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.
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly
owned asset management subsidiary of PaineWebber Incorporated ("PaineWebber")
serves as investment adviser, administrator and distributor for the fund. 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
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The Fund and Its Investment Policies............................................................... 2
The Fund's Investments, Related Risks and Limitations.............................................. 2
Strategies Using Derivative Instruments............................................................ 18
Organization of the Corporation; Board Members and Officers; Principal Holders and
Management Ownership of Securities................................................................ 25
Investment Advisory, Administration and Distribution Arrangements.................................. 32
Portfolio Transactions............................................................................. 36
Reduced Sales Charges, Additional Exchange and Redemption Information and Other Services........... 38
Conversion of Class B Shares....................................................................... 44
Valuation of Shares................................................................................ 44
Performance Information............................................................................ 45
Taxes.............................................................................................. 48
Other Information.................................................................................. 51
Financial Statements............................................................................... 52
Appendix........................................................................................... A-1
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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 depositary receipts. Common stocks,
the most familiar type, represent an equity (ownership) interest in a
corporation.
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Preferred stock has certain fixed income features, like a bond, but is
actually an equity security 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 the 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 the 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
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classification and between classifications. An issuer's obligations under its
bonds are subject to the provisions of bankruptcy, insolvency and other laws
affecting the rights and remedies of bond holders or other creditors of an
issuer; litigation or other conditions may also adversely affect the power or
ability of issuers to meet their obligations for the payment of interest and
principal on their bonds.
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, high risk 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 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 program, the
principal and interest components are individually numbered and separately
issued by the U.S. Treasury.
Treasury inflation-indexed securities ("TIIS") are Treasury bonds on
which the principal value is adjusted daily in accordance with changes in the
Consumer Price Index. Interest on TIIS is payable semi-annually on the adjusted
principal value. The principal value of TIIS 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 TIIS, the fund may earn less on the TIIS than it would on conventional
Treasury bonds. Any increase in the principal value of TIIS 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 and vice versa.
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
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securities that Mitchell Hutchins believe may assist the fund in achieving its
investment objective. Similarly, the 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
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date. Principal prepayments on the Mortgage Assets may cause CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrued on all classes of a CMO (other than any 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 traditional debt securities. Among the major differences are that interest
and principal payments are made more frequently, usually monthly, and that
principal may be prepaid
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at any time because the underlying mortgage loans or other obligations generally
may be prepaid at any time. Prepayments on a pool of mortgage loans are
influenced by a variety of economic, geographic, social and other factors,
including changes in mortgagors' housing needs, job transfers, unemployment,
mortgagors' net equity in the mortgaged properties and servicing decisions.
Generally, however, prepayments on fixed-rate mortgage loans will increase
during a period of falling interest rates and decrease during a period of rising
interest rates. Similar factors apply to prepayments on asset-backed securities,
but the receivables underlying asset-backed securities generally are of a
shorter maturity and thus are less likely to experience substantial prepayments.
Such securities, however, often provide that for a specified time period the
issuers will replace receivables in the pool that are repaid with comparable
obligations. If the issuer is unable to do so, repayment of principal on the
asset-backed securities may commence at an earlier date. Mortgage- and
asset-backed securities may decrease in value as a result of increases in
interest rates and may benefit less than other fixed-income securities from
declining interest rates because of the risk of prepayment.
The rate of interest on mortgage-backed securities is lower than the
interest rates paid on the mortgages included in the underlying pool due to the
annual fees paid to the servicer of the mortgage pool for passing through
monthly payments to certificateholders and to any guarantor, and due to any
yield retained by the issuer. Actual yield to the holder may vary from the
coupon rate, even if adjustable, if the mortgage-backed securities are purchased
or traded in the secondary market at a premium or discount. In addition, there
is normally some delay between the time the issuer receives mortgage payments
from the servicer and the time the issuer makes the payments on the
mortgage-backed securities, and this delay reduces the effective yield to the
holder of such securities.
Yields on pass-through securities are typically quoted by investment
dealers and vendors based on the maturity of the underlying instruments and the
associated average life assumption. The average life of pass-through pools
varies with the maturities of the underlying mortgage loans. A pool's term may
be shortened by unscheduled or early payments of principal on the underlying
mortgages. Because prepayment rates of individual pools vary widely, it is not
possible to predict accurately the average life of a particular pool. In the
past, a common industry practice 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
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sufficient to pay the interest accruing on the ARM, any such excess interest is
added to the mortgage loan ("negative amortization"), which is repaid through
future 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 con-
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siderations and market supply and demand, can cause particular securities to
respond somewhat differently to changes in 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 the 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 realized 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 the 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
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unmatured interest coupons (unmatured interest payments) and receipts or
certificates representing interests in 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
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as part of its normal investment program. Such investments 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 applicable,
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 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 the 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."
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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 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 it holds, 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 board 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.
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SHORT SALES "AGAINST THE BOX." The fund may engage in short sales of
securities it owns or has the right to acquire at no added cost through
conversion or exchange of other securities it owns (short sales "against the
box"). To make delivery to the purchaser in a short sale, the executing broker
borrows the securities being sold short on behalf of 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. With regard to the borrowing limitation in fundamental limitation
number 3, the fund will comply with the applicable restrictions of Section 18 of
the Investment Company Act.
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.
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(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 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.
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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, however, the fund's use
of these instruments will place at risk a much smaller portion of its assets.
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, a contract is closed out prior to its expiration
date.
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.
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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 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."
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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 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.
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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 portion
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
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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.
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
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a borrowing, but rather is in the nature of a performance bond or good-faith
deposit that is returned to the fund at the termination of the transaction if
all contractual obligations have been satisfied. Under certain circumstances,
such as periods of high volatility, 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.
23
<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.
24
<PAGE>
ORGANIZATION OF THE CORPORATION; 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 presently 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 THE
NAME AND ADDRESS; AGE CORPORATION BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ----------------- ---------------------------------------------
<S> <C> <C>
Margo N. Alexander*+; 53 Director Mrs. Alexander is Chairman (since March
1999), 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 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
One Old Church Road firm (since April 1991 and principal
Unit #6 occupation since March 1995). He is also a
Greenwich, CT 06830 director of AlFresh Beverages Canada, Inc. (a
Canadian Beverage subsidiary of AlFresh Foods
Inc.) (since October 2000). Mr. Armstrong was
chairman of the 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 Mo`t 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 THE
NAME AND ADDRESS; AGE CORPORATION BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ----------------- ---------------------------------------------
<S> <C> <C>
E. Garrett Bewkes, Jr.**+; 74 Director and Mr. Bewkes is a consultant to PaineWebber
Chairman of the Board (since May 1999). Prior to November 2000, he
of Directors was a Directors director of PaineWebber Group
Inc. ("PW Group", formerly the holding
company of PaineWebber and Mitchell Hutchins)
and prior to 1996, he was a consultant to PW
Group. Prior to 1988, he was chairman of the
board, president and chief executive officer
of American Bakeries Company. Mr. Bewkes is a
director of Interstate Bakeries Corporation.
Mr. Bewkes is a director or trustee of 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
Washington, DC 20004 firm) (since March 1994) and a partner of
McKinsey & Company (management consulting
firm) (since 1991). He is also a director of
Archer-Daniels-Midland Co. (agricultural
commodities), 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
Columbia University Management of the Graduate School of
101 Uris Hall Business, Columbia University. Prior to 1989,
New York, NY 10027 he was president of 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 THE
NAME AND ADDRESS; AGE 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
1455 Pennsylvania Ave., N.W. Partners (merchant bank) and chairman of
Suite 350 Thayer Hotel Investors II and Lodging
Washington, DC 20004 Opportunities Fund (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. (teleservices), 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 THE
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
and President October 2000) and president 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 president and 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 14 investment companies for
which Mitchell Hutchins, PaineWebber or one
of their affiliates serves as investment
adviser.
Thomas Disbrow***, 34 Vice President and Mr. Disbrow is a first vice president and a
Assistant Treasurer senior manager of the mutual fund finance
department of Mitchell Hutchins. Prior to
November 1999, he was a vice president of
Zweig/Glaser Advisers. Mr. Disbrow 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.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH THE
NAME AND ADDRESS; AGE CORPORATION BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ----------------- ---------------------------------------------
<S> <C> <C>
Amy R. 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.
John J. Lee***; 32 Vice President and Mr. Lee is a vice president and a manager of
Assistant Treasurer the mutual fund finance department of
Mitchell Hutchins. Prior to September 1997,
he was an audit manager in the financial
services practice of Ernst & Young LLP. Mr.
Lee is a vice president and assistant
treasurer of 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
Assistant Treasurer of 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 a
portfolio manager of Mitchell Hutchins. Ms.
Ryan is a vice president of six investment
companies for which Mitchell Hutchins,
PaineWebber or one of their affiliates serves
as investment adviser.
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH THE
NAME AND ADDRESS; AGE CORPORATION BUSINESS EXPERIENCE; OTHER DIRECTORSHIPS
--------------------- ----------------- ---------------------------------------------
<S> <C> <C>
Paul H. Schubert***; 37 Vice President and Mr. Schubert is a senior vice president and
Treasurer the 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.
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 senior 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 and/or PaineWebber.
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 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.
30
<PAGE>
COMPENSATION TABLE+
<TABLE>
<CAPTION>
AGGREGATE TOTAL COMPENSATION
COMPENSATION FROM THE
FROM THE CORPORATION AND THE
NAME OF PERSON, POSITION CORPORATION* FUND COMPLEX**
------------------------- ------------ --------------------
<S> <C> <C>
Richard Q. Armstrong, Director................... $4,060 $104,650
Richard R. Burt, Director........................ 4,060 102,850
Meyer Feldberg, Director......................... 4,060 143,650
George W. Gowen, Director........................ 4,807 138,400
Frederic V. Malek, Director...................... 4,060 104,650
Carl W. Schafer, Director........................ 4,000 104,650
</TABLE>
---------------
+ 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
fund's records as owning 5% or more of the fund's Class Y shares. Management is
not aware of any other person who owns of record or beneficially 5% or more of
any class of the fund's shares.
PERCENTAGE OF CLASS Y SHARES
NAME AND ADDRESS OWNED AS OF NOVEMBER 30, 2000
----------------- -----------------------------
Anne L. Solnit, Trustee of the
Anne L. Solnit Trust dated 05/06/97 12.99%
PaineWebber Custodian
Siegfried Richard Weigele 5.37%
PaineWebber Custodian
PaineWebber CDNFBO
Fred Bruce IRA 5.16%
------------
* The shareholders listed may be contacted c/o Mitchell Hutchins Asset
Management Inc., 51 West 52nd Street, New York, NY 10019-6114.
31
<PAGE>
INVESTMENT ADVISORY, ADMINISTRATION AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY AND ADMINISTRATION ARRANGEMENTS. Mitchell Hutchins
acts as the investment adviser and administrator of the fund pursuant to a
contract ("Advisory Contract") with the Corporation. Under the Advisory
Contract, the fund pays 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 ended August 31, 2000, August 31, 1999 and
August 31, 1998, Mitchell Hutchins earned (or accrued) advisory and
administration fees of $1,697,170, $1,890,996 and $1,709,264, respectively.
Under the terms of the 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 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 years ended August 31, 2000,
August 31, 1999 and August 31, 1998, the fund paid (or accrued) $12,738, $17,852
and $28,144, respectively, to PaineWebber for its services as securities lending
agent.
32
<PAGE>
NET ASSETS. The following table shows the approximate net assets as of
November 30, 2000, sorted by category of investment objective, of the investment
companies as to which Mitchell Hutchins serves as adviser. An investment company
may fall into more than one of the categories below.
Net Assets
Investment Category ($mil)
------------------------------------ ------
Domestic (excluding Money Market)................ $ 7,949
Global........................................... 4,526
Equity/Balanced.................................. 8,456
Fixed Income (excluding Money Market)............ 4,019
Taxable Fixed Income...................... 2,631
Tax-Free Fixed Income..................... 1,387
Money Market Funds............................... 47,003
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.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of
each class of shares of the fund under a 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 agreement
between Mitchell Hutchins and PaineWebber relating to each class of shares of
the fund ("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 and Class C shares, respectively. There is no distribution plan with
respect to the fund's Class Y shares, and the fund pays no service or
distribution fees with respect to its Class Y shares.
Mitchell Hutchins uses the service fees under the Plans for Class A,
Class B and Class 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.
33
<PAGE>
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 Contract for Class A, Class B
and Class C shares specify that the 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 Corporation and who have no direct or indirect financial
interest in the operation of the Plan or any agreement related to the Plan,
acting in person at a meeting called for that purpose, (3) payments by 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................................. $461,035
Class B................................. 233,944
Class C................................. 179,819
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.............................$278,493
Amortization of commissions........................... 0
Printing of prospectuses and SAIs..................... 1,225
Branch network costs allocated and interest expense... 564,748
Service fees paid to PaineWebber Financial Advisors... 177,525
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CLASS B
Marketing and advertising.............................$35,341
Amortization of commissions........................... 91,470
Printing of prospectuses and SAIs..................... 143
Branch network costs allocated and interest expense... 85,048
Service fees paid to PaineWebber Financial Advisors... 22,544
CLASS C
Marketing and advertising.............................$27,167
Amortization of commissions........................... 51,937
Printing of prospectuses and SAIs..................... 131
Branch network costs allocated and interest expense... 56,022
Service fees paid to PaineWebber Financial Advisors... 17,311
"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 Pricing(SM) 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
shareholders, (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
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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 each 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 each Plan in that Mitchell
Hutchins would receive service, distribution and advisory fees that are
calculated based upon a percentage of the average net assets of the fund, which
fees would increase if the Plan were successful and the fund attained and
maintained significant asset levels.
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
reallowances to PaineWebber as dealer.
FISCAL YEARS ENDED AUGUST 31,
2000 1999 1998
---- ---- ----
Earned....................$ 24,562 $ 91,158 $ 368,103
Retained.................. 7,332 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............................ $ 0
Class B............................57,916
Class C............................ 4,710
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
ended August 31, 2000, August 31, 1999 and August 31, 1998, the fund paid
$246,379, $367,133 and $290,954, respectively in brokerage commissions.
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The fund has no obligation to deal with any broker or group of brokers
in the execution of portfolio transactions. The fund contemplates that,
consistent with the policy of obtaining the best net results, brokerage
transactions may be conducted through Mitchell Hutchins or its affiliates,
including PaineWebber. 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. During the fiscal years
ended August 31, 2000, August 31, 1999 and August 31, 1998, the fund paid
$10,324, $14,808 and $1,038, respectively, in brokerage commissions to
PaineWebber.
During the fiscal year ended August 31, 2000, the brokerage commissions
paid by the fund to PaineWebber represented 4.19% of the total commissions paid
by the fund and 5.45% 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 $42,727,369 in portfolio transactions to brokers chosen because they
provided research services, for which the fund paid $58,665 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 effects securities transactions may be used
by Mitchell Hutchins in advising other funds or accounts and, conversely,
research services furnished to Mitchell Hutchins by brokers or dealers in
connection with other funds or accounts that it advises may be used in advising
the fund.
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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 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.
As of August 31, 2000, the fund owned securities issued by the
following companies which are regular broker-dealers for the fund:
ISSUER TYPE OF SECURITY VALUE
------- ---------------- ------
FleetBoston Financial Corp. Common Stock $ 1,809,950
Morgan Stanley Dean Witter & Co. Common Stock 4,808,044
Morgan Stanley Dean Witter & Co. Corp. Bond 2,299,173
Bank One Corp. Corp. Bond 789,813
Lehman Brothers Holdings Inc. Corp. Bond 1,312,845
HSBC Capital Funding Corp. Bond 744,884
CS First Boston Mortgage Securities
Corp., Series 1997-2, Class A CMO 192,886
Morgan Stanley Capital I Inc, Series
1997-C1, Class A1-A CMO 24,709
Morgan Stanley Capital I Inc, Series
1997-WF1, Class A1 CMO 452,672
SG Cowen & Co. Repurchase Agreement 5,812,000
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 ended August 31, 2000 and August
31, 1999 were 151% and 234%, respectively.
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;
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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.
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.
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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 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 A SHARES THROUGH THE PAINEWEBBER INSIGHTONE(SM)
PROGRAM. Investors who purchase shares through the PaineWebber InsightOne(SM)
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.
PAYMENTS BY MITCHELL HUTCHINS -- CLASS Y SHARES. Class Y shares are
sold without sales charges and do not pay ongoing 12b-1 distribution or service
fees. As distributor of the Class Y shares, Mitchell Hutchins may, from time to
time, make payments out of its own resources to PaineWebber and other dealers
who sell Class Y shares to shareholders who buy $10 million or more of PACEor
PaineWebber fund shares at any one time.
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 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
for employees of PaineWebber and certain of its affiliates, 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,
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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, the 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 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's Class A, Class B or
Class C shares. In addition to providing a convenient and disciplined manner of
investing, 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,
since an 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 in Class B or
Class C shares would qualify for Class A sales load reductions.
SYSTEMATIC WITHDRAWAL PLAN--CLASS A, CLASS B AND CLASS C SHARES. The
systematic withdrawal plan allows investors to set up monthly, quarterly (March,
June, September and December), semi-annual (June and
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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 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)
Class A, Class B, Class C and Class Y shares of PaineWebber mutual
funds, including the PACE 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
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<PAGE>
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 in Class B or Class C shares would qualify for Class A sales load
reductions.
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.
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<PAGE>
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
portion 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 securi-
44
<PAGE>
ties 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 formula method that takes
into consideration market indices, matrices, yield curves and other specific
adjustments. This may result in the securities being valued at a price different
from the price that would have been determined had the matrix or formula method
not been used. Securities may be valued based upon appraisals derived from
information concerning the security or similar securities received from
recognized dealers in those securities. All cash, receivables and current
payables are carried at their face value. 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:
P(1 + T)n = 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.
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.
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<PAGE>
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.
<TABLE>
<CAPTION>
CLASS CLASS A CLASS B CLASS C CLASS Y
----- ------- ------- ------- -------
(INCEPTION DATE) (7/1/91) (12/12/86) (7/2/92) (3/26/98)
---------------- --------- ---------- -------- ---------
<S> <C> <C> <C> <C>
Year ended August 31, 2000:
Standardized Return*.................. 3.37% 2.56% 6.49% 8.54%
Non-Standardized Return............... 8.27% 7.44% 7.46% 8.54%
Five Years ended August 31, 2000:
Standardized Return*.................. 12.22% 12.19% 12.43% N/A
Non-Standardized Return............... 13.27% 12.44% 12.43% N/A
Ten Years ended August 31, 2000:
Standardized Return*.................. N/A 11.49% N/A N/A
Non-Standardized Return............... N/A 11.49% N/A N/A
Inception to August 31, 2000:
Standardized Return*.................. 10.87% 9.65% 10.64% 5.70%
Non-Standardized Return............... 11.43% 9.65% 10.64% 5.70%
</TABLE>]
--------------
* All Standardized Return figures for Class A shares reflect deduction of the
current maximum sales charge of 4.5%. All Standardized Return figures for
Class B and Class C shares reflect deduction of the applicable contingent
deferred sales charges imposed on a redemption of shares held for the period.
Class Y shares do not impose an initial or contingent deferred sales charge;
therefore, the performance information is the same for both standardized
return and non-standardized return for the periods indicated.
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 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.
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<PAGE>
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 fund's
performance to CD performance, investors should keep in mind that bank CDs are
insured in whole or in part by an agency of the U.S. government and offer fixed
principal and fixed or variable rates of interest, and that bank CD yields may
vary depending on the financial institution offering the CD and prevailing
interest rates. 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.
[REPRESENTATION OF GRAPH IN PRINTED PIECE.]
IBBOTSON CHART PLOT POINTS
Chart showing performance of S&P 500, long-term U.S. government bonds,
Treasury Bills and inflation from 1925 through 1999
<TABLE>
<CAPTION>
YEAR COMMON STOCKS LONG-TERM GOV'T BONDS INFLATION/CPI TREASURY BILLS
<S> <C> <C> <C> <C>
1925 $10,000 $10,000 $10,000 $10,000
1926 $11,162 $10,777 $9,851 $10,327
1927 $15,347 $11,739 $9,646 $10,649
1928 $22,040 $11,751 $9,553 $11,028
1929 $20,185 $12,153 $9,572 $11,552
1930 $15,159 $12,719 $8,994 $11,830
1931 $8,590 $12,044 $8,138 $11,957
1932 $7,886 $14,073 $7,300 $12,072
1933 $12,144 $14,062 $7,337 $12,108
1934 $11,969 $15,472 $7,486 $12,128
1935 $17,674 $16,243 $7,710 $12,148
1936 $23,669 $17,464 $7,803 $12,170
1937 $15,379 $17,504 $8,045 $12,207
1938 $20,165 $18,473 $7,821 $12,205
1939 $20,082 $19,570 $7,784 $12,208
1940 $18,117 $20,761 $7,859 $12,208
1941 $16,017 $20,955 $8,622 $12,216
1942 $19,275 $21,629 $9,423 $12,248
1943 $24,267 $22,080 $9,721 $12,291
1944 $29,060 $22,702 $9,926 $12,332
1945 $39,649 $25,139 $10,149 $12,372
1946 $36,449 $25,113 $11,993 $12,416
1947 $38,529 $24,454 $13,073 $12,478
1948 $40,649 $25,285 $13,426 $12,580
1949 $48,287 $26,916 $13,184 $12,718
1950 $63,601 $26,932 $13,948 $12,870
1951 $78,875 $25,873 $14,767 $13,063
1952 $93,363 $26,173 $14,898 $13,279
1953 $92,439 $27,125 $14,991 $13,521
1954 $141,084 $29,075 $14,916 $13,638
1955 $185,614 $28,699 $14,972 $13,852
1956 $197,783 $27,096 $15,400 $14,193
1957 $176,457 $29,117 $15,866 $14,639
1958 $252,975 $27,342 $16,145 $14,864
1959 $283,219 $26,725 $16,387 $15,303
1960 $284,549 $30,407 $16,629 $15,711
1961 $361,060 $30,703 $16,741 $16,045
1962 $329,545 $32,818 $16,946 $16,483
1963 $404,685 $33,216 $17,225 $16,997
1964 $471,388 $34,381 $17,430 $17,598
1965 $530,081 $34,625 $17,765 $18,289
1966 $476,737 $35,889 $18,361 $19,159
1967 $591,038 $32,594 $18,920 $19,966
1968 $656,415 $32,509 $19,814 $21,005
1969 $600,590 $30,860 $21,024 $22,388
1970 $624,653 $34,596 $22,179 $23,849
1971 $714,058 $39,173 $22,924 $24,895
1972 $849,559 $41,400 $23,706 $25,851
1973 $725,003 $40,942 $25,792 $27,643
1974 $533,110 $42,725 $28,939 $29,855
1975 $731,443 $46,653 $30,969 $31,588
1976 $905,842 $54,470 $32,458 $33,193
1977 $840,766 $54,095 $34,656 $34,893
1978 $895,922 $53,458 $37,784 $37,398
1979 $1,061,126 $52,799 $42,812 $41,279
1980 $1,405,137 $50,715 $48,120 $45,917
1981 $1,336,161 $51,657 $52,421 $52,671
1982 $1,622,226 $72,507 $54,451 $58,224
1983 $1,987,451 $72,979 $56,518 $63,347
1984 $2,111,991 $84,274 $58,753 $69,586
1985 $2,791,166 $110,371 $60,968 $74,960
1986 $3,306,709 $137,446 $61,657 $79,580
1987 $3,479,675 $133,716 $64,376 $83,929
1988 $4,064,583 $146,650 $67,221 $89,257
1989 $5,344,555 $173,215 $70,345 $96,728
1990 $5,174,990 $183,924 $74,640 $104,286
1991 $6,755,922 $219,420 $76,927 $110,121
1992 $7,274,115 $237,092 $79,159 $113,982
1993 $8,000,785 $280,339 $81,334 $117,284
1994 $8,105,379 $258,556 $83,510 $121,862
1995 $11,139,184 $340,435 $85,630 $128,680
1996 $13,709,459 $337,265 $88,475 $135,381
1997 $18,272,762 $390,735 $89,897 $142,496
1998 $23,495,420 $441,777 $91,513 $149,416
1999 $28,456,286 $402,177 $93,998 $156,414
</TABLE>
Source: STOCKS, BONDS, BILLS AND INFLATION 1999 YEARBOOK(TM), Ibbotson Assoc.,
Chi., (annual updates work by Roger G. Ibbotson & Rex A. Sinquefield).
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.
47
<PAGE>
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 in 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 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 and determined without regard to any deduction for dividends paid)
("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.
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, (a) 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 (b) 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 fund
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 the fund receives from U.S.
corporations. However, dividends a corporate shareholder receives and deducts
pursuant to the dividends-received deduction are subject indirectly to the
federal alternative minimum tax.
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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.
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 the 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 and listed nonequity options (such as those
on a securities index) 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"
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(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 that the fund holds or enters into in any actively
traded security, option or futures contract 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 the 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 the fund is exercised, it 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 underlying security's
basis.
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 appreciated financial
position unhedged for 60 days after that closing (i.e., at no time during that
60-day period is the fund's risk of loss 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-indexed securities
("TIIS"), 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 TIIS 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.
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The fund may acquire TIIS (that is, Treasury inflation-indexed
securities (formerly known as Treasury inflation-protection securities)), on
which principal is adjusted based on changes in the Consumer Price Index. The
fund must include in its gross income the amount of any principal increases on
TIIS during the taxable year, even if it receives no corresponding payment on
them during the year. Because the fund annually must distribute substantially
all of its investment company taxable income (determined without regard to any
deduction for dividends paid), including any non-cash income, to satisfy the
Distribution Requirement and avoid imposition of the Excise Tax, it might 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, if necessary, from the
proceeds of sales of its portfolio securities. 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 investment must be determined in order to
determine the applicable charge. Although the transfer agency fee will differ on
a per account basis as stated above, the specific extent to which the transfer
agency fees will differ between the classes as a percentage of net assets is not
certain, because the fee as a percentage of net assets will be affected by the
number of shareholder accounts in each class and the relative amounts of net
assets in each class.
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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 the 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
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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.
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Investors 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 PaineWebber
provide you with information that is Balanced Fund
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.
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Statement of Additional Information
December 31, 2000
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(C)2000 PaineWebber Incorporated. All rights reserved.
