an opportunity to make an alternative
investment. Depending on market conditions, the fund's when-issued and
delayed-delivery purchase commitments could cause its net asset value per share
to be more volatile, because such securities may increase the amount by which
the fund's total assets, including the value of when-issued and delayed-delivery
securities held by that fund, exceeds its net assets.
A security purchased on a when-issued or delayed delivery basis is
recorded as an asset on the commitment date and is subject to changes in market
value, generally based upon changes in the level of interest rates. Thus,
fluctuation in the value of the security from the time of the commitment date
will affect the fund's net asset value. When the 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 "The Fund's Investments,
Related Risks and Limitations -- Segregated Accounts." The fund's when-issued
and delayed delivery purchase commitments could cause its net asset value per
share to be more volatile. The fund 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.
LENDING OF PORTFOLIO SECURITIES. The fund is authorized to lend its
portfolio securities to broker-dealers or institutional investors that Mitchell
Hutchins deems qualified. Lending securities enables the fund to earn additional
income but could result in a loss or delay in recovering these securities. The
borrower of a fund's portfolio securities must maintain acceptable collateral
with the fund's custodian in an amount, marked to market daily, at least equal
to the market value of the securities loaned, plus accrued interest and
dividends. Acceptable collateral is limited to cash, U.S. government securities
and irrevocable letters of credit that meet certain guidelines established by
Mitchell Hutchins. The fund may reinvest any cash collateral in money market
investments or other short-term liquid investments, including other investment
companies. The fund also may reinvest cash collateral in private investment
vehicles similar to money market funds, including one managed by Mitchell
Hutchins. In determining whether to lend securities to a particular
broker-dealer or institutional investor, Mitchell Hutchins will consider, and
during the period of the loan will monitor, all relevant facts and
circumstances, including the creditworthiness of the borrower. The fund will
retain authority to terminate any of its loans at any time. The fund may pay
reasonable fees in connection with a loan and may pay the borrower or placing
broker a negotiated portion of the interest earned on the reinvestment of cash
held as collateral. The fund will receive amounts equivalent to any dividends,
interest or other distributions on the securities loaned. The fund will regain
record ownership of loaned securities to exercise beneficial rights, such as
voting and subscription rights, when regaining such rights is considered to be
in the fund's interest.
Pursuant to procedures adopted by the boards governing the fund's
securities lending program, PaineWebber has been retained to serve as lending
agent for the 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. The board periodically reviews all portfolio securities loan
transactions for which PaineWebber acted as lending agent. PaineWebber also has
been approved as a borrower under the fund's securities lending program.
SHORT SALES "AGAINST THE BOX." Short sales of securities the fund owns or
has the right to acquire at no added cost through conversion or exchange of
other securities it owns are known as 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
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behalf of the fund, and the fund is obligated to replace the securities borrowed
at a date in the future. When the 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, in a segregated account with its
custodian, 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."
The fund might make a short sale "against the box" 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.
SEGREGATED ACCOUNTS. When the 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, 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 below under "Strategies Using Derivative
Instruments," segregated accounts may also be required in connection with
certain transactions involving options, futures or swaps.
INVESTMENT LIMITATIONS OF THE FUND
FUNDAMENTAL LIMITATIONS. The following investment limitations cannot be
changed for the fund without the affirmative vote of the lesser of (a) more than
50% of its outstanding shares or (b) 67% or more of the shares present at a
shareholders' meeting if more than 50% of its outstanding shares are represented
at the meeting in person or by proxy. If a percentage restriction is adhered to
at the time of an investment or transaction, a later increase or decrease in
percentage resulting from changing values of portfolio securities or amount of
total assets will not be considered a violation of any of the following
limitations.
The 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 and then not in excess of 33 1/3% of the fund's total
assets (including the amount of the senior securities issued but reduced by any
liabilities not constituting senior securities) at the time of the issuance or
borrowing, except that
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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
non-fundamental and may be changed by the vote of the board without shareholder
approval. If a percentage restriction is adhered to at the time of an investment
or transaction, a later increase or decrease in percentage resulting from
changing values of portfolio securities or amount of total assets will not be
considered a violation of any of the following limitations.
The fund will not:
(1) invest more than 10% of its net assets in illiquid securities.
(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 Investment Company Act and except that this limitation
does not apply to securities received or acquired as dividends, through offers
of exchange, or as a result of reorganization, consolidation, or merger.
(5) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
STRATEGIES USING DERIVATIVE INSTRUMENTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS. Mitchell Hutchins may use a
variety of financial instruments ("Derivative Instruments"), including certain
options, futures contracts (sometimes referred to as "futures"), options on
futures contracts and swap transactions. The fund may enter into transactions
involving one or more types of Derivative Instruments under which the full value
of its portfolio is at risk. Under normal circumstances,
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however, the fund's use of these instruments will place at risk a much smaller
portion of its assets. The fund may use all of the instruments identified below.
The particular Derivative Instruments that may be used by the fund is described
below.
The fund might not use any Derivative Instruments or derivative
strategies, and there can be no assurance that using any strategy will succeed.
If Mitchell Hutchins is incorrect in its judgment on market values, interest
rates or other economic factors in using a Derivative Instrument or strategy,
the fund may have lower net income and a net loss on the investment.
OPTIONS ON EQUITY AND DEBT SECURITIES -- A call option is a short-term
contract pursuant to which the purchaser of the option, in return for a premium,
has the right to buy the security underlying the option at a specified price at
any time during the term of the option or at specified times or at the
expiration of the option, depending on the type of option involved. The writer
of the call option, who receives the premium, has the obligation, upon exercise
of the option during the option term, to deliver the underlying security against
payment of the exercise price. A put option is a similar contract that gives its
purchaser, in return for a premium, the right to sell the underlying security at
a specified price during the option term or at specified times or at the
expiration of the option, depending on the type of option involved. The writer
of the put option, who receives the premium, has the obligation, upon exercise
of the option during the option term, to buy the underlying security at the
exercise price.
OPTIONS ON SECURITIES INDICES -- A securities index assigns relative
values to the securities included in the index and fluctuates with changes in
the market values of those securities. A securities index option operates in the
same way as a more traditional securities option, except that exercise of a
securities index option is effected with cash payment and does not involve
delivery of securities. Thus, upon exercise of a securities index option, the
purchaser will realize, and the writer will pay, an amount based on the
difference between the exercise price and the closing price of the securities
index.
SECURITIES INDEX FUTURES CONTRACTS -- A securities index futures contract
is a bilateral agreement pursuant to which one party agrees to accept, and the
other party agrees to make, delivery of an amount of cash equal to a specified
dollar amount times the difference between the securities index value at the
close of trading of the contract and the price at which the futures contract is
originally struck. No physical delivery of the securities comprising the index
is made. Generally, contracts are closed out prior to the expiration date of the
contract.
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 bonds, 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 or currency, 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 or currency, 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 that
represents the amount by which the market price of the futures contract exceeds,
in the case of a call, or is less than, in the case of a put, the exercise price
of the option on the future. The writer of an option, upon exercise, will assume
a short position in the case of a call and a long position in the case of a put.
GENERAL DESCRIPTION OF STRATEGIES USING DERIVATIVE INSTRUMENTS. The fund
may use Derivative Instruments to attempt to hedge its portfolio and also to
attempt to enhance income or return or realize gains and to manage the duration
of its bond portfolio. In addition, the fund may use Derivative Instruments to
adjust its exposure to different asset classes or to maintain exposure to stocks
or bonds while maintaining a cash balance for
18
<PAGE>
fund management purposes (such as to provide liquidity to meet anticipated
shareholder sales of fund shares and for fund operating expenses). The fund also
may use Derivative Instruments to facilitate trading and to reduce transaction
costs.
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 the fund's portfolio. Thus, in a short hedge the 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, the
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 the 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, the 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, the 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.
The fund may purchase and write (sell) covered straddles on securities or
indices of securities. A long straddle is a combination of a call and a put
option purchased on the same security or on the same futures contract, where the
exercise price of the put is equal to the exercise price of the call. The fund
might enter into a long straddle when Mitchell Hutchins believes it likely that
the prices of the securities will be more volatile during the term of the option
than the option pricing implies. A short straddle is a combination of a call and
a put written on the same security where the exercise price of the put is equal
to the exercise price of the call. The fund might enter into a short straddle
when Mitchell Hutchins believes it unlikely that the prices of the securities
will be as volatile during the term of the option as the option pricing implies.
Derivative Instruments on securities generally are used to hedge against
price movements in one or more particular securities positions that a fund owns
or intends to acquire. Derivative Instruments on stock indices, in contrast,
generally are used to hedge against price movements in broad stock market
sectors in which the fund has invested or expects to invest. Derivative
Instruments on bonds may be used to hedge either individual securities or broad
fixed income market sectors.
Income strategies using Derivative Instruments may include the writing of
covered options to obtain the related option premiums. Return or gain strategies
may include using Derivative Instruments to increase or decrease the fund's
exposure to different asset classes without buying or selling the underlying
instruments. The fund also may use derivatives to simulate full investment by
the fund while maintaining a cash balance for fund management purposes (such as
to provide liquidity to meet anticipated shareholder sales of fund shares and
for fund operating expenses).
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 fund's
ability to use Derivative Instruments may be limited by tax considerations. See
"Taxes."
In addition to the products, strategies and risks described below and in
the Prospectus, Mitchell Hutchins may discover additional opportunities in
connection with Derivative Instruments and with hedging, income, return and gain
strategies. These new opportunities may become available as regulatory
authorities broaden the range of permitted transactions and as new Derivative
Instruments and techniques are developed. Mitchell Hutchins may
19
<PAGE>
use these opportunities for the fund to the extent that they are consistent with
the fund's investment objective and permitted by its investment limitations and
applicable regulatory authorities. The fund's Prospectus or this SAI 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 the ability
of Mitchell Hutchins to predict movements of the overall securities or 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 that are being hedged. For example, if the value of a Derivative
Instrument used in a short hedge increased by less than the decline in value of
the hedged investment, the hedge would not be fully successful. Such a lack of
correlation might occur due to factors affecting the markets in which Derivative
Instruments are traded, rather than the value of the investments being hedged.
The effectiveness of hedges using Derivative Instruments on indices will depend
on the degree of correlation between price movements in the index and price
movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable price movements in
the investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if the 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, the 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 the fund was
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 positions expired or matured. These requirements might impair the
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. The fund's ability to close out a
position in a Derivative Instrument prior to expiration or maturity depends on
the existence of a liquid secondary market or, in the absence of such a market,
the ability and willingness of a counterparty to enter into a transaction
closing out the position. Therefore, there is no assurance that any hedging
position can be closed out at a time and price that is favorable to the fund.
COVER FOR STRATEGIES USING DERIVATIVE INSTRUMENTS. Transactions using
Derivative Instruments, other than purchased options, expose the funds to an
obligation to another party. The fund will not enter into any such transactions
unless it owns either (1) an offsetting ("covered") position in securities or
other options or 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 fund will comply with SEC guidelines
regarding cover for such 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, committing a large por-
20
<PAGE>
tion of the fund's assets to cover positions or to segregated accounts could
impede portfolio management or the fund's ability to meet redemption requests or
other current obligations.
OPTIONS. The fund may purchase put and call options, and write (sell)
covered put or call options on securities in which it invests and related
indices. The purchase of call options may serve as a long hedge, and the
purchase of put options may serve as a short hedge. The fund may also use
options to attempt to enhance return or realize gains by increasing or reducing
its exposure to an asset class without purchasing or selling the underlying
securities. 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. 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. 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
security depreciates to a price lower than the exercise price of the put option,
it can be expected that the put option will be exercised and the fund will be
obligated to purchase the security at more than its market value. The securities
or other assets used as cover for over-the-counter options written by a fund
would be considered illiquid to the extent described under "The Fund's
Investments, Related Risks and Limitations-- 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, over-the-counter options on bonds are
European-style options. This means that the option can only be exercised
immediately prior to its expiration. This is in contract to American-style
options that may be exercised at any time. There are also other types of options
that may be exercised on certain specified dates before expiration. Options that
expire unexercised have no value.
The fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the 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, the 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 fund to realize profits or
limit losses on an option position prior to its exercise or expiration.
The fund may purchase and write both exchange-traded and over-the-counter
options. Currently, many options on equity securities (stocks) are
exchange-traded. Exchange markets for options on bonds exist but are relatively
new, and these instruments are primarily traded on the over-the-counter market.
Exchange-traded options in the United States are issued by a clearing
organization affiliated with the exchange on which the option is listed that, in
effect, guarantees completion of every exchange-traded option transaction. In
contrast, over-the-counter options are contracts between the fund and its
counterparty (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the fund purchases or writes an
over-the-counter option, it relies on the counterparty to make or take delivery
of the underlying investment upon exercise of the option. Failure by the
counterparty to do so would result in the loss of any premium paid by the fund
as well as the loss of any expected benefit of the transaction.
The fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The 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 a
market will exist at any particular time. Closing transactions can be made for
over-the-counter options only by negotiating directly with the counterparty, or
by a transaction in the secondary market if any such market exists. Although the
fund will enter into over-the-counter options only with counterparties that are
expected to be capable of entering into closing transactions with the fund,
there is no assurance that the fund will in fact be able to close out an
over-the-counter option position at a favorable price prior to expiration. In
the event of insolvency of the counterparty, the fund might be unable to close
out an over-the-counter option position at any time prior to its expiration.
21
<PAGE>
If the 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 put or call
option written by the 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 fund may purchase and write put and call options on indices in much
the same manner as the more traditional options discussed above, except the
index options may serve as a hedge against overall fluctuations in a securities
market (or market sector) rather than anticipated increases or decreases in the
value of a particular security.
LIMITATIONS ON THE USE OF OPTIONS. The fund's use of options is governed
by the following guidelines, which can be changed by its board without
shareholder vote:
(1) The 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 held by the fund, does not exceed 5% of its total assets.
(2) The aggregate value of securities underlying put options written by
the fund, determined as of the date the put options are written, will not exceed
50% of its net assets.
(3) The aggregate premiums paid on all options (including options on
securities and stock or bond indices and options on futures contracts) purchased
by the fund that are held at any time will not exceed 20% of its net assets.
FUTURES. The fund may purchase and sell securities index futures contracts
or interest rate futures contracts. The fund may purchase put and call options,
and write covered put and call options, on futures in which it is allowed to
invest. The purchase of futures or call options thereon can serve as a long
hedge, and the sale of futures or the purchase of put options thereon can serve
as a short hedge. Writing covered call options on futures contracts can serve as
a limited short hedge, and writing covered put options on futures contracts can
serve as a limited long hedge, using a strategy similar to that used for writing
covered options on securities or indices. In addition, the fund may purchase or
sell futures contracts or purchase options thereon to increase or reduce its
exposure to an asset class without purchasing or selling the underlying
securities, either as a hedge or to enhance return or realize gains.
Futures strategies also can be used to manage the average duration of the
fund's bond portfolio. If Mitchell Hutchins wishes to shorten the average
duration of the fund's bond portfolio, the fund may sell a 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 the fund's bond
portfolio, the fund may buy a futures contract or a call option thereon, or sell
a put option thereon.
The fund may also write put options on 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. The 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 the 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 cir-
22
<PAGE>
cumstances, such as periods of high volatility, the 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 the fund's obligations to or from a futures
broker. When the fund purchases an option on a futures contract, the premium
paid plus transaction costs is all that is at risk. In contrast, when the fund
purchases or sells a futures contract or writes a call option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the 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.
The fund intends to enter into futures transactions only on exchanges or boards
of trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If the fund were unable to liquidate a futures or related options position
due to the absence of a liquid secondary market or the imposition of price
limits, it could incur substantial losses. The fund would continue to be subject
to market risk with respect to the position. In addition, except in the case of
purchased options, the fund would continue to be required to make daily
variation margin payments and might be required to maintain the position being
hedged by the future or option or to maintain cash or securities in a segregated
account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options markets
are subject to daily variation margin calls and might be compelled to liquidate
futures or related options positions whose prices are moving unfavorably to
avoid being subject to further calls. These liquidations could increase price
volatility of the instruments and distort the normal price relationship between
the futures or options and the investments being hedged. Also, because initial
margin deposit requirements in the futures market are less onerous than margin
requirements in the securities markets, there might be increased participation
by speculators in the futures markets. This participation also might cause
temporary price distortions. In addition, activities of large traders in both
the futures and securities markets involving arbitrage, "program trading" and
other investment strategies might result in temporary price distortions.
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. The fund's use of
futures and related options is governed by the following guidelines, which can
be changed by its board without shareholder vote:
(1) The aggregate initial margin and premiums on futures contracts and
options on futures positions that are not for bona fide hedging purposes (as
defined by the CFTC), excluding the amount by which options are "in-the-money,"
may not exceed 5% of the fund's net assets.
(2) The aggregate premiums paid on all options (including options on
securities, foreign currencies and securities indices and options on futures
contracts) purchased by the fund that are held at any time will not exceed 20%
of its net assets.
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<PAGE>
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by the fund will not exceed 5% of its total assets.
SWAP TRANSACTIONS. The fund may enter into swap transactions, which
include swaps, caps, floors and collars relating to interest rates, securities
or other instruments. Interest rate swaps 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 a specified time
period. Equity swaps or other swaps relating to securities or other instruments
are also similar, but they are based on changes in the value of the underlying
securities or instruments. For example, an equity swap might involve an exchange
of the value of a particular security or securities index in a certain notional
amount for the value of another security or index or for the value of interest
on that notional amount at a specified fixed or variable rate.
The fund may enter into interest rate swap transactions to preserve a
return or spread on a particular investment or portion of its bond portfolio or
to protect against any increase in the price of securities it anticipates
purchasing at a later date. The fund may use interest rate swaps, caps, floors
and collars as a hedge on either an asset-based or liability-based basis,
depending on whether it is hedging its assets or its liabilities. Interest rate
swap transactions are subject to risks comparable to those described above with
respect to other derivatives strategies.
The fund will usually enter into 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. Since 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 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 "The Fund's
Investments, Related Risks and Restrictions -- Segregated Accounts." The fund
also will establish and maintain such segregated accounts with respect to its
total obligations under any swaps that are not entered into on a net basis.
The fund will enter into interest rate swap transactions only with banks
and recognized securities dealers or their respective affiliates believed by
Mitchell Hutchins to present minimal credit risk in accordance with guidelines
established by the fund's 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.
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<PAGE>
ORGANIZATION OF THE FUND; BOARD MEMBERS AND OFFICERS; PRINCIPAL HOLDERS
AND MANAGEMENT OWNERSHIP OF SECURITIES
The Corporation was organized on October 29, 1985, as a Maryland
corporation. The Corporation has two operating series and has authority to issue
10 billion shares of common stock of separate series, par value $0.001 per share
(four billion shares are designated as shares of the fund).
The Corporation is governed by a board of directors, which oversees its
operations. The directors ("board members") and executive officers of the
Corporation, their ages, business addresses and principal occupations during the
past five years are:
<TABLE>
<CAPTION>
POSITION WITH
NAME AND ADDRESS; AGE CORPORATION BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ----------- ----------------------------------------
<S> <C> <C>
Margo N. Alexander*+; 53 Director and Mrs. Alexander is chairman (since March 1999),
President and a director of Mitchell Hutchins (since
January 1995), and an executive vice president
and a director of PaineWebber (since March 1984)
She was chief executive officer of Mitchell
Hutchins from January 1995 to October 2000. Mrs.
Alexander is president and a director or trustee
of 30 investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Richard Q. Armstrong; 65 Director Mr. Armstrong is chairman and principal of
R.Q.A. Enterprises R.Q.A. Enterprises (management consulting firm
One Old Church Road (since April 1991 and principal occupation since
Unit #6 March 1995). Mr. Armstrong was chairman of the
Greenwich, CT 06830 board, chief executive officer and co-owner of
Adirondack Beverages (producer and distributor
of soft drinks and sparkling/still waters)
(October 1993-March 1995). He was a partner of
The New England Consulting Group (management
consulting firm) (December 1992-September 1993).
He was managing director of LVMH U.S.
Corporation (U.S. subsidiary of the French
luxury goods conglomerate, Louis Vuitton Moet
Hennessey Corporation) (1987-1991) and chairman
of its wine and spirits subsidiary, Schieffelin
& Somerset Company (1987-1991). Mr. Armstrong is
a director or trustee of 29 investment companies
for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment
adviser.
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH
NAME AND ADDRESS; AGE CORPORATION BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ----------- ----------------------------------------
<S> <C> <C>
E. Garrett Bewkes, Jr.** +; 74 Director and Mr. Bewkes is a director of Paine Webber Group
Chairman of Inc. ("PW Group") (holding company of
the Board of PaineWebber and Mitchell Hutchins). Prior to
Directors 1996, he was a consultant to PW Group. He serves
as a consultant to PaineWebber (since May 1999).
Prior to 1988, he was chairman of the board,
president and chief executive officer of
American Bakeries Company. Mr. Bewkes is a
director of Interstate Bakeries Corporation. Mr.
Bewkes is a director or trustee of 40 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates serves as
investment adviser.
Richard R. Burt; 53 Director Mr. Burt is chairman of IEP Advisors, LLP
1275 Pennsylvania Ave., N.W. (international investments and consulting firm)
Washington, DC 20004 (since March 1994) and a partner of McKinsey &
Company (management consulting firm) (since
1991). He is also a director of
Archer-Daniels-Midland Co. (agricultural
commod-ities), Hollinger International Co.
(publishing), Homestake Mining Corp. (gold
mining), six investment companies in the
Deutsche Bank family of funds, nine investment
companies in the Flag Investors family of funds,
The Central European Fund, Inc. and The Germany
Fund, Inc., vice chairman of Anchor Gaming
(provides technology to gaming and wagering
industry) (since July 1999) and chairman of
Weirton Steel Corp. (makes and finishes steel
products) (since April 1996). He was the chief
negotiator in the Strategic 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 29 investment companies for which
Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
Meyer Feldberg; 58 Director Mr. Feldberg is Dean and Professor of Management
Columbia University of the Graduate School of Business, Columbia
101 Uris Hall University. Prior to 1989, he was president of
New York, NY 10027 the Illinois Institute of Technology. Dean
Feldberg is also a director of Primedia, Inc.
(publishing), Federated Department Stores, Inc.
(operator of department stores) and Revlon, Inc.
(cosmetics). Dean Feldberg is a director or
trustee of 37 investment companies for which
Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH
NAME AND ADDRESS; AGE TRUST CORPORATION BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ----------- ----------------------------------------
<S> <C> <C>
George W. Gowen; 71 Director Mr. Gowen is a partner in the law firm of
666 Third Avenue Dunnington, Bartholow & Miller. Prior to May
New York, NY 10017 1994, he was a partner in the law firm of Fryer,
Ross & Gowen. Mr. Gowen is a director or trustee
of 37 investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Frederic V. Malek; 63 Director Mr. Malek is chairman of Thayer Capital Partners
1455 Pennsylvania Ave., N.W (merchant bank) and chairman of Thayer Hotel
Suite 350 Investors II and Lodging Opportunities Fund
Washington, DC 20004 (hotel investment partnerships). From January
1992 to November 1992, he 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. and NWA
Inc. (holding company of Northwest Airlines
Inc.). Prior to 1989, he was employed by the
Marriott Corporation (hotels, restaurants,
airline catering and contract feeding), where he
most recently was an executive vice president
and president of Marriott Hotels and Resorts.
Mr. Malek is also a director of Aegis
Communications, Inc. (tele-services), American
Management Systems, Inc. (management consulting
and computer related services), Automatic Data
Processing, Inc. (computing services), CB
Richard Ellis, Inc. (real estate services), FPL
Group, Inc. (electric services), Global Vacation
Group (packaged vacations), HCR/Manor Care, Inc.
(health care), SAGA Systems, Inc. (software
company) and Northwest Airlines Inc. Mr. Malek
is a director or trustee of 29 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates serves as
investment adviser.
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH
NAME AND ADDRESS; AGE CORPORATION BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ----------- ----------------------------------------
<S> <C> <C>
Carl W. Schafer; 64 Director Mr. Schafer is president of the Atlantic
66 Witherspoon Street, #1100 Foundation (charitable foundation supporting
Princeton, NJ 08542 mainly oceanographic exploration and research).
He is a director of Labor Ready, Inc. (temporary
employment), Roadway Express, Inc. (trucking),
The Guardian Group of Mutual Funds, the Harding,
Loevner Funds, E.I.I. Realty Trust (investment
company), Evans Systems, Inc. (motor fuels,
convenience store and diversified company),
Electronic Clearing House, Inc. (financial
transactions processing), Frontier Oil
Corporation and Nutraceutix, Inc.
(bio-technology company). Prior to January 1993,
he was chairman of the Investment Advisory
Committee of the Howard Hughes Medical
Institute. Mr. Schafer is a director or trustee
of 29 investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Brian M. Storms*+; 46 Director Mr. Storms is Chief Executive Officer (since
October 2000), president and chief operating
officer of Mitchell Hutchins (since March 1999).
Mr. Storms was president of Prudential
Investments (1996-1999). Prior to joining
Prudential, he was a managing director at
Fidelity Investments. Mr. Storms is a director
or trustee of 30 investment companies for which
Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
T. Kirkham Barneby*; 54 Vice President Mr. Barneby is a managing director and chief
investment officer--quantitative investments of
Mitchell Hutchins. Mr. Barneby is a vice
president of seven investment companies for
which Mitchell Hutchins, PaineWebber or one of
their affiliates serves as investment adviser.
Amy Doberman**, 38 Vice President Ms. Doberman is a senior vice president and
general counsel of Mitchell Hutchins. From
December 1996 through July 2000, she was general
counsel of Aeltus Investment Management, Inc.
Prior to working at Aeltus, Ms. Doberman was a
Division of Investment Management Assistant
Chief Counsel at the SEC. Ms. Doberman is a vice
president of 29 investment companies and a vice
president and secretary of one investment
company for which Mitchell Hutchins, PaineWebber
or one of their affiliates serves as investment
adviser.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH
NAME AND ADDRESS; AGE CORPORATION BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ----------- ----------------------------------------
<S> <C> <C>
John J. Lee***; 32 Vice President and Mr. Lee is a vice president and a manager of the
Assistant Treasurer mutual fund finance department of Mitchell
Hutchins. Prior to September 1997, he was an
audit manager in the financial services practice
of Ernst & Young LLP. Mr. Lee is a vice
president and assistant treasurer of 30
investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Kevin J. Mahoney***; 35 Vice President and Mr. Mahoney is a first vice president and a
Assistant Treasurer senior manager of the mutual fund finance
department of Mitchell Hutchins. From August
1996 through March 1999, he was the manager of
the mutual fund internal control group of
Salomon Smith Barney. Prior to August 1996, he
was an associate and assistant treasurer for
BlackRock Financial Management L.P. Mr. Mahoney
is a vice president and assistant treasurer of
30 investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Ann E. Moran***; 43 Vice President and Ms. Moran is a vice president and a manager of
Assistant Treasurer the mutual fund finance department of Mitchell
Hutchins. Ms. Moran is a vice president and
assistant treasurer of 30 investment companies
for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment
adviser.
Dianne E. O'Donnell**; 48 Vice President and Ms. O'Donnell is a senior vice president and
Secretary deputy general counsel of Mitchell Hutchins. Ms.
O'Donnell is a vice president and secretary of
29 investment companies and vice president and
assistant secretary of one investment company
for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment
adviser.
Susan P. Ryan*; 40 Vice President Ms. Ryan is a senior vice president and
portfolio manager of Mitchell Hutchins and has
been with Mitchell Hutchins since 1982. Ms. Ryan
is a vice president of six investment companies
for which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment
adviser.
Paul H. Schubert***; 37 Vice President and Mr. Schubert is a senior vice president and
Treasurer director of the mutual fund finance department
of Mitchell Hutchins. Mr. Schubert is a vice
president and treasurer of 30 investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates serves as
investment adviser.
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH
NAME AND ADDRESS; AGE CORPORATION BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ----------- ----------------------------------------
<S> <C> <C>
Barney A. Taglialatela***; 39 Vice President and Mr. Taglialatela is a vice president and a
Assistant Treasurer manager of the mutual fund finance department of
Mitchell Hutchins. Mr. Taglialatela is a vice
president and assistant treasurer of 30
investment companies for which Mitchell
Hutchins, PaineWebber or one of their affiliates
serves as investment adviser.
Keith A. Weller**; 39 Vice President and Mr. Weller is a first vice president and
Assistant Secretary associate general counsel of Mitchell Hutchins.
Mr. Weller is a vice president and assistant
secretary of 30 investment companies for which
Mitchell Hutchins, PaineWebber or one of their
affiliates serves as investment adviser.
</TABLE>
----------
* This person's business address is 51 West 52nd Street, New York, New York
10019-6114.
** This person's business address is 1285 Avenue of the Americas, New York,
New York 10019-6028.
*** This person's business address is Newport Center III, 499 Washington
Blvd., 14th floor, Jersey City, New Jersey, 07310-1998.
+ Mrs. Alexander, Mr. Bewkes and Mr. Storms are "interested persons" of the
fund as defined in the Investment Company Act by virtue of their positions
with Mitchell Hutchins, PaineWebber, and/or PW Group.
The Corporation pays each board member who is not an "interested
person" of the Corporation $1,500 annually for the fund, an additional
$1,000 annually for the Corporation's second series and up to $150 per
series for attending annually each board meeting and each separate meeting
of a board committee. The Corporation thus pays an independent board
member $2,500 annually plus any additional annual amounts due for board or
committee meetings. Each chairman of the audit and contract review
committees of individual funds within the PaineWebber fund complex
receives additional compensation, aggregating $15,000 annually from the
relevant funds. All board members are reimbursed for any expenses incurred
in attending meetings. Because Mitchell Hutchins and PaineWebber perform
substantially all of the services necessary for the operation of the
Corporation and the fund, the Corporation requires no employees. No
officer, director or employee of Mitchell Hutchins or PaineWebber
presently receives any compensation from the Corporation for acting as a
board member or officer.
The table below includes certain information relating to the compensation
by the Corporation of its current board members and the compensation of those
board members from all PaineWebber funds during the periods indicated.
COMPENSATION TABLE+
AGGREGATE TOTAL COMPENSATION
COMPENSATION FROM THE
FROM THE CORPORATION AND THE
NAME OF PERSON, POSITION CORPORATION* FUND COMPLEX**
------------------------ ------------ --------------
Richard Q. Armstrong, Director... $ $
Richard R. Burt, Director........
Meyer Feldberg, Director.........
George W. Gowen, Director........
Frederic V. Malek, Director......
Carl W. Schafer, Director .......
30
<PAGE>
----------
+ Only independent board members are compensated by the PaineWebber funds
and identified above; board members who are "interested persons," as
defined by the Investment Company Act, do not receive compensation
from the PaineWebber funds.
* Represents fees paid by the Corporation to each board member indicated
for the fiscal year ended August 31, 2000. These fees are allocated in
part to the fund and in part to the other series of the Corporation.
** Represents total compensation paid during the calendar year ended
December 31, 1999, by 31 investment companies (34 in the case of
Messrs. Feldberg and Gowen) for which Mitchell Hutchins, PaineWebber or
one of their affiliates served as an investment adviser. No fund within
the PaineWebber fund complex has a bonus, pension, profit sharing or
retirement plan.
PRINCIPAL HOLDERS AND MANAGEMENT OWNERSHIP OF SECURITIES
As of November 30, 2000 directors and officers owned in the aggregate less
than 1% of the outstanding shares of any class of the fund.
As of November 30, 2000, the following (shareholders are shown in the
funds records as owning 5% or more of any class of the fund's shares).
Number and Percentage of Shares
Name and Address Owned as of November 30, 2000
---------------- ---------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
-----------------
* The shareholders listed may be contacted c/o Mitchelll Hutchins Asset
Management Inc., 51 West 52nd Street, New York, NY 10019-6114.
INVESTMENT ADVISORY, ADMINISTRATION AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY AND ADMINISTRATIVE ARRANGEMENTS. Mitchell Hutchins
acts as the investment adviser and administrator of the fund pursuant to a
separate contract (an "Advisory Contract") with the Corporation. Under the
Advisory Contract, the fund pay Mitchell Hutchins an annual fee, computed daily
and paid monthly, as set forth below:
ANNUAL
AVERAGE DAILY NET ASSETS RATE
------------------------ ----
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
During the fiscal years indicated, Mitchell Hutchins earned (or accrued)
advisory and administration fees in the amounts set forth below:
FISCAL YEARS ENDED AUGUST 31,
-----------------------------
2000 1999 1998
---- ---- ----
Balanced Fund........................ $ $1,890,996 $1,709,264
Under the terms of the applicable Advisory Contract, the fund bears all
expenses incurred in its operation that are not specifically assumed by Mitchell
Hutchins. General expenses of the Corporation not readily identifiable as
belonging to a specific series are allocated among series by or under the
direction of the board in such manner as the board deems fair and equitable.
Expenses borne by the fund include the following: (1) the cost (including
brokerage commissions, if any) of securities purchased or sold by the fund and
any losses incurred in connection therewith; (2) fees payable to and expenses
incurred on behalf of the fund by Mitchell Hutchins; (3) organizational
expenses; (4) filing fees and expenses relating to the registration and
qualification of the fund's shares 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 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
31
<PAGE>
asserted against 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 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 trustees and officers; and (18)
costs of mailing, stationery and communications equipment.
Under the Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by the fund in
connection with the performance of the Advisory Contract, 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. The Advisory Contract terminates
automatically upon its assignment and is terminable at any time without penalty
by the board or by vote of the holders of a majority of the fund's outstanding
voting securities, on 60 days' written notice to Mitchell Hutchins or by
Mitchell Hutchins on 60 days' written notice to the fund.
SECURITIES LENDING. During the fiscal year ended August 31, 2000, August
31, 1999 and August 31, 1998, the fund paid (or accrued) the following fees to
PaineWebber for its services as securities lending agent:
FISCAL YEARS ENDED AUGUST 31,
-----------------------------
2000 1999 1998
---- ---- ----
$ $17,852 $28,144
NET ASSETS. The following table shows the approximate net assets as of November
30, 2000, sorted by category of investment objective, of the investment
companies as to which Mitchell Hutchins serves as adviser. An investment company
may fall into more than one of the categories below.
NET ASSETS
INVESTMENT CATEGORY ($MIL)
------------------- ------
Domestic (excluding Money Market)............... $
Global.........................................
Equity/Balanced.................................
Fixed Income (excluding Money Market)...........
Taxable Fixed Income.....................
Tax-Free Fixed Income....................
Money Market Funds..............................
PERSONAL TRADING POLICIES. The fund and Mitchell Hutchins each have
adopted a code of ethics under rule 17f-1 of the Investment Company Act, which
permits personnel covered by the rule to invest in securities that may be
purchased or held by the fund but prohibits fraudulent, deceptive or
manipulative conduct in connection with that personal investing.
32
<PAGE>
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of each
class of shares of a fund under the distribution contract with the fund
("Distribution Contract"). The Distribution Contract requires Mitchell Hutchins
to use its best efforts, consistent with its other businesses, to sell shares of
the fund. Shares of the fund are offered continuously. Under a dealer agreements
between Mitchell Hutchins and PaineWebber relating to each class of shares of
the fund (collectively, "PW Dealer Agreement"), PaineWebber and its
correspondent firms sell the fund's shares. Mitchell Hutchins is located at 51
West 52nd Street, New York, New York 10019-6114 and PaineWebber is located at
1285 Avenue of the Americas, New York, New York 10019-6028.
Under separate plans of distribution pertaining to the Class A, Class B
and Class C shares of the fund adopted by the Corporation in the manner
prescribed under Rule 12b-1 under the Investment Company Act (each,
respectively, a "Class A Plan," "Class B Plan" and "Class C Plan," and,
collectively, "Plans"), the 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 the class of shares. Under the Class B Plan and the Class C Plan, the
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. There is no distribution plan with respect to the fund's Class Y
shares, and the fund's pay no service or distribution fees with respect to its
Class Y shares.
Mitchell Hutchins uses the service fees under the Plans for Class A, B and
C shares primarily to pay PaineWebber for shareholder servicing, currently at
the annual rate of 0.25% of the aggregate investment amounts maintained in each
fund by PaineWebber clients. PaineWebber then compensates its Financial Advisors
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:
o Offset the commissions it pays to PaineWebber for selling the fund's
Class B and Class C shares, respectively.
o Offset the 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 Financial Advisors when Class B and Class C shares
are bought by investors, as well as on an ongoing basis. Mitchell Hutchins
receives no special compensation from any of the funds or investors at the time
Class B or C shares are bought.
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 specify that each fund must pay service and distribution fees to
Mitchell Hutchins for its service- and distribution-related activities, not as
reimbursement for specific expenses incurred. Therefore, even if Mitchell
Hutchins' expenses exceed the service or distribution fees it receives, the fund
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 fund. Annually, the board
reviews the Plans and Mitchell Hutchins' corresponding expenses for each class
separately from the Plans and expenses of the other classes.
Among other things, each Plan provides that (1) Mitchell Hutchins will
submit to the 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 board, including those board members who are not "interested
persons" of the fund and who have no direct or indirect financial
33
<PAGE>
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 the 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 shall be committed
to the discretion of the board members who are not "interested persons" of the
corporation.
In reporting amounts expended under the Plans to the board members,
Mitchell Hutchins allocates expenses attributable to the sale of each class of
the fund's 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
the fund's shares will not be used to subsidize the sale of any other class of
fund shares.
The fund paid (or accrued) the following service and/or distribution fees
to Mitchell Hutchins under the Class A, Class B and Class C Plans during the
fiscal year ended August 31, 2000:
Class A.................... $
Class B....................
Class C....................
Mitchell Hutchins estimates that it and its parent corporation,
PaineWebber, incurred the following shareholder service-related and
distribution-related expenses with respect to the fund during the fiscal year
ended August 31, 2000:
CLASS A
Marketing and advertising.............................. $
Amortization of commissions............................
Printing of prospectuses and SAIs......................
Branch network costs allocated and interest expense ...
Service fees paid to PaineWebber Financial Advisors ...
CLASS B
Marketing and advertising.............................. $
Amortization of commissions............................
Printing of prospectuses and SAIs......................
Branch network costs allocated and interest expense ...
Service fees paid to PaineWebber Financial Advisors ...
CLASS C
Marketing and advertising.............................. $
Amortization of commissions............................
Printing of prospectuses and SAIs......................
Branch network costs allocated and interest expense ...
Service fees paid to PaineWebber Financial Advisors ...
"Marketing and advertising" includes various internal costs allocated by
Mitchell Hutchins to its efforts at distributing the fund's 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 the fund's overall Flexible PricingSM system of distribution,
the 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 fund and attracting new investors and assets to
the fund to the benefit of the fund and its share-
34
<PAGE>
holders, (2) facilitate distribution of the fund's shares and (3) maintain the
competitive position of the fund in relation to other funds that have
implemented or are seeking to implement similar distribution arrangements.
In approving the Class A Plan, the board considered all the features of
the distribution system, including (1) the conditions under which initial sales
charges would be imposed and the amount of such charges, (2) Mitchell Hutchins'
belief that the initial sales charge combined with a service fee would be
attractive to PaineWebber Financial Advisors and correspondent firms, resulting
in greater growth of the fund than might otherwise be the case, (3) the
advantages to the shareholders of economies of scale resulting from growth in
the fund's assets and potential continued growth, (4) the services provided to
the fund and its shareholders by Mitchell Hutchins, (5) the services provided by
PaineWebber pursuant to its PW Dealer Agreement with Mitchell Hutchins and (6)
Mitchell Hutchins' shareholder service-related expenses and costs.
In approving the Class B Plan, the 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 fund
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 Financial Advisors 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 Financial Advisors
and correspondent firms, resulting in greater growth of the fund than might
otherwise be the case, (4) the advantages to the shareholders of economies of
scale resulting from growth in the fund's assets and potential continued growth,
(5) the services provided to the fund and its shareholders by Mitchell Hutchins,
(6) the services provided by PaineWebber pursuant to its PW 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 Financial
Advisors, 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, the 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 Financial Advisors 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 Financial Advisors and
correspondent firms, resulting in greater growth to the fund than might
otherwise be the case, (4) the advantages to the shareholders of economies of
scale resulting from growth in the fund's assets and potential continued growth,
(5) the services provided to the fund and its shareholders by Mitchell Hutchins,
(6) the services provided by PaineWebber pursuant to its PW 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 Financial
Advisors, without the concomitant receipt by Mitchell Hutchins of initial sales
charges or contingent deferred sales charges upon redemption after one year
following purchase was conditioned upon its expectation of being compensated
under the Class C Plan.
With respect to the Plan, the board 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 board also considered the
benefits that would accrue to Mitchell Hutchins under the 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 the fund, which
fees would increase if the Plan were successful and the fund attained and
maintained significant asset levels.
35
<PAGE>
Under the Distribution Contract for Class A shares, for the fiscal years
set forth below, Mitchell Hutchins earned the following approximate amounts of
sales charges and retained the following approximate amounts, net of concessions
to PaineWebber as dealer.
FISCAL YEARS ENDED AUGUST 31,
-----------------------------
2000 1999 1998
---- ---- ----
Earned......................... $ $ 91,158 $ 368,103
Retained....................... 8,956 16,048
Mitchell Hutchins earned and retained the following contingent deferred
sales charges paid upon certain redemptions of shares for the fiscal year ended
August 31, 2000:
Class A............................. $
Class B.............................
Class C.............................
PORTFOLIO TRANSACTIONS
Subject to policies established by the board, Mitchell Hutchins is
responsible for the execution of the 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 fund, taking into
account such factors as the price (including the applicable brokerage commission
or dealer spread), size of order, difficulty of execution and operational
facilities of the firm involved. While Mitchell Hutchins generally seeks
reasonably competitive commission rates, payment of the lowest commission is not
necessarily consistent with obtaining the best net results. Prices paid to
dealers in principal transactions 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. The fund may invest in securities traded
in the over-the-counter market and will engage primarily in transactions
directly with the dealers who make markets in such securities, unless a better
price or execution could be obtained by using a broker. During the fiscal years
indicated, the fund paid the brokerage commissions set forth below:
FISCAL YEARS ENDED AUGUST 31,
-----------------------------
2000 1999 1998
---- ---- ----
$ $367,133 $290,954
The fund has no obligation to deal with any broker or group of brokers in
the execution of portfolio transactions. The funds 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.
The board has adopted procedures in conformity with Rule 17e-1 under the
Investment Company Act to ensure that all brokerage commissions paid to
PaineWebber are reasonable and fair. Specific provisions in the Advisory
Contract authorize Mitchell Hutchins and any of its affiliates that is a member
of a national securities exchange to effect portfolio transactions for the 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
indicated, the fund paid brokerage commissions to PaineWebber as follows:
FISCAL YEARS ENDED AUGUST 31,
-----------------------------
2000 1999 1998
---- ---- ----
$ $14,808 $1,038
36
<PAGE>
During the fiscal year ended August 31, 2000, the brokerage commissions
paid by the fund to PaineWebber represented % of the total commissions paid by
the fund and % of the aggregate dollar amount of transactions involving
brokerage commission payments.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs"), who receive brokerage commissions for their services. The
fund's procedures in selecting FCMs to execute its 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.
In selecting brokers, Mitchell Hutchins will consider the full range and
quality of a broker's services. Consistent with the interests of the fund and
subject to the review of the board, Mitchell Hutchins may cause a fund to
purchase and sell portfolio securities through brokers who provide Mitchell
Hutchins with brokerage or research services. The fund may pay those brokers a
higher commission than may be charged by other brokers, provided that Mitchell
Hutchins determines in good faith that the 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.
Research services obtained from brokers may include written reports,
pricing and appraisal services, analysis of issues raised in proxy statements,
educational seminars, subscriptions, portfolio attribution and monitoring
services, and computer hardware, software and access charges which are directly
related to investment research. Research services may be received in the form of
written reports, online services, telephone contacts and personal meetings with
securities analysts, economists, corporate and industry spokespersons and
government representatives.
For the fund's fiscal year ended August 31, 2000, Mitchell Hutchins
directed $ in portfolio transactions to brokers chosen because they provided
research services, for which the fund paid $ in commissions.
For purchases or sales with broker-dealer firms that act as principal,
Mitchell Hutchins seeks best execution. Although Mitchell Hutchins may receive
certain research or execution services in connection with these transactions, it
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. Mitchell Hutchins may engage in agency
transactions in over-the-counter equity and debt securities in return for
research and execution services. These transactions are entered into only
pursuant to procedures that are designed to ensure 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.
Research services and information received from brokers or dealers are
supplemental to Mitchell Hutchins' own research efforts and, when utilized, are
subject to internal analysis before being incorporated into its investment
processes. Information and research services furnished by brokers or dealers
through which or with which the fund effect 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 it advises may be used in advising
the fund.
Investment decisions for the 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 the fund and one or more accounts. In
those cases, simultaneous transactions are inevitable. Purchases or sales are
then averaged as to price and allocated between the fund and the other
account(s) as to amount in a manner deemed equitable to the fund and the 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
simultaneous transactions and the ability to participate in volume transactions
will benefit the fund.
The fund will not purchase securities that are offered in underwritings in
which PaineWebber is a member of the underwriting or selling group, except
pursuant to procedures adopted by each board pursuant to Rule
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10f-3 under the Investment Company Act. Among other things, these procedures
require that the spread or commission paid in connection with such a purchase be
reasonable and fair, 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 PaineWebber or any affiliate thereof not participate in or benefit from
the sale to the fund.
PORTFOLIO TURNOVER. The fund's annual portfolio turnover rates may vary
greatly from year to year, but they will not be a limiting factor when
management deems portfolio changes appropriate. The portfolio turnover rate 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 securities in the portfolio during the year.
The fund's portfolio turnover rates for the fiscal years shown were:
FISCAL YEARS ENDED AUGUST 31,
-----------------------------
2000 1999
---- ----
% 234%
REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHER SERVICES
WAIVERS OF SALES CHARGES/CONTINGENT DEFERRED SALES CHARGES -- CLASS A
SHARES. The following additional sales charge waivers are available for Class A
shares if you:
o Purchase shares through 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 l% of the amount invested;
o Acquire 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 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;
o Acquire shares in connection with a reorganization pursuant to which the
fund acquires substantially all of the assets and liabilities of another
fund in exchange solely for shares of the acquiring fund; or
o Acquire shares in connection with the disposition of proceeds from the
sale of shares of Managed High Yield Plus Fund Inc. that were acquired
during that fund's initial public offering of shares and that meet
certain other conditions described in its prospectus.
In addition, reduced sales charges on Class A shares are available through
the combined purchase plan or through rights of accumulation described below.
Class A share purchases of $1 million or more are not subject to an initial
sales charge; however, if a shareholder sells these shares 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.
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COMBINED PURCHASE PRIVILEGE -- CLASS A SHARES. Investors and eligible
groups of related fund investors may combine purchases of Class A shares of the
fund with concurrent purchases of Class A shares of any other PaineWebber mutual
fund and thus take advantage of the reduced sales charges indicated in the table
of sales charges for Class A shares in the Prospectus. The sales charge payable
on the purchase of Class A shares of the 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 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 fund 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.
REINSTATEMENT PRIVILEGE -- CLASS A SHARES. Shareholders who have redeemed
Class A shares of the fund may reinstate their account without a sales charge 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, although a loss arising out of a
redemption might not be deductible under certain circumstances. See "Taxes"
below.
WAIVERS OF CONTINGENT DEFERRED SALES CHARGES -- CLASS B SHARES. 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. Among other circumstances, the contingent
deferred sales charge on
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Class B shares 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.
PURCHASES OF CLASS Y SHARES THROUGH THE PACE(SM) MULTI ADVISOR PROGRAM. An
investor who participates in the PACE(SM) Multi Advisor Program is eligible to
purchase Class Y shares. The PACE(SM) 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(SM) Multi Advisor Program is
subject to payment of an advisory fee at the effective 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 Financial Advisor or
PaineWebber's correspondent firms for more information concerning mutual funds
that are available through the PACE(SM) Multi Advisor Program.
PURCHASES OF CLASS A SHARES THROUGH THE PAINEWEBBER INSIGHTONE(SM)
PROGRAM. Investors who purchase shares through the PaineWebber InsightOneSM
Program are eligible to purchase Class A shares without a sales load. The
PaineWebber InsightOne(SM) Program offers a nondiscretionary brokerage account
to PaineWebber clients for an asset-based fee at an annual rate of up to 1.50%
of the assets in the account. Account holders may purchase or sell certain
investment products without paying commissions on other markups/markdowns.
PURCHASES AND SALES OF CLASS Y SHARES FOR PARTICIPANTS IN PW 401(k) PLUS
PLAN. The trustee of the PW 401(k) Plus Plan, a defined contribution plan
sponsored by PW Group, buys and sells Class Y shares of the funds that are
included as investment options under the Plan to implement the investment
choices of individual participants with respect to their Plan contributions.
Individual Plan participants should consult the Summary Plan Description and
other plan material of the PW 401(k) Plus Plan (collectively, "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 (1-888-793-2237). As described in the Plan Documents, the price at
which Class Y shares are bought and sold by the trustee of PW 401(k) Plus Plan
might be more or less than the price per share at the time the participants made
their investment choices.
ADDITIONAL EXCHANGE AND REDEMPTION INFORMATION. As discussed in the
Prospectus, eligible shares of the fund may be exchanged for shares of the
corresponding class of most other PaineWebber mutual funds. Class Y shares are
not eligible for exchange. Shareholders will receive at least 60 days' notice of
any termination or material modification of the exchange offer, except 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 these securities into cash. The fund has
elected, however, to be governed by Rule 18f-1 under the Investment Company Act,
under which it is obligated to redeem shares solely in cash up to the lesser of
$250,000 or 1% of its net asset value during any 90-day period for one
shareholder. This election is irrevocable unless the SEC permits its withdrawal.
The fund may suspend redemption privileges or postpone the date of payment
during any period (1) when the New York Stock Exchange is closed or trading on
the New York Stock Exchange is restricted as determined by the SEC, (2) when an
emergency exists, as defined by the SEC, that makes it not reasonably
practicable for a fund to dispose of securities owned by it or fairly to
determine the value of its assets or (3) as the SEC may otherwise
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permit. The redemption price may be more or less than the shareholder's cost,
depending on the market value of a fund's portfolio at the time.
SERVICE ORGANIZATIONS. The fund may authorize service organizations, and
their agents, to accept on its behalf purchase and redemption orders that are in
"good form" in accordance with the policies of those service organizations. The
fund will be deemed to have received these purchase and redemption orders when a
service organization or its agent accepts them. Like all customer orders, these
orders will be priced based on the fund's net asset value next computed after
receipt of the order by the service organizations or their agents. Service
organizations may include retirement plan service providers who aggregate
purchase and redemption instructions received from numerous retirement plans or
plan participants.
AUTOMATIC INVESTMENT PLAN. PaineWebber offers an automatic investment plan
with a minimum initial investment of $1,000 through which the fund will deduct
$50 or more on a monthly, quarterly, semi-annual or annual basis from the
investor's bank account to invest directly in the fund. Participation in the
automatic investment plan enables an investor to use the technique of "dollar
cost averaging." When an investor invests the same dollar amount each month
under the plan, the investor will purchase more shares when the fund's net asset
value per share is low and fewer shares when the net asset value per share is
high. Using this technique, an investor's average purchase price per share over
any given period will be lower than if the investor purchased a fixed number of
shares on a monthly basis during the period. Of course, investing through the
automatic investment plan does not assure a profit or protect against loss in
declining markets. Additionally, because the automatic investment plan involves
continuous investing regardless of price levels, an investor should consider his
or her financial ability to continue purchases through periods of both low and
high price levels. An investor should also consider whether a large, single
investment would qualify for sales load reductions.
SYSTEMATIC WITHDRAWAL PLAN. The systematic withdrawal plan allows
investors to set up monthly, quarterly (March, June, September and December),
semi-annual (June and December) or annual (December) withdrawals from their
PaineWebber mutual fund accounts. Minimum balances and withdrawals vary
according to the class of shares:
o Class A and Class C shares. Minimum value of fund shares is $5,000;
minimum withdrawals of $100.
o Class B shares. Minimum value of fund shares is $10,000; minimum
monthly, quarterly, and semi-annual and annual withdrawals of $100,
$200, $300 and $400, respectively.
Withdrawals under the systematic withdrawal plan will not be subject to a
contingent deferred sales charge if the investor withdraws 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 this 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 the minimum values specified
above. Purchases of additional shares of the 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, semi-annual and annual plans, PaineWebber will arrange for
redemption by the fund of sufficient fund shares to provide the withdrawal
payments specified by participants in the fund's systematic withdrawal plan. The
payments generally are mailed approximately five Business Days (defined under
"Valuation of Shares") after the redemption date. Withdrawal payments should not
be considered dividends, but redemption proceeds. If periodic withdrawals
continually exceed reinvested dividends and other distributions, a shareholder's
investment may be correspondingly reduced. A shareholder may change the amount
of the systematic withdrawal or terminate participation in the systematic
withdrawal plan at any time without charge or penalty by written instructions
with signatures guaranteed to PaineWebber or PFPC Inc. Instructions
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<PAGE>
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 PFPC. Shareholders may
request the forms needed to establish a systematic withdrawal plan from their
PaineWebber Financial Advisors, correspondent firms or PFPC at 1-800-647-1568.
INDIVIDUAL RETIREMENT ACCOUNTS. Self-directed IRAs are available through
PaineWebber in which purchases of PaineWebber mutual 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 the fund in a
PaineWebber brokerage account transfer their brokerage accounts to another firm,
the fund shares will be moved to an account with PFPC. 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.
PAINEWEBBER RMA RESOURCE ACCUMULATION PLAN(SM);
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(R) (RMA)(R)
Shares of PaineWebber mutual funds (each a "PW Fund" and, collectively,
the "PW Funds") are available for purchase through the RMA Resource Accumulation
Plan ("Plan") by customers of PaineWebber and its correspondent firms who
maintain Resource Management Accounts ("RMA accountholders"). The Plan allows an
RMA accountholder to continually invest in one or more of the PW Funds at
regular intervals, with payment for shares purchased automatically deducted from
the client's RMA account. The client may elect to invest at monthly or quarterly
intervals and may elect either to invest a fixed dollar amount (minimum $100 per
period) or to purchase a fixed number of shares. A client can elect to have Plan
purchases executed on the first or fifteenth day of the month. Settlement occurs
three Business Days (defined under "Valuation of Shares") after the trade date,
and the purchase price of the shares is withdrawn from the investor's RMA
account on the settlement date from the following sources and in the following
order: uninvested cash balances, balances in RMA money market funds, or margin
borrowing power, if applicable to the account.
To participate in the Plan, an investor must be an RMA accountholder, must
have made an initial purchase of the shares of each PW Fund selected for
investment under the Plan (meeting applicable minimum investment requirements)
and must complete and submit the RMA Resource Accumulation Plan Client Agreement
and Instruction Form available from PaineWebber. The investor must have received
a current prospectus for each PW Fund selected prior to enrolling in the Plan.
Information about mutual fund positions and outstanding instructions under the
Plan are noted on the RMA accountholder's account statement. Instructions under
the Plan may be changed at any time, but may take up to two weeks to become
effective.
The terms of the Plan, or an RMA accountholder's participation in the
Plan, may be modified or terminated at any time. It is anticipated that, in the
future, shares of other PW Funds and/or mutual funds other than the PW Funds may
be offered through the Plan.
PERIODIC INVESTING AND DOLLAR COST AVERAGING. Periodic investing in the PW
Funds or other mutual funds, whether through the Plan or otherwise, helps
investors establish and maintain a disciplined approach to accumulating assets
over time, de-emphasizing the importance of timing the market's highs and lows.
Periodic investing also permits an investor to take advantage of "dollar cost
averaging." By investing a fixed amount in mutual fund shares at established
intervals, an investor purchases more shares when the price is lower and fewer
shares when the price is higher, thereby increasing his or her earning
potential. Of course, dollar cost averaging does not guarantee a profit or
protect against a loss in a declining market, and an investor should consider
his or her financial ability to continue investing through periods of both low
and high share prices. However, over time, dollar cost averaging generally
results in a lower average original investment cost than if an investor invested
a larger dollar amount in a mutual fund at one time. In deciding whether to use
dollar cost averaging, an investor should also consider whether a large, single
investment would qualify for sales load reductions.
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PAINEWEBBER'S RESOURCE MANAGEMENT ACCOUNT. In order to enroll in the Plan,
an investor must have opened an RMA account with PaineWebber or one of its
correspondent firms. The RMA account is PaineWebber's comprehensive asset
management account and offers investors a number of features, including the
following:
o monthly Premier account statements that itemize all account activity,
including investment transactions, checking activity and Platinum
MasterCard(R) transactions during the period, and provide unrealized
and realized gain and loss estimates for most securities held in the
account;
o comprehensive year-end summary statements that provide information on
account activity for use in tax planning and tax return preparation;
o automatic "sweep" of uninvested cash into the RMA accountholder's
choice of one of the six RMA money market funds - RMA Money Market
Portfolio, RMA U.S. Government Portfolio, RMA Tax-Free Fund, RMA
California Municipal Money Fund, RMA New Jersey Municipal Money Fund
and RMA New York Municipal Money Fund. AN INVESTMENT IN A MONEY MARKET
FUND IS NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE
CORPORATION OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH A MONEY MARKET
FUND SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT AT $1.00 PER SHARE,
IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN A MONEY MARKET FUND;
o check writing, with no per-check usage charge, no minimum amount on
checks and no maximum number of checks that can be written. RMA
accountholders can code their checks to classify expenditures. All
canceled checks are returned each month;
o Platinum MasterCard(R), 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
Platinum MasterCard(R) are debited to the RMA account once monthly,
permitting accountholders to remain invested for a longer period of
time;
o 24-hour access to account information through toll-free numbers, and
more detailed personal assistance during business hours from the RMA
Service Center;
o unlimited electronic funds transfers and bill payment service for an
additional fee;
o expanded account protection for the net equity securities balance in
the event of the liquidation of PaineWebber. This protection does not
apply to shares of funds that are held at PFPC and not through
PaineWebber; and
o automatic direct deposit of checks into your RMA account and automatic
withdrawals from the account.
The annual account fee for an RMA account is $85, which includes the
Platinum MasterCard(R), with an additional fee of $40 if the investor selects an
optional line of credit with the Platinum MasterCard(R).
CONVERSION OF CLASS B SHARES
Class B shares of the fund will automatically convert to Class A shares,
based on the relative net asset values per share of the two classes, as of the
close of business on the first Business Day (as defined under "Valuation of
Shares") of the month in which the sixth anniversary of the initial issuance of
such Class B shares occurs. For the purpose of calculating the holding period
required for conversion of Class B shares, the date of initial issuance shall
mean (1) the date on which such Class B shares were issued or (2) for Class B
shares obtained through an exchange, or a series of exchanges, the date on which
the original Class B shares were issued. For purposes of conversion to Class A
shares, Class B shares purchased through the reinvestment of dividends and other
distributions paid in respect of Class B shares will be held in a separate
sub-account. Each time any Class B shares in the shareholder's regular account
(other than those in the sub-account) convert to Class A shares, a pro rata por-
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tion of the Class B shares in the sub-account will also convert 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 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 that 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 will
not continue to be met.
VALUATION OF SHARES
The fund determines its net asset value per share separately for each
class of shares, normally as of the close of regular trading (usually 4:00 p.m.,
Eastern time) on the New York Stock Exchange on each Business Day, which is
defined as each Monday through Friday when the New York Stock Exchange is open.
Prices will be calculated earlier when the New York Stock Exchange closes early
because trading has been halted for the day. Currently the New York Stock
Exchange 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 and other assets are valued based upon market quotations when
those quotations are readily available unless, in Mitchell Hutchins' judgment,
those quotations do not adequately reflect the fair value of the security.
Securities that are listed on exchanges normally are valued at the last sale
price on the day the securities are 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
over-the-counter market and listed on the Nasdaq Stock Market ("Nasdaq")
normally are valued at the last available sale price on Nasdaq prior to
valuation; other over-the-counter securities are valued at the last bid price
available prior to valuation (other than short-term investments that mature in
60 days or less, which are valued as described further below). Securities and
assets for which market quotations are not readily available may be 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 and assets are valued at fair value as determined in good faith
by or under the direction of the board. It should be recognized that judgment
often plays a greater role in valuing thinly traded securities, including many
lower rated bonds, than is the case with respect to securities for which a
broader range of dealer quotations and last-sale information is available. The
amortized cost method of valuation generally is used to value debt obligations
with 60 days or less remaining until maturity, unless the board determines that
this does not represent fair value.
PERFORMANCE INFORMATION
The 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 the fund's Performance Advertisements are
calculated according to the following formula:
n
P(1 + T) = ERV
where: P = a hypothetical initial payment of $1,000 to purchase shares
of a specified class
T = average annual total return of shares of that class
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment at
the beginning of that period.
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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, the
maximum 4.5% 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 or Class C shares held for the period is
deducted. All dividends and other distributions are assumed to have been
reinvested at net asset value.
The 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"). The fund calculates Non-Standardized Return
for specified periods of time by assuming an 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 those charges would reduce
the return.
Both Standardized Return and Non-Standardized Return for Class B shares
for periods of over six years reflect conversion of the Class B shares to Class
A shares at the end of the sixth year.
The following tables show performance information for each class of the
fund's shares outstanding for the periods indicated. All returns for periods of
more than one year are expressed as an average annual return.
CLASS CLASS A CLASS B CLASS C CLASS Y
(INCEPTION DATE) (7/1/91) (12/12/86) (7/2/92) (3/26/98)
---------------- -------- ---------- -------- ---------
Year ended August 31, 2000:
Standardized Return*...... % % % %
Non-Standardized Return... % % % %
Five Years ended August 31, 2000:
Standardized Return*...... % % % N/A
Non-Standardized Return*.. % % % N/A
Ten Years ended August 31, 2000:
Standardized Return....... N/A % N/A N/A
Non-Standardized Return... N/A % N/A N/A
Inception to August 31, 2000:
Standardized Return*...... % % % %
Non-Standardized Return... % % % %
----------
* All Standardized Return figures for Class A shares reflect deduction of the
current maximum sales charge of 4.5%. All Standardized Return figures for
Class B and Class C shares reflect deduction of the applicable contingent
deferred sales charges imposed on a redemption of shares held for the period.
Class Y shares do not impose an initial or contingent deferred sales charge;
therefore, the performance information is the same for both standardized
return and non-standardized return for the periods indicated.
OTHER INFORMATION. In Performance Advertisements, the fund may compare its
Standardized Return and/or their Non-Standardized Return with data published by
Lipper Inc. ("Lipper") CDA Investment Technologies, Inc. ("CDA"), Wiesenberger
Investment Companies Service ("Wiesenberger"), Investment Company Data, Inc.
("ICD") or Morningstar Mutual Funds ("Morningstar"), with the performance of
recognized stock, bond and other indices, including the Standard & Poor's 500
Composite Stock Price Index ("S&P 500"), the Dow Jones Industrial Average, the
International Finance Corporation Global Total Return Index, the Nasdaq
Composite Index, the Russell 2000 Index, the Wilshire 5000 Index, the Lehman
Bond Index, the Morgan Stanley Capital International Perspective Indices, the
Morgan Stanley Capital International Energy Sources Index, the Standard & Poor's
Oil Composite Index, the Morgan Stanley Capital International World Index, the
Lehman Brothers 20+ Year Treasury Bond Index, the Lehman Brothers
Government/Corporate Bond Index, other similar
45
<PAGE>
Lehman Brothers indices or components thereof, the Salomon Smith Barney Non-U.S.
World Government Bond Index, and changes in the Consumer Price Index as
published by the U.S. Department of Commerce. The 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,
SMART MONEY, MUTUAL FUNDS, 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.
The 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
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.
The fund may also compare its performance with the performance of bank
certificates of deposit (CDs) as measured by the CDA Certificate of Deposit
Index, the Bank Rate Monitor National Index and the averages of yields of CDs of
major banks published by Banxquote(R) Money Markets. In comparing the funds'
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. Shares of the fund are not insured or guaranteed by the U.S.
government and returns and net asset values will fluctuate. The debt securities
held by the fund generally have longer maturities than most CDs and may reflect
interest rate fluctuations for longer term debt securities. An investment in any
fund involves greater risks than an investment in either a money market fund or
a CD.
The fund may also compare its performance to general trends in the stock
and bond markets, as illustrated by the following graph prepared by Ibbotson
Associates, Chicago.
Chart to Come
Source: STOCKS, BONDS, BILLS AND INFLATION 1999 YEARBOOK(TM), Ibbotson Assoc.,
Chi., (annual updates work by Roger G. Ibbotson & Rex A. Sinquefield).
46
<PAGE>
The chart is shown for illustrative purposes only and does not represent
any fund's performance. These returns consist of income and capital appreciation
(or depreciation) and should not be considered an indication or guarantee of
future investment results. Year-to-year fluctuations in certain markets have
been significant and negative returns have been experienced in certain markets
from time to time. Stocks are measured by the S&P 500, an unmanaged weighted
index comprising 500 widely held common stocks and varying in composition.
Unlike investors in bonds and U.S. Treasury bills, common stock investors do not
receive fixed income payments and are not entitled to repayment of principal.
These differences contribute to investment risk. Returns shown for long-term
government bonds are based on U.S. Treasury bonds with 20-year maturities.
Inflation is measured by the Consumer Price Index. The indexes are unmanaged and
are not available for investment.
Over time, although subject to greater risks and higher volatility, stocks
have outperformed all other investments by a wide margin, offering a solid hedge
against inflation. From January 1, 1926 to December 31, 1999, stocks beat all
other traditional asset classes. A $10,000 investment in the S&P 500 grew to
$28,456,286, significantly more than any other investment.
TAXES
BACKUP WITHHOLDING. The 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 or
PaineWebber with a correct taxpayer identification number. Withholding at that
rate also is required from dividends and capital gain distributions payable to
those shareholders who otherwise are subject to backup withholding.
SALE OR EXCHANGE OF FUND SHARES. A shareholder's sale (redemption) of fund
shares may result in a taxable gain or loss, depending on whether the
shareholder receives more or less than his or her adjusted basis for the shares
(which normally includes any initial sales charge paid on Class A shares). An
exchange of the fund's shares for shares of another PaineWebber mutual fund
generally will have similar tax consequences. In addition, if the 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 RULE FOR CLASS A SHAREHOLDERS. A special tax rule applies when a
shareholder sells or exchanges Class A shares of the fund within 90 days of
purchase and subsequently acquires Class A shares of the same fund 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 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.
CONVERSION OF CLASS B SHARES. A shareholder will recognize no gain or loss
as a result of a conversion of Class B shares to Class A shares.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY. The fund intends to
continue to qualify for treatment as a regulated investment company ("RIC")
under the Internal Revenue Code. To so qualify, the fund must distribute to its
shareholders for each taxable year at least 90% of its investment company
taxable income (consisting generally of net investment income and net short-term
capital gain) ("Distribution Requirement") and must meet several additional
requirements. For the 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 or 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 that are 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.
47
<PAGE>
government securities or the securities of other RICs) of any one issuer. If the
fund failed to qualify for treatment as a RIC for any taxable year, (1) it would
be taxed as an ordinary corporation on its taxable income for that year without
being able to deduct the distributions it makes to its shareholders and (2) the
shareholders would treat all those distributions, including distributions of net
capital gain (the excess of net long-term capital gain over net short-term
capital loss), as dividends (that is, ordinary income) to the extent of the
fund's earnings and profits. In addition, the fund could be required to
recognize unrealized gains, pay substantial taxes and interest and make
substantial distributions before requalifying for RIC treatment.
OTHER INFORMATION. Dividends and other distributions the fund declares in
December of any year that are payable to shareholders of record on a date in
that month will be deemed to have been paid by the fund and received by the
shareholders on December 31 if the distributions are paid by the fund during the
following January.
A portion of the dividends (whether paid in cash or in additional shares)
from the fund's investment company taxable income may be eligible for the
dividends-received deduction allowed to corporations. The eligible portion for
the fund may not exceed the aggregate dividends received by the 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 federal 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 thereon. Investors also
should be aware that if shares are purchased shortly before the record date for
a 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.
The 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 the calendar year and capital gain
net income for the one-year period ending on October 31 of that year, plus
certain other amounts.
The fund may invest in the stock of "passive foreign investment companies"
("PFICs") if that stock is a permissible investment. A PFIC is any foreign
corporation (with certain exceptions) 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 that stock (collectively
"PFIC income"), plus interest thereon, even if the fund distributes the PFIC
income as a taxable dividend to its shareholders. The balance of the PFIC income
will be included in the fund's investment company taxable income and,
accordingly, will not be taxable to it to the extent it distributes that income
to its shareholders.
If 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 (which it
may have to distribute to satisfy the Distribution Requirement and avoid
imposition of the Excise Tax) even if the QEF does not distribute those earnings
and gain to the fund. In most instances it will be very difficult, if not
impossible, to make this election because of certain of its requirements.
The 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 under the election (and under regulations proposed in 1992
that provided a similar election with respect to the stock of certain PFICs).
The fund's adjusted basis in each PFIC's stock with respect to which it has made
this election will be adjusted to reflect the amounts of income included and
deductions taken thereunder.
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<PAGE>
The use of hedging strategies involving Derivative Instruments, such as
writing (selling) and purchasing options and futures contracts, involves complex
rules that will determine for income tax purposes the amount, character and
timing of recognition of the gains and losses a fund realizes in connection
therewith. Gains from options and futures derived by the fund with respect to
its business of investing in securities will qualify as permissible income under
the Income Requirement.
Certain futures contracts in which the fund may invest may be subject to
section 1256 of the Internal Revenue Code ("section 1256 contracts"). Any
section 1256 contracts a fund holds at the end of each taxable year generally
must be "marked-to-market" (that is, treated as having been sold at that time
for their fair market value) for federal income tax purposes, with the result
that unrealized gains or losses will be treated as though they were realized.
Sixty percent of any net gain or loss recognized on these deemed sales, and 60%
of any net realized gain or loss from any actual sales of section 1256
contracts, will be treated as long-term capital gain or loss, and the balance
will be treated as short-term capital gain or loss. These rules may operate to
increase the amount that the fund must distribute to satisfy the Distribution
Requirement (i.e., with respect to the portion treated as short-term capital
gain), which will be taxable to its shareholders as ordinary income, and to
increase the net capital gain a fund recognizes, without in either case
increasing the cash available to the fund. The fund may elect not to have the
foregoing rules apply to any "mixed straddle" (that is, a straddle, clearly
identified by the fund in accordance with the regulations, at least one (but not
all) of the positions of which are section 1256 contracts), although doing so
may have the effect of increasing the relative proportion of net short-term
capital gain (taxable as ordinary income) and thus increasing the amount of
dividends that must be distributed.
Offsetting positions in any actively traded security, option or futures
contract entered into or held by the fund may constitute a "straddle" for
federal income tax purposes. Straddles are subject to certain rules that may
affect the amount, character and timing of the fund's gains and losses with
respect to positions of the straddle by requiring, among other things, that (1)
loss realized on disposition of one position of a straddle be deferred to the
extent of any unrealized gain in an offsetting position until the latter
position is disposed of, (2) the fund's holding period in certain straddle
positions not begin until the straddle is terminated (possibly resulting in gain
being treated as short-term rather than long-term capital gain) and (3) losses
recognized with respect to certain straddle positions, that otherwise would
constitute short-term capital losses, be treated as long-term capital losses.
Applicable regulations also provide certain "wash sale" rules, which apply to
transactions where a position is sold at a loss and a new offsetting position is
acquired within a prescribed period, and "short sale" rules applicable to
straddles. Different elections are available to the funds, which may mitigate
the effects of the straddle rules, particularly with respect to mixed straddles.
When a covered call option written (sold) by a fund expires, it will
realize a short-term capital gain equal to the amount of the premium it received
for writing the option. When the fund terminates its obligations under such an
option by entering into a closing transaction, it will realize a short-term
capital gain (or loss), depending on whether the cost of the closing transaction
is less (or more) than the premium it received when it wrote the option. When a
covered call option written by a fund is exercised, the fund will be treated as
having sold the underlying security, producing long-term or short-term capital
gain or loss, depending on the holding period of the underlying security and
whether the sum of the option price received on the exercise plus the premium
received when it wrote the option is more or less than the basis of the
underlying security.
If the fund has an "appreciated financial position" -- generally, an
interest (including an interest through an option or futures contract or short
sale) with respect to any stock, debt instrument (other than "straight debt") or
partnership interest the fair market value of which exceeds its adjusted basis
-- and enters into a "constructive sale" of the position, the fund will be
treated as having made an actual sale thereof, with the result that gain will be
recognized at that time. A constructive sale generally consists of a short sale,
an offsetting notional principal contract or a futures contract entered into by
the fund or a related person with respect to the same or substantially identical
property. In addition, if the appreciated financial position is itself a short
sale or such a contract, acquisition of the underlying property or substantially
identical property will be deemed a constructive sale. The foregoing will not
apply, however, to a fund's transaction during any taxable year that otherwise
would be treated as a constructive sale if the transaction is closed within 30
days after the end of that year and the fund holds the appre-
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<PAGE>
ciated financial position unhedged for 60 days after that closing (i.e., at no
time during that 60-day period is the fund's risk of loss regarding that
position reduced by reason of certain specified transactions with respect to
substantially identical or related property, such as having an option to sell,
being contractually obligated to sell, making a short sale or granting an option
to buy substantially identical stock or securities).
If the fund acquires zero coupon or other securities issued with original
issue discount ("OID") and/or Treasury inflation-protected securities ("TIPS"),
on which principal is adjusted based on changes in the Consumer Price Index, it
must include in its gross income the OID that accrues on those securities and
the amount of any principal increases on TIPS during the taxable year, even if
it receives no corresponding payment on them during the year. Similar treatment
applies with respect to securities purchased at a discount from their face value
("market discount"). Because the fund annually must distribute substantially all
of its investment company taxable income, including any accrued OID, market
discount and other non-cash income, to satisfy the Distribution Requirement and
avoid imposition of the Excise Tax, it 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 would have to be made from the fund's
cash assets or from the proceeds of sales of portfolio securities, if necessary.
The fund might realize capital gains or losses from those sales, which would
increase or decrease its investment company taxable income and/or net capital
gain.
The foregoing is only a general summary of some of the important federal
tax considerations generally affecting the fund and its shareholders. No attempt
is made to present a complete explanation of the federal tax treatment of the
fund's activities, and this discussion is not intended as a substitute for
careful tax planning. Accordingly, potential investors are urged to consult
their own tax advisers for more detailed information and for information
regarding any state, local or foreign taxes applicable to the fund and to
dividends and other distributions therefrom.
OTHER INFORMATION
CLASSES OF SHARES. A share of each class of the fund represents an
identical interest in the 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, if any. The different sales
charges and other expenses applicable to the different classes of shares of the
fund will affect the performance of those classes. Each share of the 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 and liquidation proceeds on Class A, B, C and Y shares
will differ.
VOTING RIGHTS. Shareholders of the 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 may elect all its board members. The shares of the
fund will be voted together, except that only the shareholders of a particular
class of the fund may vote on matters affecting only that class, such as the
terms of a Rule 12b-1 Plan as it relates to the class. The shares of each series
of the Corporation will be voted separately, except when an aggregate vote of
all the series is required by law.
The fund does not hold annual meetings. Shareholders of record of no less
than two-thirds of the outstanding shares of the Corporation 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
outstanding shares of the Corporation.
CLASS-SPECIFIC EXPENSES. The fund may 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 bear higher transfer agency fees per shareholder account than
those borne by Class A or Class Y shares. 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 invest-
50
<PAGE>
ment 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.
CUSTODIAN AND RECORDKEEPING AGENT; TRANSFER AND DIVIDEND AGENT. State
Street Bank and Trust Company, located at 1776 Heritage Drive, North Quincy,
Massachusetts 02171, serves as custodian and recordkeeping agent for each fund.
PFPC Inc., a subsidiary of PNC Bank, N.A, serves as the fund's transfer and
dividend disbursing agent. It is located at 400 Bellevue Parkway, Wilmington, DE
19809
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C. 20036-1800, serves as counsel to the fund.
Kirkpatrick & Lockhart LLP also acts as counsel to PaineWebber and Mitchell
Hutchins in connection with other matters.
AUDITORS. PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New
York, New York 10036, serves as the fund's independent accountants.
FINANCIAL STATEMENTS
The fund's Annual Report to Shareholders for the fiscal year ended August
31, 2000 is a separate document supplied with this SAI, and the financial
statements, accompanying notes and report of independent accountants appearing
therein are incorporated herein by this reference.
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APPENDIX
RATINGS INFORMATION
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 payment 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; Caa. Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest; Ca. Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings; C. Bonds which are rated C are the lowest rated class of
bonds, and issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category, the modifier
2 indicates a mid-range ranking, and the modifier 3 indicates a ranking in the
lower end of that 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 highest rated
obligations only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong; 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
least degree of speculation and C the highest. While such obligations 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 certainties 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
A-1
<PAGE>
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; CCC. An obligation rated CCC is
currently vulnerable to nonpayment and is dependent upon favorable business,
financial and economic conditions for the obligor to meet its financial
commitment on the obligation. In the event of adverse business, financial, or
economic conditions, the obligor is not likely to have the capacity to meet its
financial commitment on the obligation; CC. An obligation rated CC is currently
highly vulnerable to nonpayment; C. The C rating may be used to cover a
situation where a bankruptcy petition has been filed or similar action has been
taken, but payments on this obligation are not being continued; D. An obligation
rated D is in payment default. The D rating category is used when payments on an
obligation are not made on the date due even if the applicable grace period has
not expired, unless S&P believes that such payments will be made during such
grace period. The D rating also will be used upon the filing of a bankruptcy
petition or the taking of a similar action if payments on a obligation are
jeopardized.
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.
r. This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk-such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
A-2
<PAGE>
You should rely only on the information contained in the Prospectus and this
Statement of Additional Information. The fund and its distributor has not
authorized anyone to provide you with information that is different. The
Prospectus and this Statement of Additional Information are not an offer to sell
shares of the fund in any jurisdiction where the fund or its distributor may not
lawfully sell those shares.
------------
(C) 2000 PaineWebber Incorporated. All rights reserved.
PaineWebber
Balanced Fund
--------------------------------------------
Statement of Additional Information
December 31, 2000
--------------------------------------------
PaineWebber
(c) 2000 PaineWebber Incorporated. All rights reserved.
<PAGE>
PART C. OTHER INFORMATION
Item 23. EXHIBITS
(1) Restated Articles of Incorporation (1)
(2) Restated By-Laws (1)
(3) Instruments defining the rights of holders of the Registrant's
common stock (2)
(4) Investment Advisory and Administration Contract (1)
(5) (a) Form of Distribution Contract (filed herewith)
(b) Form of Dealer Agreement (filed herewith)
(6) Bonus, profit sharing or pension plans - none
(7) Custodian Agreement (1)
(8) Transfer Agency Agreement (1)
(9) Opinion and consent of counsel (to be filed)
(10) Other opinions, appraisals, rulings and consents: Accountant's
Consent (to be filed)
(11) Financial statements omitted from prospectus - none
(12) Letter of investment intent (1)
(13) (a) Plan of Distribution pursuant to Rule 12b-1 with respect to
Class A Shares (3)
(b) Plan of Distribution pursuant to Rule 12b-1 with respect to
Class B Shares (3)
(c) Plan of Distribution pursuant to Rule 12b-1 with respect to
Class C Shares (3)
(14) Multiple Class Plan pursuant to Rule 18f-3 (filed herewith)
(15) Code of Ethics for Registrant, its investment manager and its
principal distributor (4)
(1) Incorporated by reference from Post-Effective Amendment No. 34 to the
registration statement, SEC File No. - 33-2524, filed June 29, 1998.
(2) Incorporated by reference from Articles Sixth, Seventh, Eighth,
Eleventh and Twelfth of the Registrant's Restated Articles of
Incorporation and from Articles II, VIII, X, XI and XII of the
Registrant's Restated By-Laws.
(3) Incorporated by reference from Post-Effective Amendment No. 35 to the
registration statement, SEC File No. 33-2524, filed November 23, 1998.
(4) Incorporated by reference from Post-Effective Amendment No. 29 to the
registration statement of PaineWebber Mutual Fund Trust, SEC File
No. 2-98149, filed June 27, 2000.
Item 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
None.
<PAGE>
Item 25. INDEMNIFICATION
Article Eleventh of the Articles of Incorporation provides that the
directors and officers of the Registrant shall not be liable to the Registrant
or to any of its stockholders for monetary damages to the maximum extent
permitted by applicable law. Article Eleventh also provides that any repeal or
modification of Article Eleventh or adoption, or modification of any other
provision of the Articles or By-Laws inconsistent with Article Eleventh shall
not adversely affect any limitation of liability of any director or officer of
the Registrant with respect to any act or failure to act which occurred prior to
such repeal, modification or adoption.
Article Eleventh of the Articles of Incorporation and Section 10.01 of
Article X of the By-Laws provide that the Registrant shall indemnify and advance
expenses to its present and past directors, officers, employees and agents, and
any persons who are serving or have served at the request of the Registrant as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust, or enterprise, to the fullest extent permitted by law.
Section 10.02 of Article X of the By-Laws further provides that the
Registrant may purchase and maintain insurance on behalf of any person who is or
was a director, officer or employee of the Registrant, or is or was serving at
the request of the Registrant as a director, officer or employee of a
corporation, partnership, joint venture, trust or other enterprise against any
liability asserted against him or out of his or her status as such whether or
not the Registrant would have the power to indemnify him or her against such
liability.
Section 9 of the Investment Advisory and Administration Contract ("Advisory
Contract") provides that Mitchell Hutchins Asset Management Inc. ("Mitchell
Hutchins") shall not be liable for any error of judgment or mistake of law or
for any loss suffered by Registrant in connection with the matters to which the
Advisory Contract relates except for a loss resulting from willful misfeasance,
bad faith or gross negligence of Mitchell Hutchins in the performance of its
duties or from its reckless disregard of its obligations and duties under the
Advisory Contract. Section 9 further provides that any person, even though also
an officer, partner, employee or agent of Mitchell Hutchins, who may be or
become an officer, director, employee or agent of Registrant shall be deemed,
when rendering services to the Registrant or acting with respect to any business
of the Registrant, to be rendering such service to or acting solely for the
Registrant and not as an officer, partner, employee, or agent or one under the
control or direction of Mitchell Hutchins even though paid by it.
Section 9 of the Distribution Contract provides that the Registrant will
indemnify Mitchell Hutchins and its officers, directors or controlling persons
against all liabilities arising from any alleged untrue statement of material
fact in the Registration Statement or from alleged omission to state in the
Registration Statement a material fact required to be stated in it or necessary
to make the statements in it, in light of the circumstances under which they
were made, not misleading, except insofar as liability arises from untrue
statements or omissions made in reliance upon and in conformity with information
furnished by Mitchell Hutchins to the Registrant for use in the Registration
Statement; and provided that this indemnity agreement shall not protect any such
persons against liabilities arising by reason of their bad faith, gross
negligence or willful misfeasance; and shall not inure to the benefit of any
such persons unless a court of competent jurisdiction or controlling precedent
determines that such result is not against public policy as expressed in the
Securities Act of 1933. Section 9 of the Distribution Contract also provides
that Mitchell Hutchins agrees to indemnify, defend and hold the Registrant, its
officers and directors free and harmless of any claims arising out of any
alleged untrue statement or any alleged omission of material fact contained in
information furnished by Mitchell Hutchins for use in the Registration Statement
or arising out of an agreement between Mitchell Hutchins and any retail dealer,
or arising out of supplementary literature or advertising used by Mitchell
Hutchins in connection with the Distribution Contract.
Section 9 of the Dealer Agreement contains provisions similar to Section 9
of the Distribution Contract, with respect to PaineWebber Incorporated
("PaineWebber").
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended, may be provided to directors, officers and controlling
persons of the Registrant, pursuant to the foregoing provisions or
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<PAGE>
otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in connection with the successful defense
of any action, suit or proceeding or payment pursuant to any insurance policy)
is asserted against the Registrant by such director, officer or controlling
person in connection with the securities being registered, the Registrant will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
Item 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Mitchell Hutchins, a Delaware corporation, is a registered investment
adviser and is a wholly owned subsidiary of PaineWebber which is, in turn, a
wholly owned subsidiary of Paine Webber Group Inc. Mitchell Hutchins is
primarily engaged in the investment advisory business. Information as to the
officers and directors of Mitchell Hutchins is included in its Form ADV, as
filed with the Securities and Exchange Commission (registration number
801-13219) and is incorporated herein by reference.
Item 27. PRINCIPAL UNDERWRITERS
a) Mitchell Hutchins serves as principal underwriter and/or investment
adviser for the following investment companies:
ALL-AMERICAN TERM TRUST, INC.
GLOBAL HIGH INCOME DOLLAR FUND, INC.
INSURED MUNICIPAL INCOME FUND, INC.
INVESTMENT GRADE MUNICIPAL INCOME FUND, INC.
MANAGED HIGH YIELD PLUS FUND INC.
MITCHELL HUTCHINS LIR MONEY SERIES
MITCHELL HUTCHINS PORTFOLIOS
MITCHELL HUTCHINS SECURITIES TRUST
MITCHELL HUTCHINS SERIES TRUST
PAINEWEBBER AMERICA FUND
PAINEWEBBER FINANCIAL SERVICES GROWTH FUND, INC.
PAINEWEBBER INDEX TRUST
PAINEWEBBER INVESTMENT SERIES
PAINEWEBBER INVESTMENT TRUST
PAINEWEBBER INVESTMENT TRUST II
PAINEWEBBER MANAGED ASSETS TRUST
PAINEWEBBER MANAGED INVESTMENTS TRUST
PAINEWEBBER MASTER SERIES, INC.
PAINEWEBBER MUNICIPAL SERIES
PAINEWEBBER MUTUAL FUND TRUST
PAINEWEBBER OLYMPUS FUND
PAINEWEBBER SECURITIES TRUST
STRATEGIC GLOBAL INCOME FUND, INC.
2002 TARGET TERM TRUST, INC.
b) Mitchell Hutchins is the principal underwriter for the Registrant.
PaineWebber acts as dealer for the shares of the Registrant. The
directors and officers of Mitchell Hutchins, their principal business
addresses and their positions and offices with Mitchell Hutchins are
identified in its Form ADV, as filed with the Securities and
C-3
<PAGE>
Exchange Commission (registration number 801-13219). The
directors and officers of PaineWebber, their principal business
addresses and their positions and offices with PaineWebber are
identified in its Form ADV, as filed with the Securities and Exchange
Commission (registration number 801-7163). The foregoing information
is hereby incorporated herein by reference. The information set forth
below is furnished for those directors and officers of Mitchell
Hutchins or PaineWebber who also serve as directors or officers of the
Registrant.
<TABLE>
<CAPTION>
Position and Offices With Underwriter or
Name Position and Offices With Registrant Dealer
---- ----------------------------------- ----------------------------------------
<S> <C> <C>
Margo N. Alexander* Director and President Chairman, Chief Executive Officer and a Director
of Mitchell Hutchins and an Executive Vice
President and a Director of PaineWebber
Brian M. Storms* Director Chief Executive Officer, President and Chief
Operating Officer of Mitchell Hutchins
T. Kirkham Barneby* Vice President Managing Director and Chief Investment Officer -
Quantitative Investments of Mitchell Hutchins
Amy Doberman** Vice President Senior Vice President and General Counsel of
Mitchell Hutchins
John J. Lee*** Vice President and Assistant Treasurer Vice President and a Manager of the Mutual Fund
Finance Department of Mitchell Hutchins
Kevin J. Mahoney*** Vice President and Assistant Treasurer First Vice President and a Senior Manager of the
Mutual Fund Finance Department of Mitchell
Hutchins
Ann E. Moran*** Vice President and Assistant Treasurer Vice President and a Manager of the Mutual Fund
Finance Department of Mitchell Hutchins
Dianne E. O'Donnell** Vice President and Secretary Senior Vice President and Deputy General Counsel
of Mitchell Hutchins
Susan P. Ryan* Vice President Senior Vice President and Portfolio Manager of
Mitchell Hutchins
Paul H. Schubert*** Vice President and Treasurer Senior Vice President and Director of the Mutual
Fund Finance Department of Mitchell Hutchins
Barney A. Taglialatela*** Vice President and Assistant Treasurer Vice President and a Manager of the Mutual Fund
Finance Department of Mitchell Hutchins
Keith A. Weller** Vice President and Assistant Secretary First Vice President and Associate General
Counsel of Mitchell Hutchins
</TABLE>
-----------------
* This person's business address is 51 West 52nd Street, New York, New York
10019-6114.
** This person's business address is 1285 Avenue of the Americas, New York,
New York 10019-6028.
*** This person's business address is Newport Center III, 499 Washington Blvd.,
Jersey City, New Jersey 07310-1998.
c) None
Item 28. LOCATION OF ACCOUNTS AND RECORDS
The books and other documents required by paragraphs (b)(4), (c) and
(d) of Rule 31a-1 under the Investment
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<PAGE>
Company Act of 1940 are maintained in the physical possession of
Mitchell Hutchins at 1285 Avenue of the Americas, New York, New York
10019-6028 and 51 West 52nd Street, New York, New York 10019-6114. All
other accounts, books and documents required by Rule 31a-1 are
maintained in the physical possession of Registrant's transfer agent
and custodian.
Item 29. MANAGEMENT SERVICES
Not applicable.
Item 30. UNDERTAKINGS
None.
C-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this
Post-Effective Amendment to its Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of New York
and State of New York, on the 30th day of October, 2000.
PAINEWEBBER MASTER SERIES, INC.
By: /s/ DIANNE E. O'DONNELL
--------------------------------
Dianne E. O'Donnell
Vice President and Secretary
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment has been signed below by the following persons in the
capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ MARGO N. ALEXANDER President and Director October 30, 2000
-------------------------- (Chief Executive Officer)
Margo N. Alexander *
/s/ E. GARRETT BEWKES, JR. Director and Chairman October 30, 2000
-------------------------- of the Board of Directors
E. Garrett Bewkes, Jr. *
/s/ RICHARD Q. ARMSTRONG Director October 30, 2000
--------------------------
Richard Q. Armstrong *
/s/ RICHARD R. BURT Director October 30, 2000
--------------------------
Richard R. Burt *
/s/ MEYER FELDBERG Director October 30, 2000
--------------------------
Meyer Feldberg *
/s/ GEORGE W. GOWEN Director October 30, 2000
--------------------------
George W. Gowen *
/s/ FREDERIC V. MALEK Director October 30, 2000
--------------------------
Frederic V. Malek *
/s/ CARL W. SCHAFER Director October 30, 2000
--------------------------
Carl W. Schafer *
/s/ BRIAN M. STORMS Director October 30, 2000
--------------------------
Brian M. Storms **
/s/ PAUL H. SCHUBERT Vice President and October 30, 2000
-------------------------- Treasurer (Chief Financial
Paul H. Schubert and Accounting Officer)
<PAGE>
SIGNATURES (CONTINUED)
* Signature affixed by Elinor W. Gammon pursuant to powers of attorney
dated May 21, 1996 and incorporated by reference from Post-Effective
Amendment No. 25 to the registration statement of PaineWebber RMA
Tax-Free Fund, Inc., SEC File 2-78310, filed June 27, 1996.
** Signature affixed by Elinor W. Gammon pursuant to power of attorney
dated May 14, 1999 and incorporated by reference from Post-Effective
Amendment No. 38 to the registration statement of PaineWebber Cashfund,
Inc., SEC File 2-60655, filed May 28, 1999.
<PAGE>
PAINEWEBBER MASTER SERIES, INC.
EXHIBIT INDEX
Exhibit
NUMBER
(1) Restated Articles of Incorporation (1)
(2) Restated By-Laws (1)
(3) Instruments defining the rights of holders of the Registrant's
common stock (2)
(4) Investment Advisory and Administration Contract (1)
(5) (a) Form of Distribution Contract (filed herewith)
(b) Form of Dealer Agreement (filed herewith)
(6) Bonus, profit sharing or pension plans - none
(7) Custodian Agreement (1)
(8) Transfer Agency Agreement (1)
(9) Opinion and consent of counsel (to be filed)
(10) Other opinions, appraisals, rulings and consents: Accountant's Consent
(to be filed)
(11) Financial statements omitted from prospectus - none
(12) Letter of investment intent (1)
(13) (a) Plan of Distribution pursuant to Rule 12b-1 with respect to
Class A Shares (3)
(b) Plan of Distribution pursuant to Rule 12b-1 with respect to
Class B Shares (3)
(c) Plan of Distribution pursuant to Rule 12b-1 with respect to
Class C Shares (3)
(14) Multiple Class Plan pursuant to Rule 18f-3 (filed herewith)
(15) Code of Ethics for Registrant, its investment manager and its
principal distributor (4)
(1) Incorporated by reference from Post-Effective Amendment No. 34 to the
registration statement, SEC File No. 33-2524, filed June 29, 1998.
(2) Incorporated by reference from Articles Sixth, Seventh, Eighth, Eleventh
and Twelfth of the Registrant's Restated Articles of Incorporation and
from Articles II, VIII, X, XI and XII of the Registrant's Restated
By-Laws.
(3) Incorporated by reference from Post-Effective Amendment No. 35 to the
registration statement, SEC File No. 33-2524, filed November 23, 1998.
(4) Incorporated by reference from Post-Effective Amendment No. 29 to the
registration statement of PaineWebber Mutual Fund Trust, SEC File
No. 2-98149, filed June 27, 2000.
