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AMERICAN CAPITAL FEDERAL MORTGAGE TRUST
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2800 Post Oak Boulevard, Houston, Texas 77056, (800) 421-5666
May 1, 1995
American Capital Federal Mortgage Trust (the "Fund") is a mutual fund whose
investment objective is to seek to provide investors with a high current return
and relative safety of capital. The Fund invests primarily in mortgage-related
securities issued or guaranteed by an agency or instrumentality of the U.S.
Government. In order to hedge against changes in interest rates, the Fund may
purchase or write options on such securities and engage in transactions
involving interest rate futures contracts and options on such contracts.
There is no assurance that the Fund will achieve its investment objective.
This Prospectus tells investors briefly the information they should know
before investing in the Fund. Investors should read and retain this Prospectus
for future reference.
A Statement of Additional Information dated the same date as this Prospectus
has been filed with the Securities and Exchange Commission ("SEC") and contains
further information about the Fund. A copy of the Statement of Additional
Information may be obtained without charge by calling or writing the Fund at the
telephone number and address printed above. The Statement of Additional
Information is incorporated by reference into this Prospectus.
THE SHARES OF THIS FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK AND ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT
INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER AGENCY.
THE SHARES OF THIS FUND ARE SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE
LOSS OF PRINCIPAL.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR STATE REGULATORS NOR HAS THE COMMISSION OR STATE
REGULATORS PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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AMERICAN CAPITAL FEDERAL MORTGAGE TRUST
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CUSTODIAN:
State Street Bank and
Trust Company
225 Franklin Street
Boston, Massachusetts 02110
SHAREHOLDER SERVICE AGENT:
ACCESS Investor Services, Inc.
P.O. Box 418256
Kansas City, Missouri 64141-9256
INVESTMENT ADVISER:
Van Kampen American Capital
Asset Management, Inc.
2800 Post Oak Boulevard
Houston, Texas 77056
DISTRIBUTOR:
Van Kampen American Capital
Distributors, Inc.
One Parkview Plaza
Oakbrook Terrace, Illinois 60181
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TABLE OF CONTENTS
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<TABLE>
<S> <C>
Prospectus Summary....... 2
Expense Synopsis......... 5
Financial Highlights..... 7
Multiple Pricing
System................. 9
Investment Objective and
Policies............... 11
Investment Practices and
Restrictions........... 18
The Fund and Its
Management............. 22
Purchase of Shares....... 23
Distribution Plans....... 31
Shareholder Services..... 32
Redemption of Shares..... 37
Dividends, Distributions
and Taxes.............. 39
Prior Performance
Information............ 41
Additional Information... 43
</TABLE>
No dealer, salesperson, or other person has been authorized to give any
information or to make any representations other than those contained in this
Prospectus or in the Statement of Additional Information, and, if given or
made, such other information or representations must not be relied upon as
having been authorized by the Fund or by the Distributor. This Prospectus does
not constitute an offering by the Distributor in any jurisdiction in which
such offering may not lawfully be made.
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PROSPECTUS SUMMARY
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SHARES OFFERED. Shares of Beneficial Interest.
MINIMUM PURCHASE. $500 minimum initial investment and $25 minimum for each
subsequent investment (or less as described under "Purchase of Shares").
TYPE OF COMPANY. Diversified, open-end management investment company.
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INVESTMENT OBJECTIVE. The Fund seeks to provide a high current return and
relative safety of capital.
INVESTMENT POLICY. Invests primarily in mortgage-related securities issued or
guaranteed by an agency or instrumentality of the U.S. Government. In order to
hedge against changes in interest rates, the Fund may purchase or write options
on such securities and engage in transactions involving interest rate futures
contracts and options on such contracts. The Fund may also purchase or sell debt
securities on a forward commitment basis and enter into interest rate swaps and
may purchase or sell interest rate caps, floors and collars.
INVESTMENT RESULTS. The investment results of the Fund since its inception are
shown in the table of "Financial Highlights."
RISK FACTORS. Since the value of debt securities owned by the Fund will
fluctuate depending upon market factors and inversely with prevailing interest
rate levels, the net asset value of shares of the Fund will fluctuate. The Fund
is not limited as to the maturities of the securities in which it may invest.
Debt securities with longer maturities generally tend to produce higher yields
and are subject to greater market fluctuation as a result of changes in interest
rates than debt securities with shorter maturities. See "Investment Objective
and Policies -- General." The Fund may invest in stripped mortgage-related and
mortgage-backed securities, which may be issued by agencies or instrumentalities
of the U.S. Government, or by private originators of, or investors in, mortgage
loans. Those securities that are issued by private originators may involve
greater risk than securities issued directly by the U.S. Government, its
agencies or instrumentalities. See "Investment Objective and Policies -- Zero
Coupon and Other Stripped Securities." The Fund may also invest in asset-backed
securities, which may be unsecured, and therefore entail certain risks not
presented by mortgage-backed securities. See "Investment Objective and
Policies -- Asset-Backed Securities." The Fund may also purchase or sell debt
securities on a forward commitment basis, purchase or sell options and engage in
transactions involving interest rate futures contracts and options on such
contracts and may lend its portfolio securities. The Fund may enter into
interest rate swaps and may purchase or sell interest rate caps, floors and
collars. Each of such activities may subject the Fund to additional risks. See
"Investment Practices and Restrictions -- Forward Commitments, Lending of
Securities, Options, Futures Contracts and Related Options and Interest Rate
Transactions." No assurance can be given as to the actual maturity of a
mortgage-related security because the mortgage loans underlying the security may
be prepaid by the obligor. Depending on market conditions, the Fund may be able
to reinvest prepayments passed through to it only at a lower yielding investment
rate. See "Investment Objective and Policies -- Federal Mortgage-Related
Securities." Shares of the Fund are not insured or guaranteed by the U.S.
Government, its agencies or instrumentalities or by any other person or entity.
INVESTMENT ADVISER. Van Kampen American Capital Asset Management, Inc. (the
"Adviser") serves as investment adviser to the Fund. The Adviser serves as
investment adviser to 50 investment company portfolios. See "The Fund and Its
Management."
DISTRIBUTOR. Van Kampen American Capital Distributors, Inc. (the
"Distributor").
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MULTIPLE PRICING SYSTEM. The Fund offers two classes of shares to the general
public, each with its own sales charge structure: Class A shares and Class C
shares. At this time, the Fund offers Class B shares only to current Fund Class
B shareholders who have elected or may elect the option to reinvest dividends
and/or capital gains distributions in shares of the Fund (other share purchases
by such shareholders must be of Class A or Class C shares), and Class B
shareholders of other American Capital funds exchanging their Class B shares for
Class B shares of the Fund. See "Purchase of Shares" and "Shareholder Services."
Each class of shares represents interest in the same portfolio of investments of
the Fund. The per share dividends on Class B and Class C shares will be lower
than the per share dividends on Class A shares. See "Multiple Pricing System."
For information on redeeming shares see "Redemption of Shares."
CLASS A SHARES. These shares are offered at net asset value per share plus a
maximum initial sales charge of 3.25% of the offering price. The Fund pays an
annual service fee of up to 0.25% of its average daily net assets attributable
to such class of shares. See "Purchase of Shares -- Class A Shares" and
"Distribution Plans."
CLASS B SHARES. The Fund has suspended sales to the public of Class B shares,
which are now available only to a limited group of investors. See "Purchase of
Shares -- Class B Shares." These shares are offered to the persons described
above at net asset value per share and are subject to a maximum contingent
deferred sales charge of three percent of redemption proceeds during the first
and second year, declining each year thereafter to zero percent after the fourth
year. See "Redemption of Shares." The Fund pays a combined annual distribution
fee and service fee of up to one percent of its average daily net assets
attributable to such class of shares. See "Purchase of Shares -- Class B Shares"
and "Distribution Plans." Class B shares will convert automatically to Class A
shares six years after the end of the calendar month in which the shareholder's
order to purchase was accepted. See "Multiple Pricing System -- Conversion
Feature."
CLASS C SHARES. These shares are offered at net asset value per share and are
subject to a contingent deferred sales charge of one percent on redemptions made
within one year of purchase. See "Redemption of Shares." The Fund pays a
combined annual distribution fee and service fee of up to one percent of its
average daily net assets attributable to such class of shares. See "Purchase of
Shares -- Class C Shares" and "Distribution Plans." Class C shares will convert
automatically to Class A shares ten years after the end of the calendar month in
which the shareholder's order to purchase was accepted. See "Multiple Pricing
System -- Conversion Feature."
DIVIDENDS AND DISTRIBUTIONS. Income dividends are declared each business day,
and paid monthly; any net short-term or long-term capital gains are distributed
at least annually. All dividends and distributions are automatically reinvested
in shares of the Fund at net asset value per share (without sales charge) unless
payment in cash is requested. A portion of the dividends and distributions paid
may constitute a return of capital for federal income tax purposes. See
"Dividends, Distributions and Taxes."
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EXPENSE SYNOPSIS
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The following tables are intended to assist investors in understanding the
expenses applicable to each class of shares:
<TABLE>
<CAPTION>
CLASS A CLASS C
SHARES CLASS B SHARES SHARES
<S> <C> <C> <C>
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SHAREHOLDER TRANSACTION
EXPENSES
Maximum sales charge imposed
on purchases (as a
percentage of offering
price)...................... 3.25%(a) None None
Sales charge imposed on
dividend
reinvestments............... None None None
Deferred sales charge (as a
percentage of original
purchase price or redemption
proceeds, whichever is
lower)...................... None* 3% during the first 1% during the
and first year(b)
second year,
decreasing
1% annually to 0%
after
the fourth year(b)
Exchange fee(c)............... $5.00 $5.00 $5.00
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average
net assets)
Management fees............... .50% .50% .50%
Rule 12b-1 fees(d)............ .24% 1.00%(f) 1.00%(f)
Other expenses(e)............. .57% .58% .57%
Total fund operating
expenses...................... 1.31% 2.08% 2.07%
</TABLE>
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(a) Reduced for purchases of $100,000 and over. See "Purchase of Shares -- Class
A Shares" -- page 16.
(b) See "Purchase of Shares -- Class B Shares" and "-- Class C Shares" -- page
18.
(c) Not charged in certain circumstances. See "Shareholder
Services -- Systematic Exchange" and "-- Automatic Exchange" -- page 20.
(d) Up to 0.25% for Class A shares, and one percent for Class B and Class C
shares. See "Distribution Plans" -- page 19.
(e) See "The Fund and Its Management" -- page 14.
(f) Long-term shareholders may pay more than the economic equivalent of the
maximum front-end sales charges permitted by NASD Rules.
* Investments of $1 million or more are not subject to any sales charge at the
time of purchase, but a contingent deferred sales charge of one percent may
be imposed on certain redemptions made within one year of the purchase.
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<TABLE>
<CAPTION>
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CUMULATIVE EXPENSES PAID FOR THE PERIOD OF:
EXAMPLE: 1 YEAR 3 YEARS 5 YEARS 10 YEARS
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<S> <C> <C> <C> <C>
An investor would pay the following
expenses on a $1,000 investment
including, for Class A shares, the
maximum $32.50 front-end sales charge
and for Class B and Class C shares, a
contingent deferred sales charge
assuming (1) an operating expense ratio
of 1.31% for Class A shares, 2.08% for
Class B shares and 2.07% for Class C
shares, (2) a 5% annual return
throughout the period and (3) redemption
at the end of the period:
Class A............................... $ 45 $ 73 $102 $185
Class B............................... $ 62 $ 98 $129 $203**
Class C............................... $ 31 $ 65 $111 $240
An investor would pay the following
expenses on the same $1,000 investment
assuming no redemption at the end of the
period:
Class A............................... $ 45 $ 73 $102 $185
Class B............................... $ 21 $ 65 $112 $203**
Class C............................... $ 21 $ 65 $111 $240
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</TABLE>
** Based on conversion to Class A shares after six years.
The purpose of the foregoing table is to assist the investor in understanding
the various costs and expenses that an investor in the Fund will bear directly
or indirectly. See "Purchase of Shares," "The Fund and Its Management" and
"Redemption of Shares." The example is included to provide a means for the
investor to compare expense levels of funds with different fee structures over
varying investment periods. To facilitate such comparison, all funds are
required to utilize a five percent annual return assumption. This assumption is
unrelated to the Fund's prior performance and is not a projection of future
performance. The example should not be considered a representation of past or
future expenses. Actual expenses may be greater or less than those shown.
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FINANCIAL HIGHLIGHTS
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(Selected data for a share of beneficial interest outstanding throughout each
of the periods indicated)
The following information for each of the five most recent years has been
audited by Price Waterhouse LLP, independent accountants, whose report thereon
was unqualified. This information should be read in conjunction with the
financial statements and notes thereto included in the Fund's Annual Report to
shareholders for the year ended December 31, 1994, which are incorporated by
reference in the Statement of Additional Information.
<TABLE>
<CAPTION>
CLASS A
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EIGHT MAY 14,
MONTHS 1986(1)
ENDED THROUGH
DECEMBER 31, APRIL 30,
1994 1993 1992 1991 1990 1989 1988 1987 1987
---- ---- ---- ---- ---- ---- ---- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE
OPERATING
PERFORMANCE
Net asset value,
beginning of
period......... $12.42 $12.63 $12.99 $12.85 $12.88 $12.39 $12.82 $13.24 $13.99
-------- -------- ------- ------- ------ ------- -------- ------- -------
INCOME FROM
INVESTMENT
OPERATIONS
Investment
income......... .62 .64 .93 1.15 1.32 1.29 1.32 .78 .94
Expenses........ (.14) (.11) (.14) (.17) (.173) (.165) (.16) (.10) (.15)
Expense
waiver......... .02 .01 .025 .025 -- -- -- -- --
-------- ------ ------- ------- ------ ------- ------ ------- -------
Net investment
income......... .50 .54 .815 1.005 1.147 1.125 1.16 .68 .79
Net realized and
unrealized
gains or losses
on
securities..... (.4817) (.1485)(4) (.417) .206 (.004) .4955 (.495) (.365) (.375)
-------- ------ ------- ------- ------ ------- ------- ------- -------
Total from
investment
operations..... .0183 .3915 .398 1.211 1.143 1.6205 .665 .315 .415
-------- ------ ------- ------- ------ ------- ------- ------- -------
LESS
DISTRIBUTIONS
Dividends from
net investment
income......... (.5383) (.6015) (.758) (1.071) (1.173) (1.1305) (1.095) (.735) (1.165)
Distributions
from net
realized gain
on
securities..... -- -- -- -- -- -- -- (.035) (.405)
-------- ------ ------- ------- ------ ------- ------- ------- -------
Total
distributions.. (.5383) (.6015) (.758) (1.071) (1.173) (1.1305) (1.095) (.735) (1.165)
-------- ------ ------- ------- ------ ------- ------- ------- -------
Net asset value,
end of
period......... $11.90 $12.42 $12.63 $12.99 $12.85 $12.88 $12.39 $12.82 $13.24
======== ======== ======= ======= ======= ======== ======= ======= =======
TOTAL
RETURN(3)...... .16% 3.15% (4) 3.15% 9.78% 9.50% 13.72% 5.14% 2.49% 1.82%
RATIOS/
SUPPLEMENTAL
DATA
Net assets, end
of period
(millions)..... $41.2 $64.3 $103.7 $95.8 $32.3 $37.3 $48.3 $66.2 $88.8
Ratios to
average net
assets
Expenses....... 1.15% 1.03% 0.91% 1.16% 1.38% 1.32% 1.22% 1.15% (2) 1.02% (2)
Expenses,
without
waiver....... 1.31% 1.15% 1.12% 1.36% -- -- -- -- --
Net investment
income....... 4.75% 5.49% 6.36% 7.96% 9.11% 8.97% 9.00% 7.96% (2) 5.28% (2)
Net investment
income,
without
waiver....... 4.58% 5.37% 6.15% 7.66% -- -- -- -- --
Portfolio
turnover
rate........... 161% 102% 254% 293% 341% 314% 506% 38% 254%
</TABLE>
(Table continued on following page)
7
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<TABLE>
<CAPTION>
CLASS B CLASS C
------------------------------------------------ --------------------------
NOVEMBER 5, MAY 10,
YEAR ENDED 1991(1) 1993 (1)
DECEMBER 31 THROUGH YEAR ENDED THROUGH
--------------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31,
1994 1993 1992 1991(5) 1994 1993(5)
-------- -------- ------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
Net asset value, beginning of period............. $12.43 $12.64 $12.99 $12.99 $12.41 $12.60
-------- -------- ------- ------- -------- --------
INCOME FROM INVESTMENT OPERATIONS
Investment income................................ .62 .67 .935 .12 .67 .44
Expenses......................................... (.22) (.20) (.24) (.03) (.24) (.14)
Expense waiver................................... .02 .01 .03 .02 .02 .02
-------- -------- ------- ------- -------- --------
Net investment income............................ .42 .48 .725 .11 .45 .32
Net realized and unrealized gains or losses on
securities......................................) (.4977) (.1845)(4) (.413) .036 (.5177) (.1914)(4)
-------- -------- ------- ------- -------- --------
Total from investment operations................. (.0777) .2955 .312 .146 (.0677) .1286
-------- -------- ------- ------- -------- --------
DIVIDENDS FROM NET INVESTMENT INCOME............. (.4423) (.5055) (.662) (.146) (.4423) (.3186)
-------- -------- ------- ------- -------- --------
Net asset value, end of period................... $11.91 $12.43 $12.64 $12.99 $11.90 $12.41
======== ======== ======= ======= ======== ========
TOTAL RETURN(3).................................. (.62%) 2.37%(4) 2.46% 1.13% (.55%) 1.03%(4)
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period (millions)............. $18.4 $26.9 $38.4 $9.4 $5.8 $7.1
Ratios to average net assets
Expenses........................................ 1.91% 1.79% 1.60% 0.59%(2) 1.90% 1.47%(2)
Expenses, without waiver........................ 2.08% 1.91% 1.81% 1.84%(2) 2.07% 1.64%(2)
Net investment income........................... 3.99% 4.70% 5.44% 5.73%(2) 3.98% 3.79%(2)
Net investment income, without waiver........... 3.82% 4.58% 5.23% 4.48%(2) 3.81% 3.62%(2)
Portfolio turnover rate.......................... 161% 102% 254% 293% 161% 102%
</TABLE>
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(1) Commencement of the offering of sales.
(2) Annualized.
(3) Total return for periods of less than one full year are not annualized.
Total return does not consider the effect of sales charges.
(4) During 1993, certain securities held by the Fund were mispriced. The
Adviser reimbursed the Fund to eliminate any loss to shareholders. Without
the reimbursement, the total return would have been lower by approximately
6.25 percentage points.
(5) Based on average month-end shares outstanding.
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MULTIPLE PRICING SYSTEM
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The Multiple Pricing System permits an investor to choose the method of
purchasing shares that is most beneficial given the amount of the purchase and
the length of time the investor expects to hold the shares.
CLASS A SHARES. Class A shares are sold at net asset value plus an initial
maximum sales charge of up to 3.25% at the time of purchase. Class A shares are
subject to an ongoing service fee at an annual rate of up to 0.25% of the Fund's
aggregate average daily net assets attributable to the Class A shares. Certain
purchases of Class A shares qualify for reduced initial sales charges. See
"Purchase of Shares -- Class A Shares."
CLASS B SHARES. The Fund has suspended sales of Class B shares to the general
public. Class B shares are now available only in connection with the
reinvestment of dividends and/or distributions by existing Class B shareholders
of the Fund and exchanges into the Fund by Class B shareholders of other
American Capital funds. See "Purchase of Shares." Class B shares are sold at net
asset value and are subject to a deferred sales charge if they are redeemed
within four years of purchase. Class B shares are subject to an ongoing service
fee at an annual rate of up to 0.25% of the Fund's aggregate average daily net
assets attributable to the Class B shares and an ongoing distribution fee at an
annual rate of up to 0.75% of the Fund's aggregate average daily net assets
attributable to the Class B shares. Class B shares enjoy the benefit of
permitting all of the investor's dollars to work from the time the investment is
made. The ongoing distribution fee paid by Class B shares will cause such shares
to have a higher expense ratio and to pay lower dividends than those related to
Class A shares. See "Purchase of Shares -- Class B Shares." Class B shares will
automatically convert to Class A shares six years after the end of the calendar
month in which the shareholder's order to purchase was accepted. See "Conversion
Feature" herein for discussion on applicability of the conversion feature to
Class B shares.
CLASS C SHARES. Class C shares are sold at net asset value and are subject to
a deferred sales charge if redeemed within one year of purchase, Class C shares
are subject to an ongoing service fee at an annual rate of up to 0.25% of the
Fund's aggregate average daily net assets attributable to the Class C shares and
an ongoing distribution fee at an annual rate of up to 0.75% of the Fund's
aggregate average daily net assets attributable to the Class C shares. Class C
shares enjoy the benefit of permitting all of the investor's dollars to work
from the time the investment is made. The ongoing distribution fee paid by Class
C shares will cause such shares to have a higher expense ratio and to pay lower
dividends than those related to Class A shares. See "Purchase of Shares -- Class
C Shares." Class C shares will automatically convert to Class A shares ten years
after the end of the calendar month in which the shareholder's order to purchase
was accepted. See "Conversion Feature" herein for discussion on applicability of
the conversion feature to Class C shares.
CONVERSION FEATURE. Class B shares and Class C shares will automatically
convert to Class A shares six years or ten years, respectively, after the end of
the calendar month in which the shares were purchased and will no longer be
subject to the distribution fee. Such conversion will be on the basis of the
relative net asset values per share, without the
9
<PAGE> 10
imposition of any sales load, fee or other charge. The purpose of the conversion
feature is to relieve the holders of Class B shares and Class C shares that have
been outstanding for a period of time sufficient for the Distributor to have
been substantially compensated for distribution expenses related to the Class B
shares or Class C shares as the case may be, from the burden of the ongoing
distribution fee.
For purposes of conversion to Class A, shares purchased through the
reinvestment of dividends and distributions paid on Class B shares and Class C
shares in a shareholder's Fund account will be considered to be held in a
separate sub-account. Each time any Class B shares or Class C shares in the
shareholder's Fund account (other than those in the sub-account) convert to
Class A, an equal pro rata portion of the Class B shares and Class C shares in
the sub-account will also convert to Class A.
The conversion of Class B shares and Class C shares to Class A shares is
subject to the continuing availability of an opinion of counsel to the effect
that (i) the assessment of the distribution fee and higher transfer agency costs
with respect to Class B shares and Class C shares does not result in the Fund's
dividends or distributions constituting "preferential dividends" under the
Internal Revenue Code, as amended (the "Code"), and (ii) the conversion of
shares does not constitute a taxable event under federal income tax law. The
conversion of Class B shares and Class C shares may be suspended if such an
opinion is no longer available. In that event, no further conversions of Class B
shares and Class C shares would occur, and shares might continue to be subject
to the distribution fee for an indefinite period which may extend beyond the
period ending six years or ten years, respectively, after the end of the
calendar month in which the shareholder's order to purchase was accepted.
FACTORS FOR CONSIDERATION. In deciding which class of shares to purchase,
investors should take into consideration their investment goals, present and
anticipated purchase amounts, time horizons and temperaments. Investors should
consider whether, during the anticipated life of their investment in the Fund,
the accumulated distribution fees and contingent deferred sales charges on Class
C shares prior to conversion would be less than the initial sales charge on
Class A shares purchased at the same time, and to what extent such differential
would be offset by the higher dividends per share on Class A shares. To assist
investors in making this determination, the table under the caption "Expense
Synopsis" sets forth examples of the charges applicable to each class of shares.
In this regard, Class A shares may be more beneficial to the investor who
qualifies for reduced initial sales charges or purchases shares at net asset
value, as described herein under "Purchase of Shares -- Class A Shares." For
these reasons, the Distributor will reject any order of $1 million or more for
Class C shares.
Class A shares are not subject to an ongoing distribution fee and,
accordingly, receive correspondingly higher dividends per share. However,
because initial sales charges are deducted at the time of purchase, investors in
Class A shares do not have all their funds invested initially and, therefore,
initially own fewer shares. Other investors might determine that it is more
advantageous to purchase Class C shares and have all their funds invested
initially, although remaining subject to ongoing distribution fees and, for a
four-year or one-year period, respectively, being subject to a contingent
deferred sales charge. Ongoing distribution fees on Class C shares will be
offset to the extent of the additional
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<PAGE> 11
funds originally invested and any return realized on these funds. However, there
can be no assurance as to the return, if any, which will be realized on such
additional funds. For investments held for ten years or more, the relative value
upon liquidation of the three classes tends to favor Class A, rather than Class
C shares.
Class A shares may be appropriate for investors who prefer to pay the sales
charge up front, want to take advantage of the reduced sales charges available
on larger investments, wish to maximize their current income from the start,
prefer not to pay redemption charges and/or have a longer-term investment
horizon. Class C shares may be appropriate for investors who wish to avoid a
front-end sales charge, put 100% of their investment dollars to work
immediately, have a shorter-term investment horizon and/or desire a short
contingent deferred sales charge schedule.
The distribution expenses incurred by the Distributor in connection with the
sale of the shares will be reimbursed, in the case of Class A shares, from the
proceeds of the initial sales charge and, in the case of Class C shares, from
the proceeds of the ongoing distribution fee and any contingent deferred sales
charge incurred upon redemption within one year of purchase. Sales personnel of
broker-dealers distributing the Fund's shares and other persons entitled to
receive compensation for selling such shares may receive differing compensation
for selling such shares. INVESTORS SHOULD UNDERSTAND THAT THE PURPOSE AND
FUNCTION OF THE CONTINGENT DEFERRED SALES CHARGE AND ONGOING DISTRIBUTION FEE
WITH RESPECT TO THE CLASS C SHARES ARE THE SAME AS THOSE OF THE INITIAL SALES
CHARGE WITH RESPECT TO CLASS A SHARES. See "Distribution Plans."
GENERAL. Dividends paid by the Fund with respect to Class A, Class B and
Class C shares will be calculated in the same manner at the same time on the
same day, except that the distribution fees and any incremental transfer agency
costs relating to Class B or Class C shares will be borne by the respective
class. See "Dividends, Distributions and Taxes." Shares of the Fund may be
exchanged, subject to certain limitations, for shares of the same class of other
mutual funds advised by the Adviser. See "Shareholder Services -- Exchange
Privilege."
The Trustees of the Fund have determined that currently no conflict of
interest exists between the classes of shares. On an ongoing basis, the Trustees
of the Fund, pursuant to their fiduciary duties under the Investment Company Act
of 1940 (the "1940 Act") and state laws, will seek to ensure that no such
conflict arises.
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INVESTMENT OBJECTIVE AND POLICIES
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GENERAL. The investment objective of the Fund is to seek to provide high
current return and relative safety of capital. The Fund invests primarily in
mortgage-related securities issued or guaranteed by an agency or instrumentality
of the U.S. Government. See "Federal Mortgage -- Related Securities" below.
Under normal circumstances, at least 65% of the total assets of the Fund are
invested in such securities. The Fund may invest up to 35% of its assets in
mortgage-related securities which are not so guaranteed, mortgage-backed
securities, asset-backed securities, and U.S. Government securities. In order to
hedge against changes in interest rates, the Fund may purchase or write options
on
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<PAGE> 12
debt securities, and engage in transactions involving interest rate futures
contracts and options on such contracts. See "Investment Practices and
Restrictions -- Options, Futures Contracts and Related Options" and the
Statement of Additional Information for discussion of options, futures contracts
and related options. The Fund may also purchase or sell debt securities on a
forward commitment basis and enter into interest rate swaps and may purchase or
sell interest rate caps, floors and collars. See "Investment Practices and
Restrictions -- Forward Commitments and Interest Rate Transactions." There can
be no assurance that the Fund's investment objective will be achieved. The Fund
is not designed for investors seeking capital appreciation. Shares of the Fund
are not insured or guaranteed by the U.S. Government, its agencies or
instrumentalities or by any other person or entity.
For temporary defensive purposes, the entire portfolio of the Fund may be
invested in obligations of the U.S. Government, its agencies and
instrumentalities and repurchase agreements secured by such obligations. For a
description of repurchase agreements, see "Investment Practices and
Restrictions -- Repurchase Agreements."
Since the value of debt securities owned by the Fund will fluctuate depending
upon market factors and inversely with prevailing interest rate levels, the net
asset value of shares of the Fund will fluctuate. The Fund is not limited as to
the maturities of the securities in which it may invest. Debt securities with
longer maturities generally tend to produce higher yields and are subject to
greater market fluctuation as a result of changes in interest rates than debt
securities with shorter maturities. The potential for such fluctuation may be
reduced however to the extent that the Fund invests in adjustable rate mortgage
securities. See "Adjustable Rate Mortgage Securities." The Fund's current
operating policy is to maintain a portfolio duration within a range of six
months to five years. Duration is a measure of the expected life of a debt
security that was developed as a more precise alternative to the concept of
"term to maturity." Duration incorporates a debt security's yield, coupon
interest payments, final maturity and call features into one measure.
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 "price volatility" of the security). However,
"term to maturity" measures only the time until a debt security provides its
final payment taking no account of the pattern of the security's payments of
interest or principal prior to maturity. Duration is a measure of the expected
life of a debt security on a present value basis expressed in years. It measures
the length of the time interval between the present and the time when the
interest and principal payments are scheduled (or in the case of a callable
bond, expected to be received), weighing them by the present value 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, and for zero coupon issues duration and term to maturity are
equal. In general, the lower the coupon rate of interest or the longer the
maturity, or the lower the yield-to-maturity of a debt security, the longer its
duration; conversely, the higher the coupon rate of interest the shorter the
maturity or the higher the yield to maturity of a debt security, the shorter its
duration.
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<PAGE> 13
There are some situations where even 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 resets. Another example where the interest rate exposure is not properly
captured by duration is the case of mortgage pass-through securities. The stated
final maturity of such securities is generally 30 years, but current prepayment
rates are more critical in determining the securities' interest rate exposure.
In these and other similar situations, the Adviser will use more sophisticated
analytical techniques that incorporate the economic life of a security into the
determination of its interest rate exposure. At December 31, 1994, the average
maturity of the securities owned by the Fund was approximately 2.49 years and
the duration of the portfolio was approximately 2.13 years.
The Fund generally purchases debt securities at a premium over the principal
or face value in order to obtain higher current income. The amount of any
premium declines during the term of the security to zero at maturity. Such
decline generally is reflected in the market price of the security and thus in
the Fund's net asset value. Any such decline is realized for accounting purposes
as a capital loss at maturity or upon resale. Prior to maturity or resale, such
decline in value could be offset, in whole or part, or increased by changes in
the value of the security due to changes in interest rate levels.
FEDERAL MORTGAGE-RELATED SECURITIES. Mortgage loans made by banks, savings and
loan institutions, and other lenders are often assembled into pools, which are
issued or guaranteed by an agency or instrumentality of the U.S. Government,
though not necessarily by the U.S. Government itself. Interest in such pools are
what this Prospectus calls "federal mortgage-related securities."
Federal mortgage-related securities include, but are not limited to,
obligations issued or guaranteed by the Government National Mortgage Association
("GNMA"), the Federal National Mortgage Association ("FNMA") and the Federal
Home Loan Mortgage Corporation ("FHLMC"). GNMA is a wholly-owned corporate
instrumentality of the United States whose securities and guarantees are backed
by the full faith and credit of the United States. FNMA, a federally chartered
and privately-owned corporation, and FHLMC, a federal corporation, are
instrumentalities of the United States. The securities and guarantees of FNMA
and FHLMC are not backed, directly or indirectly, by the full faith and credit
of the United States. Although the Secretary of the Treasury of the United
States has discretionary authority to lend FNMA up to $2.25 billion outstanding
at any time, neither the United States nor any agency thereof is obligated to
finance FNMA's or FHLMC's operations or to assist FNMA or FHLMC in any other
manner.
Mortgage-related securities are characterized by monthly payments to the
holder, reflecting the monthly payments made by the borrowers who received the
underlying mortgage loans. The payments to the security holders (such as the
Fund), like the payments on the underlying loans, represent both principal and
interest. Although the underlying mortgage loans are for specified periods of
time, such as 20 or 30 years, the borrowers can, and typically do, pay them off
sooner. Thus, the security holders frequently receive prepayments of principal,
in addition to the principal which is part of the regular monthly payment. A
borrower is more likely to prepay a mortgage which bears a
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<PAGE> 14
relatively high rate of interest. This means that in times of declining interest
rates, some of the Fund's higher yielding securities might be converted to cash,
and the Fund will be forced to accept lower interest rates when that cash is
used to purchase additional securities. The increased likelihood of prepayment
when interest rates decline also limits market price appreciation of
mortgage-related securities. If the Fund buys mortgage-related securities at a
premium, mortgage foreclosures or mortgage prepayments may result in a loss to
the Fund of up to the amount of the premium paid since only timely payment of
principal and interest is guaranteed.
ADJUSTABLE RATE MORTGAGE SECURITIES. Adjustable rate mortgage securities
("ARMS") are federal mortgage-related securities collateralized by mortgages
with adjustable, rather than fixed, interest rates. The ARMS in which the Fund
invests are issued primarily by GNMA, FNMA and FHLMC, and are actively traded in
the secondary market. The underlying mortgages which collateralize ARMS issued
by GNMA are fully guaranteed by the Federal Housing Administration or the
Veterans Administration. The underlying mortgages which collateralize ARMS
issued by FHLMC or FNMA are typically conventional residential mortgages
conforming to standard underwriting size and maturity constraints.
For certain types of ARMS in which the Fund may invest, the rate of
amortization of principal and interest payments changes in accordance with
movements in a predetermined interest rate index. The interest rates paid on
ARMS are generally readjusted at intervals of one year or less to an increment
over this predetermined interest rate index. The amount of interest due is
calculated by adding a specified additional amount (margin) to the index,
subject to limitations (caps and floors) on the maximum and minimum interest
charged to the mortgagor during the life of the mortgage or to the maximum and
minimum changes to that interest rate during a given period.
ARMS allow the Fund to participate in increases in interest rates through
periodic adjustments in the coupons of the underlying mortgages, resulting in
higher current yields and lower price fluctuations. The Fund, however, will not
benefit from increases in interest rates if they rise to the point where they
cause the current coupon to exceed the maximum allowable cap rates for a
particular mortgage. The resetting of the interest rates should cause the net
asset value of the Fund to fluctuate less dramatically than it would with
investments in long-term fixed-rate debt securities. However, during periods of
rising interest rates, changes in the coupon rate lag behind changes in the
market rate resulting in possibly a slightly lower net asset value until the
coupon resets to market rates. In addition, while there is less risk of decline
in the market value of ARMS during periods when interest rates rise, there may
be less potential for capital appreciation than other investments of similar
maturities due to the likelihood of increased prepayments.
The Fund currently seeks to maintain a more consistent and less volatile net
asset value than funds investing primarily in longer duration fixed rate
mortgage securities by investing a significant portion of its assets in ARMS and
in shorter duration fixed rate mortgage-related securities. See "Investment
Objective and Policies -- General" above.
OTHER MORTGAGE-RELATED AND MORTGAGE-BACKED SECURITIES. The Fund may also
invest in securities issued by certain private, nongovernment corporations, such
as financial institutions, if the securities are fully collateralized at the
time of issuance by
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<PAGE> 15
securities or certificates issued or guaranteed by the U.S. Government, its
agencies or instrumentalities. Two principal types of mortgage-backed securities
are collateralized mortgage obligations (CMOs) and real estate mortgage
investment conduits (REMICs).
CMOs are debt securities issued by U.S. Government agencies or by financial
institutions and other mortgage lenders and collateralized by a pool of
mortgages held under an indenture. CMOs are issued in a number of classes or
series with different maturities. The classes or series are retired in sequence
as the underlying mortgages are repaid. Prepayment may shorten the stated
maturity of the obligation and can result in a loss of premium, if any has been
paid. Certain of these securities may have variable or floating interest rates
and others may be stripped (securities which provide only the principal or
interest feature of the underlying security).
REMICs, which were authorized under the Tax Reform Act of 1986, are private
entities formed for the purpose of holding a fixed pool of mortgages secured by
an interest in real property. REMICs are similar to CMOs in that they issue
multiple classes of securities.
CMOs and REMICs issued by private entities are not government securities and
are not directly guaranteed by any government agency. They are secured by the
underlying collateral of the private issuer. The Fund intends to invest in
privately-issued CMOs and REMICs only if they are rated at the time of purchase
in the two highest grades by a nationally-recognized rating agency.
The Fund may also invest in private mortgage pass-through securities ("Private
Pass-Throughs") which are structured similarly to the GNMA, FNMA, and FHLMC
mortgage-related securities described above and are issued by originators of and
investors in mortgage loans, including savings and loan associations, mortgage
banks, commercial banks, investment banks and special purpose subsidiaries of
the foregoing. Private Pass-Throughs are usually backed by a pool of
conventional fixed rate or adjustable rate mortgage loans. The Fund intends to
invest in such debt securities only if they are rated at the time of purchase in
the two highest grades by a nationally-recognized rating agency.
The Fund may also invest in mortgage-backed securities. A mortgage-backed
security is a general obligation of the issuer, which is additionally secured by
mortgage collateral. Such securities have a known maturity date and a
pre-determined cash flow. This category may include debt securities issued by a
public utility secured by mortgages on properties owned by the public utility.
The Fund intends to invest in such debt securities only if at the time of
purchase they are rated in the two highest grades by a nationally-recognized
rating agency.
U.S. GOVERNMENT SECURITIES. U.S. Government securities include U.S. Treasury
obligations, which differ only in their interest rates, maturities and times of
issuance and consist of U.S. Treasury bills (maturities of one year or less),
U.S. Treasury notes (maturities of one to ten years) and U.S. Treasury bonds
(generally maturities of greater than ten years).
ZERO COUPON AND OTHER STRIPPED SECURITIES. The Fund may also invest in the
interest only or principal only components of debt securities described above.
This includes "zero coupon" Treasury securities and stripped securities.
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<PAGE> 16
The Fund may invest in "zero coupon" Treasury securities which are U.S.
Treasury bills, notes, and bonds which have been stripped of their unmatured
interest coupons and receipts or certificates representing interests in such
stripped debt obligations. A zero coupon security pays no interest in cash to
its holder during its life although interest is accrued for federal income tax
purposes. Its value to an investor consists of the difference between its face
value at the time of maturity and the price for which it was acquired, which is
generally an amount significantly less than its face value (sometimes referred
to as a "deep discount" price). Investing in "zero coupon" Treasury securities
may help to preserve capital during periods of declining interest rates. For
example, if interest rates decline, GNMA Certificates owned by the Fund which
were purchased at greater than par are more likely to be prepaid, which would
cause a loss of principal. In anticipation of this, the Fund might purchase zero
coupon Treasury securities, the value of which would be expected to increase
when interest rates decline.
Currently the principal U.S. Treasury security issued without coupons is the
Treasury bill. The Treasury has also recently made wire transferable zero coupon
Treasury securities available. However, in the last few years a number of banks
and brokerage firms have separated ("stripped") the principal portions
("corpus") from the coupon portions of the U.S. Treasury bonds and notes and
sold them separately in the form of receipts or certificates representing
undivided interests in these instruments (which instruments are generally held
by a bank in a custodial or trust account).
Zero coupon Treasury securities do not entitle the holder to any periodic
payments of interest prior to maturity. Accordingly, such securities usually
trade at a deep discount from their face or par value and will be subject to
greater fluctuations of market value in response to changing interest rates than
debt obligations of comparable maturities which make periodic distributions of
interest. On the other hand, because there are no periodic interest payments to
be reinvested prior to maturity, zero coupon securities eliminate the
reinvestment risk and lock in a rate of return to maturity. Current federal tax
law requires that a holder (such as the Fund) of a zero coupon security accrue a
portion of the discount at which the security was purchased as income each year
even though the Fund received no interest payment in cash on the security during
the year. For additional discussion of the tax treatment of zero coupon Treasury
securities, see "Dividends, Distributions and Taxes."
Stripped mortgage-related and mortgage-backed securities (hereinafter referred
to as "Stripped Mortgage Securities") are derivative multiclass mortgage
securities. Stripped Mortgage Securities may be issued by agencies or
instrumentalities of the U.S. Government, or by private originators of, or
investors in, mortgage loans, including savings and loan associations, mortgage
banks, commercial banks, investment banks and special purpose subsidiaries of
the foregoing.
Stripped Mortgage Securities are usually structured with two classes that
receive different proportions of the interest and principal distributions on a
pool of mortgage assets. A common type of Stripped Mortgage Securities will have
one class receiving some of the interest and most of the principal from the
mortgage assets, while the other class will receive most of the interest and the
remainder of the principal. In the most extreme case, one class will receive all
of the interest (the interest-only or "IO" class), while the
16
<PAGE> 17
other class will receive all of the principal (the principal-only or "PO"
class). The yield to maturity on an IO class is extremely sensitive to the rate
of principal payments (including prepayments) on the related underlying mortgage
assets, and a rapid rate of principal payments may have a material adverse
effect on the securities' yield to maturity. If the underlying mortgage assets
experience greater than anticipated prepayments of principal, the Fund may fail
to fully recoup its initial investment in these securities even if the security
is rated AAA or Aaa. Holders of PO securities are not entitled to any periodic
payments of interest prior to maturity. Accordingly, such securities usually
trade at a deep discount from their face or par value and are subject to greater
fluctuations of market value in response to changing interest rates than debt
obligations of comparable maturities which make current distributions of
interest. Current federal tax law requires that a holder (such as the Fund) of
such securities accrue a portion of the discount at which the security was
purchased as income each year even though the holder receives no interest
payment in cash on the certificate during the year. Such securities may involve
greater risk than securities issued directly by the U.S. Government, its
agencies or instrumentalities.
Although the market for government-issued IO and PO securities backed by
fixed-rate mortgages is increasingly liquid, certain of such securities may not
be readily marketable and will be considered illiquid for purposes of the Fund's
limitation on investments in illiquid securities. The Trustees of the Fund will
establish guidelines and standards for determining whether a particular
government-issued IO or PO backed by fixed-rate mortgages is liquid. Generally,
such a security may be deemed liquid if it can be disposed of promptly in the
ordinary course of business at a value reasonably close to that used in the
calculation of the net asset value per share. Stripped Mortgage Securities,
other than government-issued IO and PO securities backed by fixed-rate
mortgages, are presently considered by the staff of the SEC to be illiquid
securities and thus subject to the Fund's limitation on investment in illiquid
securities.
ASSET-BACKED SECURITIES. Asset-backed securities are similar to
mortgage-backed securities. However, the underlying assets include assets such
as automobile and credit card receivables. The assets are securitized either in
a pass-through structure (similar to a mortgage pass-through structure) or in a
pay-through structure (similar to the CMO structure). The Fund may invest in
these and other types of asset-backed securities that may be developed in the
future. Although the collateral supporting asset-backed securities generally is
of a shorter maturity than mortgage loans and historically has been less likely
to experience substantial prepayments, no assurance can be given as to the
actual maturity of an asset-backed security because prepayments of principal may
be made at any time.
Asset-backed securities entail certain risks not presented by mortgage-backed
securities. Asset-backed securities do not have the benefit of the same type of
security interest in the related collateral. Credit card receivables are
generally unsecured and a number of state and federal consumer credit laws give
debtors the right to set off certain amounts owed on the credit cards, thereby
reducing the outstanding balance. In the case of automobile receivables, there
is a risk that the holders may not have either a proper or first security
interest in all of the obligations backing such receivables due to the large
number of vehicles involved in a typical issuance, and technical requirements
under state laws.
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<PAGE> 18
Therefore, recoveries on repossessed collateral may not always be available to
support payments on the securities. For a further discussion of the risks of
investing in asset-backed securities, see the Statement of Additional
Information.
The Fund will invest in asset-backed securities only if they are rated at the
time of purchase in the two highest grades by a nationally-recognized rating
agency. The Fund does not presently propose to invest more than ten percent of
its assets in asset-backed securities.
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INVESTMENT PRACTICES AND RESTRICTIONS
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REPURCHASE AGREEMENTS. The Fund may enter into repurchase agreements with
domestic banks or broker-dealers in order to earn a return on temporarily
available cash. A repurchase agreement is a short-term investment in which the
purchaser (e.g., the Fund) acquires ownership of a debt security and the seller
agrees to repurchase the obligation at a future time and set price, thereby
determining the yield during the holding period. Repurchase agreements involve
certain risks in the event of a default by the other party. The Fund will not
invest in repurchase agreements maturing in more than seven days if any such
investment, together with any other illiquid securities held by the Fund,
exceeds ten percent of the value of its net assets. In the event of the
bankruptcy of the seller of a repurchase agreement, the Fund could experience
both delays in liquidating the underlying securities and loss including: (a)
possible decline in the value of the underlying security during the period while
the Fund seeks to enforce its rights thereto, (b) possible lack of access to
income on the underlying security during this period, and (c) expenses of
enforcing its rights. See the Statement of Additional Information.
For the purpose of investing in repurchase agreements, the Adviser may
aggregate the cash that substantially all of the funds advised or subadvised by
the Adviser would otherwise invest separately into a joint account. The cash in
the joint account is then invested and the funds that contributed to the joint
account share pro rata in the net revenue generated. The Adviser believes that
the joint account produces greater efficiencies and economies of scale that may
contribute to reduced transaction costs, higher returns, higher quality
investments and greater diversity of investments for the Fund than would be
available to the Fund investing separately. The manner in which the joint
account is managed is subject to conditions set forth in the SEC order obtained
by the Fund authorizing this practice, which conditions are designed to ensure
the fair administration of the joint account and to protect the amounts in that
account.
FORWARD COMMITMENTS. The Fund may purchase or sell mortgage-related securities
and U.S. Government securities on a "when-issued" or "delayed delivery" basis
("Forward Commitments"). These transactions occur when securities are purchased
or sold by the Fund with payment and delivery taking place in the future,
frequently a month or more after such transaction. The price is fixed on the
date of the commitment, and the seller continues to accrue interest on the
securities covered by the Forward Commitment until delivery and payment takes
place. At the time of settlement, the market value of the securities may be more
or less than the purchase or sale price.
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<PAGE> 19
The Fund may either settle a Forward Commitment by taking delivery of the
securities or resell or repurchase a Forward Commitment on or before the
settlement date, in which event the Fund may reinvest the proceeds in another
Forward Commitment. The Fund's use of Forward Commitments may increase its
overall investment exposure and thus its potential for gain or loss. When
engaging in Forward Commitments, the Fund relies on the other party to complete
the transaction; should the other party fail to do so, the Fund might lose a
purchase or sale opportunity that could be more advantageous than alternative
opportunities at the time of the failure. Forward Commitments are not traded on
an exchange and thus may be less liquid than exchange traded contracts.
The Fund maintains a segregated account (which is marked to market daily) of
cash, U.S. Government securities or the security covered by the Forward
Commitment with the Fund's custodian in an aggregate amount equal to the amount
of its commitment as long as the obligation to purchase or sell continues.
LENDING OF SECURITIES. The Fund may lend its portfolio securities to
broker-dealers and other financial institutions in an amount up to ten percent
of the net assets, provided that such loans are callable at any time by the
Fund, and are at all times secured by cash collateral that is at least equal to
the market value, determined daily, of the loaned securities. During the period
of the loan, the Fund receives the income on both the loaned securities and the
collateral and thereby increases its yield after payment of lending fees.
Lending portfolio securities involves risks of delay in recovery of the loaned
securities or in some cases loss of rights in the collateral should the borrower
fail financially. Accordingly, loans of portfolio securities will only be made
to borrowers considered by the Adviser to be creditworthy.
PORTFOLIO TURNOVER. The Fund generally experiences a high rate of portfolio
turnover, which may vary from year to year. A 100% turnover rate would occur,
for example, if all the securities held by the Fund were replaced in a period of
one year. Higher portfolio turnover involves correspondingly greater brokerage
commissions and other transaction costs, which are borne directly by the Fund.
The higher portfolio turnover may also increase the recognition of short-term,
rather than long-term, capital gains. The rate of portfolio turnover is not a
limiting factor when the Adviser deems it desirable to purchase or sell
securities or to engage in transactions in options, futures contracts and
related options.
OPTIONS, FUTURES CONTRACTS AND RELATED OPTIONS. The investment policies of the
Fund permit the Fund to invest in or write options, futures contracts and
related options.
The Fund presently expects to utilize options, futures contracts and options
thereon in several different ways, depending upon the status of the Fund's
portfolio and the Adviser's expectations concerning the securities markets. See
the Statement of Additional Information for discussion of options, futures
contracts and related options.
Potential Risks of Options, Futures Contracts and Related Options. The
purchase and sale of options and futures contracts involve risks different from
those involved with direct investments in securities. While utilization of
options, futures contracts and similar instruments may be advantageous to the
Fund, if the Adviser is not suc-
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<PAGE> 20
cessful in employing such instruments in managing the Fund's investments, the
Fund's performance will be worse than if the Fund did not make such investments.
In addition, the Fund pays commissions and other costs in connection with such
investments, which may increase the Fund's expenses and reduce its return. The
Fund may write or purchase options in privately negotiated transactions ("OTC
Options") as well as listed options. OTC Options can be closed out only by
agreement with the other party to the transaction. Any OTC Options purchased by
the Fund will be considered an illiquid security. Any OTC Option written by the
Fund will be with a qualified dealer pursuant to an agreement under which the
Fund may repurchase the option at a formula price. Such options will be
considered illiquid to the extent that the formula price exceeds the intrinsic
value of the option. The Fund may not purchase or sell futures contracts or
related options for which the aggregate initial margin and premiums exceed five
percent of the fair market value of the Fund's assets. In order to prevent
leverage in connection with the purchase of futures contracts by the Fund, an
amount of cash, cash equivalents or liquid high grade debt securities equal to
the market value of the obligation under the futures contracts (less any related
margin deposits) will be maintained in a segregated account with the Custodian.
The Fund may not invest more than ten percent of its net assets in illiquid
securities and repurchase agreements which have a maturity of longer than seven
days. See "Investment Restrictions" below.
INTEREST RATE TRANSACTIONS. The Fund may enter into interest rate swaps and
may purchase or sell interest rate caps, floors and collars. The Fund expects to
enter into these transactions primarily to preserve a return or spread on a
particular investment or portion of its portfolio. The Fund may also enter into
these transactions to protect against any increase in the price of securities
the Fund anticipates purchasing at a later date. The Fund does not intend to use
these transactions as speculative investments and will not enter into interest
rate swaps or sell interest rate caps or floors where it does not own or have
the right to acquire the underlying securities or other instruments providing
the income stream the Fund may be obligated to pay. Interest rate swaps involve
the exchange by the Fund with another party of their respective commitments to
pay or receive interest, i.e., an exchange of floating rate payments for
fixed-rate payments. The purchase of an interest rate cap entitles the
purchaser, to the extent that a specified index exceeds a predetermined interest
rate, to receive payments of interest on a contractually-based principal amount
from the party selling the interest rate cap. The purchase of an interest rate
floor entitles the purchaser, to the extent that a specified index falls below a
predetermined interest rate, to receive payments of interest on a
contractually-based principal amount from the party selling the interest rate
floor. An interest rate collar combines the elements of purchasing a cap and
selling a floor. The collar protects against an interest rate rise above the
maximum amount but foregoes the benefit of an interest rate decline below the
minimum amount. Interest rate swaps, caps, floors and collars will be treated as
illiquid securities and will, therefore, be subject to the Fund's investment
restriction limiting investment in illiquid securities. See the Statement of
Additional Information for further discussion on such interest rate
transactions.
The net amount of the excess, if any, of the Fund's obligations over its
entitlements with respect to each interest rate swap will be accrued on a daily
basis and an amount of cash or high-quality liquid debt securities having an
aggregate net asset value at least equal to the accrued excess will be
maintained in a segregated account by the Fund's cus-
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<PAGE> 21
todian. If the Fund enters into an interest rate swap on other than a net basis,
the Fund would maintain a segregated account in the full amount accrued on a
daily basis of the Fund's obligations with respect to the swap.
PORTFOLIO TRANSACTIONS AND BROKERAGE PRACTICES. The Adviser is responsible for
the placement of orders for the purchase and sale of portfolio securities for
the Fund. The debt securities in which the Fund invests are traded in the
over-the-counter market. Such securities are generally traded on a net basis
with dealers acting as principal for their own accounts without a stated
commission, although the prices of the securities usually include a profit to
the dealers. It is the policy of the Fund to seek to obtain the best net result
taking into account such factors as price (including the applicable dealer
spread), the size, type and difficulty of the transaction involved, the firm's
general execution and operational facilities, the firm's risk in positioning the
securities involved, and the provision of supplemental investment research by
the firm. While the Fund seeks reasonably competitive dealer spreads, the Fund
will not necessarily be paying the lowest spread available. Brokerage
commissions are paid on transactions in listed options, futures contracts and
options thereon. The Adviser is authorized to place portfolio transactions with
broker-dealers participating in the distribution of shares of the Fund and other
American Capital mutual funds if it reasonably believes that the quality of the
execution and any commissions are comparable to that available from other
qualified firms. The Adviser is authorized to pay higher commissions to
brokerage firms that provide it with investment and research information than to
firms which do not provide such services if the Adviser determines that such
commissions are reasonable in relation to the overall services provided. The
information received may be used by the Adviser in managing the assets of other
advisory accounts as well as in the management of the assets of the Fund.
INVESTMENT RESTRICTIONS. The Fund has adopted certain investment restrictions
which, like the investment objective, may not be changed without approval by a
majority (as defined in the 1940 Act) vote of the Fund's shareholders. These
restrictions provide, among other things, that the Fund may not:
1. With respect to 75% of its assets, invest more than five percent of its
assets in the securities of any one issuer (except obligations of the U.S.
Government, its agencies or instrumentalities) or purchase more than ten
percent of the outstanding voting securities of any one issuer.
2. Borrow in excess of five percent of the market or other fair value of its
total assets, or pledge its assets to an extent greater than five percent
of the market or other fair value of its total assets. Any such borrowings
shall be from banks and shall be undertaken only as a temporary measure for
extraordinary or emergency purposes. Deposits in escrow in connection with
the writing of covered or fully collateralized call or secured put options,
or in connection with the purchase or sale of futures contracts and related
options, are not deemed to be a pledge or other encumbrance.
3. Purchase an illiquid security if, as a result of such purchase, more than
ten percent of the Fund's net assets would be invested in such securities.
Illiquid securities are securities subject to legal or contractual
restrictions on resale, which include
21
<PAGE> 22
repurchase agreements maturing in more than seven days and any over-the-
counter options or other restricted securities purchased by the Fund.
4. Write, purchase or sell puts, calls or combinations thereof, except that
the Fund may (a) write covered or fully collateralized call options, write
secured put options, and enter into closing or offsetting purchase
transactions with respect to such options, (b) purchase and sell options to
the extent that the premiums paid for all such options owned at any time do
not exceed ten percent of its total assets and (c) engage in transactions
in interest rate futures contracts and related options provided that such
transactions are entered into for bona fide hedging purposes (or that the
underlying commodity value of the Fund's long positions do not exceed the
sum of certain identified liquid investments as specified in CFTC
regulations), provided further that the aggregate initial margin and
premiums do not exceed five percent of the fair market value of the Fund's
total assets, and provided further that the Fund may not purchase futures
contracts or related options if more than 30% of the Fund's total assets
would be so invested.
- ------------------------------------------------------------------------------
THE FUND AND ITS MANAGEMENT
- ------------------------------------------------------------------------------
The Fund is an open-end, diversified management investment company. This type
of company is commonly known as a mutual fund. A mutual fund provides, for those
who have similar investment goals, a practical and convenient way to invest in a
diversified portfolio of securities by combining their resources in an effort to
achieve such goals.
Eight Trustees have the responsibility for overseeing the affairs of the Fund.
The Adviser, 2800 Post Oak Boulevard, Houston, Texas 77056, determines the
investment of the Fund's assets, provides administrative services and manages
the Fund's business and affairs. The Adviser together with its predecessors, has
been in the investment advisory business since 1926. As of March 31, 1995, the
Adviser presently provides investment advice to 47 investment company portfolios
with total net assets of approximately $16.4 billion.
The Adviser and the Distributor are wholly owned subsidiaries of Van Kampen
American Capital, Inc. ("VKAC"), which is a wholly owned subsidiary of VK/AC
Holding, Inc. VK/AC Holding, Inc. is controlled, through the ownership of a
substantial majority of its common stock, by the Clayton & Dubilier Private
Equity Fund IV Limited Partnership ("C&D L.P."), a Connecticut limited
partnership. C&D L.P. is managed by Clayton, Dubilier & Rice, Inc., a New York
based private investment firm. The General Partner of C&D L.P. is Clayton &
Dubilier Associates IV Limited Partnership ("C&D Associates L.P."). The general
partners of C&D Associates L.P. are Joseph L. Rice, III, B. Charles Ames,
Alberto Cribiore, Donald J. Gogel and Hubbard C. Howe, each of whom is a
principal of Clayton, Dubilier & Rice, Inc. In addition, certain officers,
directors and employees of VKAC own, in the aggregate, not more than six percent
of the common stock of VK/AC Holding, Inc. and have the right to acquire, upon
the exercise of options, approximately an additional 10% of the common stock of
VK/AC Holding, Inc.
Mr. Don G. Powell is President and Director of the Fund, President, Chief
Executive Officer and Director of the Adviser, and Chairman, Chief Executive
Officer and Director of
22
<PAGE> 23
the Distributor. Most other officers of the Fund are also officers and/or
directors of the Adviser.
The Fund retains the Adviser to manage the investment of its assets and to
place orders for the purchase and sale of its portfolio securities. Under an
investment advisory agreement dated December 20, 1994 (the "Advisory
Agreement"), the Fund pays the Adviser a monthly fee computed on average daily
net assets of the Fund at an annual rate of 0.50% of the first $1 billion of net
assets; 0.475% of the next $1 billion of net assets; 0.45% of the next $1
billion of net assets; 0.40% of the next $1 billion of net assets; and 0.35% of
net assets in excess of $4 billion. Under the Advisory Agreement the Fund also
reimburses the Adviser for the costs of the Fund's accounting services, which
include maintaining its financial books and records and calculating its daily
net asset value. Operating expenses paid by the Fund include shareholder service
agency fees, distribution fees, service fees, custodial fees, legal and
accounting fees, the cost of reports and proxies to shareholders, Trustees'
fees, and all other business expenses not specifically assumed by the Adviser.
Advisory (management) fee, and total operating expense ratios are shown under
the caption "Expense Synopsis" herein.
The Adviser may utilize at its own expense credit analysis, research and
trading support services provided by its affiliate, Van Kampen American Capital
Investment Advisory Corp. (formerly Van Kampen Merritt Investment Advisory
Corp.).
Ted Mundy is primarily responsible for the day-to-day management of the Fund's
investment portfolio. Mr. Mundy is Vice President of the Fund and has been
primarily responsible for managing the Fund's investment portfolio since June
30, 1994. From September, 1990 to June, 1994, Mr. Mundy was a portfolio manager
with AMR Investment Services, Inc. Prior to that he was a trader with Howard,
Weil, Labouisse and Friedrichs.
- ------------------------------------------------------------------------------
PURCHASE OF SHARES
- ------------------------------------------------------------------------------
GENERAL
The Fund offers two classes of shares to the general public. Class A shares
are sold with an initial sales charge and Class C shares are sold without an
initial sales charge and are subject to a contingent deferred sales charge upon
certain redemptions. See "Multiple Pricing System" for a discussion of factors
to consider in selecting which class of shares to purchase. Contact the Service
Department at (800) 421-5666 for further information and appropriate forms. At
this time, the Fund offers Class B shares only to current Fund Class B
shareholders who have elected or may elect the option to reinvest dividends and/
or capital gains distributions in shares of the Fund (other share purchases by
such shareholders must be of Class A or Class C shares), and Class B
shareholders of other American Capital funds exchanging their Class B shares for
shares of the Fund. See "Shareholder Services."
Class A and Class C shares of the Fund are offered continuously for sale by
the Distributor and are available through authorized investment dealers. Initial
investments must be at least $500 and subsequent investments must be at least
$25. Both minimums may be
23
<PAGE> 24
waived by the Distributor for plans involving periodic investments. Shares of
the Fund may be sold in foreign countries where permissible. The Fund and the
Distributor reserve the right to refuse any order for the purchase of shares.
The Fund also reserves the right to suspend the sale of the Fund's shares in
response to conditions in the securities markets or for other reasons.
Shares may be purchased on any business day through authorized dealers. Shares
may also be purchased by completing the application included in this Prospectus
and forwarding the application, through the designated dealer, to the
shareholder service agent, ACCESS Investor Services, Inc. ("ACCESS"). When
purchasing shares of the Fund, investors must specify whether the purchase is
for Class A or Class C shares.
Shares are offered at the next determined net asset value per share, plus a
front-end or contingent deferred sales charge which will vary depending on the
method of purchasing shares chosen by the investor, as shown in the tables
herein. Net asset value per share is determined once daily as of the close of
trading on the New York Stock Exchange (the "Exchange") (currently 4:00 p.m.,
New York time) each day the Exchange is open. Net asset value per share for each
class is determined by dividing the value of the Fund's securities, cash and
other assets (including accrued interest) attributable to such class, less all
liabilities (including accrued expenses) attributable to such class by the total
number of shares of the class outstanding. U.S. Government and agency
obligations are valued at the last reported bid price. Listed options are valued
at the last reported sale price on the Exchange on which such option is traded,
or, if no sales are reported, at the mean between the last reported bid and
asked prices. Options for which market quotations are not readily available are
valued at a fair value under a method approved by the Trustees. Short-term
investments are valued in the manner described in the Notes to Financial
Statements in the Statement of Additional Information.
Generally, the net asset values per share of the Class A, Class B and Class C
shares are expected to be substantially the same. Under certain circumstances,
however, the per share net asset values of the Class A, Class B and Class C
shares may differ from one another, reflecting the daily expense accruals of the
distribution and the higher transfer agency fees applicable with respect to the
Class B and Class C shares and the differential in the dividends paid on the
classes of shares. The price paid for shares purchased is based on the next
calculation of net asset value (plus applicable Class A sales charges) after an
order is received by a dealer provided such order is transmitted to the
Distributor prior to the Distributor's close of business on such day. Orders
received by dealers after the close of the Exchange are priced based on the next
close provided they are received by the Distributor prior to the Distributor's
close of business on such day. It is the responsibility of dealers to transmit
orders received by them to the Distributor so they will be received prior to
such time. Orders of less than $500 are mailed by the dealer and processed at
the offering price next calculated after acceptance by ACCESS.
Each class of shares represents an interest in the same portfolio of
investments of the Fund, has the same rights and is identical in all respects,
except that (i) Class B and Class C shares bear the expenses of the deferred
sales arrangement and any expenses (including the distribution fee and
incremental transfer agency costs) resulting from such sales arrangement, (ii)
each class has exclusive voting rights with respect to
24
<PAGE> 25
approvals of the Rule 12b-1 distribution plan pursuant to which its distribution
fee and/or service fee is paid which relate to a specific class, and (iii) Class
B and Class C shares are subject to a conversion feature. Each class has
different exchange privileges and certain different shareholder service options
available. See "Distribution Plans" and "Shareholder Services -- Exchange
Privilege." The net income attributable to Class B and Class C shares and the
dividends payable on Class B and Class C shares will be reduced by the amount of
the distribution fee and incremental expenses associated with such distribution
fee. Sales personnel of broker-dealers distributing the Fund's shares and other
persons entitled to receive compensation for selling such shares may receive
differing compensation for selling Class A, Class B or Class C shares.
Agreements are in place which provide, among other things and subject to
certain conditions, for certain favorable distribution arrangements for shares
of the Fund with subsidiaries of The Travelers Inc.
The Distributor may from time to time implement programs under which a broker,
dealer or financial intermediary's sales force may be eligible to win nominal
awards for certain sales efforts or under which the Distributor will reallow to
any broker, dealer or financial intermediary that sponsors sales contests or
recognition programs conforming to criteria established by the Distributor, or
participates in sales programs sponsored by the Distributor, an amount not
exceeding the total applicable sales charges on sales generated by the broker or
dealer during such programs. Also, the Distributor in its discretion may from
time to time, pursuant to objective criteria established by it, pay fees to, and
sponsor business seminars for, qualifying brokers, dealers or financial
intermediaries for certain services or activities which are primarily intended
to result in sales of shares of the Fund. Such fees paid for such services and
activities with respect to the Fund will not exceed in the aggregate 1.25% of
the average total daily net assets of the Fund on an annual basis.
Compensation may include payment for travel expenses, including lodging,
incurred in connection with trips taken by invited registered representatives
and members of their families to locations within or outside of the United
States for meetings or seminars of a business nature.
CLASS A SHARES
The public offering price of Class A shares is the next determined net asset
value plus a sales charge, as set forth herein.
SALES CHARGE TABLE
<TABLE>
<CAPTION>
REALLOWED TO
DEALERS
SIZE OF AS % OF NET AS % OF (AS A % OF
INVESTMENT AMOUNT INVESTED OFFERING PRICE OFFERING PRICE)
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Less than $25,000........... 3.36% 3.25% 3.00%
$25,000 but less than
$249,999.................. 2.83% 2.75% 2.50%
$250,000 but less than
$499,999.................. 1.78% 1.75% 1.50%
$500,000 to $999,999........ 1.52% 1.50% 1.25%
$1,000,000 or more.......... (See herein) (See herein) (See herein)
- ------------------------------------------------------------------------------
</TABLE>
25
<PAGE> 26
No sales charge is payable at the time of purchase on investments of $1
million or more, although for such investments the Fund imposes a contingent
deferred sales charge of one percent in the event of certain redemptions within
one year of the purchase. The contingent deferred sales charge incurred upon
redemption is paid to the Distributor in reimbursement for distribution-related
expenses. A commission will be paid to dealers who initiate and are responsible
for purchases of $1 million or more as follows: one percent on sales to $2
million, plus 0.80% on the next million, plus 0.20% on the next $2 million and
0.08% on the excess over $5 million.
In addition to the reallowances from the applicable public offering price
described above, the Distributor may, from time to time, pay or allow additional
reallowances or promotional incentives, in the form of cash or other
compensation, to dealers that sell shares of the Fund. Dealers which are
reallowed all or substantially all of the sales charges may be deemed to be
underwriters for purposes of the Securities Act of 1933.
The Distributor may also pay financial institutions (which may include banks)
and other industry professionals that provide services to facilitate
transactions in shares of the Fund for their clients a transaction fee up to the
level of the reallowance allowable to dealers described herein. Such financial
institutions, other industry professionals and dealers are hereinafter referred
to as "Service Organizations." Banks are currently prohibited under the
Glass-Steagall Act from providing certain underwriting or distribution services.
If banking firms were prohibited from acting in any capacity or providing any of
the described services, the Distributor would consider what action, if any,
would be appropriate. The Distributor does not believe that termination of a
relationship with a bank would result in any material adverse consequences to
the Fund. State securities laws regarding registration of banks and other
financial institutions may differ from the interpretations of federal law
expressed herein, and banks and other financial institutions may be required to
register as dealers pursuant to certain state laws.
Class A shares of the Fund may be purchased at net asset value, upon written
assurance that the purchase is made for investment purposes and that the shares
will not be resold except through redemption by the Fund, by:
(1) Current or retired Trustees/Directors of funds advised by the Adviser, Van
Kampen American Capital Investment Advisory Corp. or John Govett & Co.
Limited and such persons' families and their beneficial accounts.
(2) Current or retired directors, officers and employees of VK/AC Holding,
Inc. and any of its subsidiaries, Clayton, Dubilier & Rice, Inc.,
employees of an investment subadviser to any such fund or an affiliate of
such subadviser; and such persons' families and their beneficial accounts.
(3) Directors, officers, employees and registered representatives of financial
institutions that have a selling group agreement with the Distributor and
their spouses and minor children when purchasing for any accounts they
beneficially own, or, in the case of any such financial institution, when
purchasing for retirement plans for such institution's employees.
(4) Registered investment advisers, trust companies and bank trust departments
investing on their own behalf or on behalf of their clients provided that
the
26
<PAGE> 27
aggregate amount invested in the Fund alone, or in any combination of
shares of the Fund and shares of certain other participating American
Capital funds as described herein under "Purchase of Shares -- Class A
Shares -- Volume Discounts," during the 13-month period commencing with
the first investment pursuant hereto equals at least $1 million. The
Distributor may pay Service Organizations through which purchases are made
an amount up to 0.50% of the amount invested, over a twelve-month period
following such transaction.
(5) Trustees and other fiduciaries purchasing shares for retirement plans of
organizations with retirement plan assets of $10 million or more. The
Distributor may pay commissions of up to one percent for such purchases.
(6) Accounts as to which a bank or broker-dealer charges an account management
fee ("wrap accounts"), provided the bank or broker-dealer has a separate
agreement with the Distributor.
(7) Investors purchasing shares of the Fund with redemption proceeds from
other mutual fund complexes on which the investor has paid a front-end
sales charge or was subject to a deferred sales charge, whether or not
paid, if such redemption has occurred no more than 30 days prior to such
purchase.
(8) Full service participant directed profit sharing and money purchase plans,
full service 401(k) plans, or similar full service recordkeeping programs
made available through Van Kampen American Capital Trust Company with at
least 50 eligible employees or investing at least $250,000 in
Participating Funds (as hereinafter defined) or American Capital Reserve
Fund, Inc. ("Reserve"). For such investments the Fund imposes a contingent
deferred sales charge of one percent in the event of redemptions within
one year of the purchase other than redemptions required to make payments
to participants under the terms of the plan. The contingent deferred sales
charge incurred upon certain redemptions is paid to the Distributor in
reimbursement for distribution-related expenses. A commission will be paid
to dealers who initiate and are responsible for such purchases as follows:
one percent on sales to $5 million, plus 0.50% on the next $5 million,
plus 0.25% on the excess over $10 million.
The term "families" includes a person's spouse, minor children and
grandchildren, parents, and a person's spouse's parents.
Purchase orders made pursuant to clause (4) may be placed either through
authorized dealers as described above or directly with ACCESS by the investment
adviser, trust company or bank trust department, provided that ACCESS receives
federal funds for the purchase by the close of business on the next business day
following acceptance of the order. An authorized dealer or financial institution
may charge a transaction fee for placing an order to purchase shares pursuant to
this provision or for placing a redemption order with respect to such shares.
Service Organizations will be paid a service fee as described herein under
"Distribution Plans" on purchases made as described in (3) through (8) above.
The Fund may terminate, or amend the terms of, offering shares of the Fund at
net asset value to such groups at any time.
27
<PAGE> 28
Investors purchasing Class A shares may, under certain circumstances, be
entitled to pay reduced sales charges. The circumstances under which such
investors may pay reduced sales charges are described herein.
VOLUME DISCOUNTS. The size of investment shown in the preceding table applies
to the total dollar amount being invested by any person in shares of the Fund
alone, or in any combination of shares of the Fund and shares of certain other
participating American Capital mutual funds (the "Participating Funds"),
although other Participating Funds may have different sales charges. The
Participating Funds are American Capital Comstock Fund, Inc., American Capital
Corporate Bond Fund, Inc. ("Corporate Bond"), American Capital Emerging Growth
Fund, Inc., American Capital Enterprise Fund, Inc., American Capital Equity
Income Fund, Inc., American Capital Federal Mortgage Trust, American Capital
Global Managed Assets Fund, Inc. ("Global Managed"), American Capital Government
Securities, Inc., American Capital Government Target Series ("Government
Target"), American Capital Growth and Income Fund, Inc., American Capital Harbor
Fund, Inc., American Capital High Yield Investments, Inc. ("High Yield"),
American Capital Municipal Bond Fund, Inc. ("Municipal Bond"), American Capital
Pace Fund, Inc., American Capital Real Estate Securities Fund, Inc. ("Real
Estate"), American Capital Tax-Exempt Trust ("Tax-Exempt"), American Capital
Texas Municipal Securities, Inc. ("Texas Municipal"), American Capital U.S.
Government Trust for Income ("Government Trust"), American Capital Utilities
Income Fund, Inc. ("Utilities Income") and American Capital World Portfolio
Series, Inc. ("World Portfolio"). A person eligible for a volume discount
includes an individual; members of a family unit comprising husband, wife, and
minor children; or a trustee or other fiduciary purchasing for a single
fiduciary account.
CUMULATIVE PURCHASE DISCOUNT. The size of investment shown in the preceding
table may also be determined by combining the amount being invested in shares of
Participating Funds plus the current offering price of all shares of the
Participating Funds which have been previously purchased and are still owned.
Shares previously purchased are only taken into account, however, if the
Distributor is notified by the investor or the investor's dealer at the time an
order is placed for a purchase which would qualify for a reduced sales charge on
the basis of previous purchases and if sufficient information is furnished to
permit confirmation of such purchases.
LETTER OF INTENT. A Letter of Intent provides an opportunity for an investor
to obtain a reduced sales charge by aggregating the investments over a 13-month
period to determine the sales charge as outlined in the preceding table. The
size of investment shown in the preceding table also includes purchases of
shares of the Funds over a 13-month period based on the total amount of intended
purchases plus the value of all shares of the Participating Funds previously
purchased and still owned. An investor may elect to compute the 13-month period
starting up to 90 days before the date of execution of a Letter of Intent. Each
investment made during the period receives the reduced sales charge applicable
to the total amount of the investment goal. If the goal is not achieved within
the period, the investor must pay the difference between the charges applicable
to the purchases made and the charges previously paid. The initial purchase must
be for an amount equal to at least five percent of the minimum total purchase
amount of the level selected. If trades not initially made under a Letter of
Intent subsequently qualify for a
28
<PAGE> 29
lower sales charge through the 90-day back-dating provisions, an adjustment will
be made at the expiration of the Letter of Intent to give effect to the lower
charge. Such adjustment in sales charge will be used to purchase additional
shares for the shareholder at the applicable discount category. Additional
information is contained in the application included in this Prospectus.
CLASS B SHARES
At this time, Class B shares are offered only in connection with the
reinvestment of dividends and/or distributions by current Class B shareholders
of the Fund or exchanges into the Fund by Class B shareholders of other American
Capital funds.
Class B shares are offered to the limited group of investors described above
at the next determined net asset value. Class B shares which are redeemed within
four years of purchase are subject to a contingent deferred sales charge at the
rates set forth in the following table charged as a percentage of the dollar
amount subject thereto. The charge is assessed on an amount equal to the lesser
of the then current market value or the cost of the shares being redeemed.
Accordingly, no sales charge is imposed on increases in net asset value above
the initial purchase price. In addition, no charge is assessed on shares derived
from reinvestment of dividends or capital gains distributions.
The amount of the contingent deferred sales charge, if any, varies depending
on the number of years from the time of payment for the purchase of Class B
shares until the time of redemption of such shares. Solely for purposes of
determining the number of years from the time of any payment for the purchases
of shares, all payments during a month are aggregated and deemed to have been
made on the last day of the month.
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES CHARGE
AS A PERCENTAGE OF
YEAR SINCE PURCHASE DOLLAR AMOUNT SUBJECT TO CHARGE
<S> <C>
- ---------------------------------------------------------------------------
First..................................... 3%
Second.................................... 3%
Third..................................... 2%
Fourth.................................... 1%
Fifth..................................... None
</TABLE>
- ------------------------------------------------------------------------------
In determining whether a contingent deferred sales charge is applicable to a
redemption, the calculation is determined in the manner that results in the
lowest possible rate being charged. Therefore, it is assumed that the redemption
is first of any shares in the shareholder's Fund account that are not subject to
a contingent deferred sales charge, second, of shares held for over four years
or shares acquired pursuant to reinvestment of dividends or distributions and
third, of shares held longest during the four-year period.
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the second year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired ten
additional shares upon dividend reinvestment. If at such time the investor makes
his or her first redemption of 50 shares (proceeds of $600), ten shares will not
be subject to charge because of dividend reinvest-
29
<PAGE> 30
ment. With respect to the remaining 40 shares, the charge is applied only to the
original cost of $10 per share and not to the increase in net asset value of $2
per share. Therefore, $400 of the $600 redemption proceeds is subject to a
deferred sales charge at a rate of three percent (the applicable rate in the
second year after purchase).
A commission or transaction fee of three percent of the purchase amount will
be paid to broker-dealers and other Service Organizations at the time of
purchase. Additionally, the Distributor may, from time to time, pay additional
promotional incentives in the form of cash or other compensation, to Service
Organizations that sell Class B shares of the Fund.
CLASS C SHARES
Class C shares are offered at the next determined net asset value. Class C
shares which are redeemed within the first year of purchase are subject to a
contingent deferred sales charge of one percent. The charge is assessed on an
amount equal to the lower of the then current market value or the cost of the
shares being redeemed. Accordingly, no sales charge is imposed on increases in
net asset value above the initial purchase price. In addition, no charge is
assessed on shares derived from reinvestment of dividends or capital gains
distributions.
In determining whether a contingent deferred sales charge is applicable to a
redemption, the calculation is determined in the manner that results in the
lowest possible rate being charged. Therefore, it is assumed that the redemption
is first of any shares in the shareholder's Fund account that are not subject to
a contingent deferred sales charge and second of shares held for more than one
year or shares acquired pursuant to reinvestment of dividends or distributions.
A commission or transaction fee of one percent of the purchase amount will be
paid to broker-dealers and other Service Organizations at the time of purchase.
Broker-dealers and other Service Organizations will also be paid ongoing
commissions and transaction fees of up to 0.25% of the average daily net assets
of the Fund's Class C shares for the second through tenth year after purchase.
Additionally, the Distributor may, from time to time, pay additional promotional
incentives in the form of cash or other compensation, to Service Organizations
that sell Class C shares of the Fund.
WAIVER OF CONTINGENT DEFERRED SALES CHARGE
The contingent deferred sales charge is waived on redemptions of Class B and
Class C shares (i) following the death or disability (as defined in the Code) of
a shareholder, (ii) in connection with certain distributions from an IRA or
other retirement plan, (iii) pursuant to the Fund's systematic withdrawal plan
but limited to 12% annually of the initial value of the account, and (iv)
effected pursuant to the right of the Fund to liquidate a shareholder's account
as described herein under "Redemption of Shares." The contingent deferred sales
charge is also waived on redemptions of Class C shares and as it relates to the
reinvestment of redemption proceeds in shares of the same class of the Fund
within 120 days after redemption. See the Statement of Additional Information
for further discussion of waiver provisions.
30
<PAGE> 31
- ------------------------------------------------------------------------------
DISTRIBUTION PLANS
- ------------------------------------------------------------------------------
Rule 12b-1 adopted by the SEC under the 1940 Act permits an investment company
to directly or indirectly pay expenses associated with the distribution of its
shares ("distribution expenses") and servicing its shareholders in accordance
with a plan adopted by the investment company's board of directors and approved
by its shareholders. Pursuant to such Rule, the Trustees of the Fund, and the
shareholders of each class have adopted three Distribution Plans hereinafter
referred to as the "Class A Plan," the "Class B Plan" and the "Class C Plan."
Each Distribution Plan is in compliance with the Rules of Fair Practice of the
National Association of Securities Dealers, Inc. ("NASD Rules") applicable to
mutual fund sales charges. The NASD Rules limit the annual distribution charges
that a mutual fund may impose on a class of shares. The NASD Rules also limit
the aggregate amount which the Fund may pay for such distribution costs. Under
the Class A Plan the Fund pays a service fee to the Distributor at an annual
rate of up to 0.25% of the Fund's aggregate average daily net assets
attributable to the Class A shares. Under the Class B Plan and the Class C Plan,
the Fund pays a service fee to the Distributor at an annual rate of up to 0.25%
and a distribution fee at an annual rate of up to 0.75% of the Fund's aggregate
average daily net assets attributable to the Class B or Class C shares to
reimburse the Distributor for service fees paid by it to Service Organizations
and for its distribution costs.
The Distributor uses the Class A, Class B and Class C service fees to
compensate Service Organizations for personal services and/or maintenance of
shareholder accounts. Under the Class B Plan, the Distributor receives
additional payments from the Fund in the form of a distribution fee at the
annual rate of up to 0.75% of the net assets of the Class B shares as
reimbursement for (i) upfront commissions and transaction fees of up to three
percent of the purchase price for Class B shares purchased by the clients of
broker/dealers and other Service Organizations and (ii) other distribution
expenses as described in the Statement of Additional Information. Under the
Class C Plan, the Distributor receives additional payments from the Fund in the
form of a distribution fee at the annual rate of up to 0.75% of the net assets
of the Class C shares as reimbursement for (i) upfront commissions and
transaction fees of up to 0.75% of the purchase price of Class C shares
purchased by the clients of broker-dealers and other Service Organizations and
ongoing commissions and transaction fees of up to 0.25% of the average daily net
assets of the Fund's Class C shares and (ii) other distribution expenses as
described in the Statement of Additional Information.
In adopting the Class A Plan, the Class B Plan and the Class C Plan, the
Trustees of the Fund determined that there was a reasonable likelihood that such
Plans would benefit the Fund and its shareholders. Information with respect to
distribution and service revenues and expenses is presented to the Trustees each
year for their consideration in connection with their deliberations as to the
continuance of the Distribution Plans. In their review of the Distribution
Plans, the Trustees are asked to take into consideration expenses incurred in
connection with the distribution and servicing of each class of shares
separately. The sales charge and distribution fee, if any, of a particular class
will not be used to subsidize the sale of shares of the other classes.
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<PAGE> 32
Service expenses accrued by the Distributor in one fiscal year may not be paid
from the Class A service fees received from the Fund in subsequent fiscal years.
Thus, if the Class A Plan were terminated or not continued, no amounts (other
than current amounts accrued but not yet paid) would be owed by the Fund to the
Distributor.
The distribution fee attributable to Class B or Class C shares is designed to
permit an investor to purchase such shares without the assessment of a front-end
sales load and at the same time permit the Distributor to compensate Service
Organizations with respect to such shares. In this regard, the purpose and
function of the combined contingent deferred sales charge and distribution fee
are the same as those of the initial sales charge with respect to the Class A
shares of the Fund in that in both cases such charges provide for the financing
of the distribution of the Fund's shares.
Actual distribution expenditures paid by the Distributor with respect to Class
B or Class C shares for any given year are expected to exceed the fees received
pursuant to the Class B Plan and Class C Plan and payments received pursuant to
contingent deferred sales charges. Such excess will be carried forward and may
be reimbursed by the Fund or its shareholders from payments received through
contingent deferred sales charges in future years and from payments under the
Class B Plan and Class C Plan so long as such Plans are in effect. For example,
if in a fiscal year the Distributor incurred distribution expenses under the
Class C Plan of $1 million, of which $500,000 was recovered in the form of
contingent deferred sales charges paid by investors and $400,000 was reimbursed
in the form of payments made by the Fund to the Distributor under the Class C
Plan, the balance of $100,000 would be subject to recovery in future fiscal
years from such sources. For the plan year ended June 30, 1994, the unreimbursed
expenses incurred by the Distributor and carried forward were approximately $1.3
million or 5.7% of average daily net assets of the class under the Class B Plan
and $155,000 or 1.7% of average daily net assets of the class under the Class C
Plan.
If the Class B Plan or Class C Plan was terminated or not continued, the Fund
would not be contractually obligated to pay and has no liability to the
Distributor for any expenses not previously reimbursed by the Fund or recovered
through contingent deferred sales charges.
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SHAREHOLDER SERVICES
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The Fund offers a number of shareholder services designed to facilitate
investment in its shares at little or no extra cost to the investor. Below is a
description of such services.
SHAREHOLDER SERVICES APPLICABLE TO ALL CLASSES
INVESTMENT ACCOUNT. Each shareholder has an investment account under which
shares are held by ACCESS. Share certificates are not issued except upon
shareholder request. Most shareholders elect not to receive certificates in
order to facilitate redemptions and transfers. A shareholder may incur an
expense to replace a lost certificate. Except as described herein, after each
share transaction in an account, the shareholder
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<PAGE> 33
receives a statement showing the activity in the account. Each shareholder who
has an account in any of the Participating Funds listed under "Purchase of
Shares -- Class A Shares -- Volume Discounts," or Reserve, may receive
statements quarterly from ACCESS showing any reinvestments of dividends and
capital gains distributions and any other activity in the account since the
preceding statement. Such shareholders also will receive separate confirmations
for each purchase or sale transaction other than reinvestment of dividends and
capital gains distributions and systematic purchases or redemptions. Additions
to an investment account may be made at any time by purchasing shares through
authorized investment dealers or by mailing a check directly to ACCESS.
REINVESTMENT PLAN. A convenient way for investors to accumulate additional
shares is by accepting dividends and capital gains distributions in shares of
the Fund. Such shares are acquired at net asset value (without sales charge) on
the record date. Unless the shareholder instructs otherwise, the reinvestment
plan is automatic. The investor may, on the initial application or prior to any
declaration, instruct that dividends be paid in cash and capital gains
distributions be reinvested at net asset value, or that both dividends and
capital gains distributions be paid in cash. The Fund has suspended sales of
Class B shares to the public; however current Fund Class B shareholders who have
elected the option to reinvest dividends and/or capital gains distributions in
shares of the Fund may continue to do so. Current Fund Class B shareholders who
have elected the option to be paid dividends and/or capital gains distributions
in cash may elect to reinvest such dividends and distributions in Class B shares
of the Fund.
AUTOMATIC INVESTMENT PLAN. An automatic investment plan is available under
which a shareholder can authorize ACCESS to charge a bank account on a regular
basis to invest pre-determined amounts in the Fund. Additional information is
available from the Distributor or authorized investment dealers.
RETIREMENT PLANS. Eligible investors may establish individual retirement
accounts ("IRAs"); SEP, and pension and profit sharing plans; 401(k) plans; or
Section 403(b)(7) plans in the case of employees of public school systems and
certain non-profit organizations. Documents and forms containing detailed
information regarding these plans are available from the Distributor. Van Kampen
American Capital Trust Company serves as custodian under the IRA, 403(b)(7) and
Keogh plans. Details regarding fees, as well as full plan administration for
profit sharing, pension and 401(k) plans, are available from the Distributor.
FUND TO FUND DIVIDENDS. A shareholder may, upon written request or by
completing the appropriate section of the application form in this Prospectus,
elect to have all dividends and other distributions paid on a Class A, Class B
or Class C account in the Fund invested into a pre-existing Class A, Class B or
Class C account in any of the Participating Funds listed under "Purchase of
Shares -- Class A Shares -- Volume Discounts" or Reserve.
Both accounts must be of the same class and of the same type, either
non-retirement or retirement. Any two non-retirement accounts can be used. If
the accounts are retirement accounts, they must both be for the same class and
of the same type of retirement plan (e.g., IRA, 403(b)(7), 401(k), Keogh) and
the benefit of the same individual. If the qualified pre-existing account does
not exist, the shareholder must establish a new
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<PAGE> 34
account subject to minimum investment and other requirements of the fund into
which distributions would be invested. Distributions are invested into the
selected fund at its net asset value as of the payable date of the distribution
only if shares of such selected fund have been registered for sale in the
investor's state.
EXCHANGE PRIVILEGE. Shares of the Fund or of any Participating Fund (listed
herein under "Purchase of Shares -- Class A Shares -- Volume Discounts"), other
than Government Target, may be exchanged for shares of the same class of any
other fund without sales charge, provided that shares of Corporate Bond, the
Fund, Global Managed, Government Trust, High Yield, Municipal Bond, Real Estate,
Tax-Exempt, Texas Municipal, Utilities Income and the Global Government
Securities Fund of World Portfolio are subject to a 30-day holding period
requirement. Shares of Government Target may be exchanged for Class A shares of
the Fund without sales charge. Class A shares of Reserve that were not acquired
in exchange for Class B or Class C shares of a Participating Fund may be
exchanged for Class A shares of the Fund upon payment of the excess, if any, of
the sales charge rate applicable to the shares being acquired over the sales
charge rate previously paid. Shares of Reserve acquired through an exchange of
Class B or Class C shares may be exchanged only for the same class of shares of
a Participating Fund without incurring a contingent deferred sales charge.
Shares of any Participating Fund or Reserve may be exchanged for shares of any
other Participating Fund if shares of that Participating Fund are available for
sale; however, during periods of suspension of sales, shares of a Participating
Fund may be available for sale only to existing shareholders of a Participating
Fund. Additional funds may be added from time to time as a Participating Fund.
Class B and Class C shareholders of the Fund have the ability to exchange
their shares ("original shares") for the same class of shares of any other
American Capital fund that offers such class of shares ("new shares") in an
amount equal to the aggregate net asset value of the original shares, without
the payment of any contingent deferred sales charge otherwise due upon
redemption of the original shares. For purposes of computing the contingent
deferred sales charge payable upon a disposition of the new shares, the holding
period for the original shares is added to the holding period of the new shares.
Class B or Class C shareholders would remain subject to the contingent deferred
sales charge imposed by the original fund upon their redemption from the
American Capital complex of funds. The contingent deferred sales charge is based
on the holding period requirements of the original fund.
The Fund has suspended sales of Class B shares, however Class B shareholders
of other American Capital funds may exchange their Class B shares of such other
funds for Class B shares of the Fund.
Shares of the Fund to be acquired must be registered for sale in the
investor's state and an exchange fee, currently $5 per transaction, is charged
by ACCESS except as described herein under "Systematic Exchange" and "Automatic
Exchange." Exchanges of shares are sales and may result in a gain or loss for
federal income tax purposes, although if the shares exchanged have been held for
less than 91 days, the sales charge paid on such shares is not included in the
tax basis of the exchanged shares, but is carried over and
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<PAGE> 35
included in the tax basis of the shares acquired. See the Statement of
Additional Information.
A shareholder wishing to make an exchange may do so by sending a written
request to ACCESS or by contacting the telephone transaction line at (800)
421-5684. A shareholder automatically has telephone exchange privileges unless
otherwise designated in the application form included in this Prospectus. VKAC
and its subsidiaries, including ACCESS (collectively, "Van Kampen American
Capital"), and the Fund employ procedures considered by them to be reasonable to
confirm that instructions communicated by telephone are genuine. Such procedures
include requiring certain personal identification information prior to acting
upon telephone instructions, tape recording telephone communications, and
providing written confirmation of instructions communicated by telephone. If
reasonable procedures are employed, neither Van Kampen American Capital nor the
Fund will be liable for following telephone instructions which it reasonably
believes to be genuine. Van Kampen American Capital and the Fund may be liable
for any losses due to unauthorized or fraudulent instructions if reasonable
procedures are not followed. Exchanges are effected at the net asset value per
share next calculated after the request is received in good order with
adjustment for any additional sales charge. See "Purchase of Shares" and
"Redemption of Shares." If the exchanging shareholder does not have an account
in the fund whose shares are being acquired, a new account will be established
with the same registration, dividend and capital gains options (except fund to
fund dividends) and dealer of record as the account from which shares are
exchanged, unless otherwise specified by the shareholder. In order to establish
a systematic withdrawal plan for the new account or reinvest dividends from the
new account into another fund, however, an exchanging shareholder must file a
specific written request. The Fund reserves the right to reject any order to
acquire its shares through exchange, or otherwise to modify, restrict or
terminate the exchange privilege at any time on 60 days' notice to its
shareholders of any termination or material amendment.
A prospectus of any of these mutual funds may be obtained from any authorized
dealer or the Distributor. An investor considering an exchange to one of such
funds should refer to the prospectus for additional information regarding such
fund prior to investing.
SYSTEMATIC EXCHANGE. A shareholder may invest regularly into any Participating
Fund by systematically exchanging from the Fund into such other fund account
($25 minimum for existing account, $100 minimum for establishing new account).
Both accounts must be of the same type and class. The exchange fee as described
under "Shareholder Services -- Exchange Privilege" will be waived for such
systematic exchanges. Additional information on how to establish this option is
available from the Distributor.
AUTOMATIC EXCHANGE. The exchange fee described above under "Shareholder
Services -- Exchange Privilege" will be waived for any exchange transmitted
through ACCESS Plus, FUNDSERV or via computer transmission. Contact the Service
Department at (800) 421-5666 for further information on how to utilize this
option.
SYSTEMATIC WITHDRAWAL PLAN. Any investor whose shares in a single account
total $10,000 or more at the offering price next computed after receipt of
instructions may establish a monthly withdrawal plan. Any investor whose shares
in a single account
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<PAGE> 36
total $5,000 or more may establish a withdrawal plan on a quarterly, semi-annual
or annual basis. This plan provides for the orderly use of the entire account,
not only the income but also the capital, if necessary. Each withdrawal
constitutes a redemption of shares on which any capital gain or loss will be
recognized. The plan holder may arrange for monthly, quarterly, semi-annual, or
annual checks in any amount not less than $25. Such a systematic withdrawal plan
may also be maintained by an investor purchasing shares for a retirement plan
established on a form made available by the Fund. See "Shareholder
Services -- Retirement Plans."
Class B and Class C shareholders who establish a withdrawal plan may redeem up
to 12% annually of the shareholder's initial account balance without incurring a
contingent deferred sales charge. Initial account balance means the amount of
the shareholder's investment in the Fund at the time the election to participate
in the plan is made. See "Purchase of Shares -- Waiver of Contingent Deferred
Sales Charge" and the Statement of Additional Information.
Under the plan, sufficient shares of the Fund are redeemed to provide the
amount of the periodic withdrawal payment. Dividends and capital gains
distributions on shares held under the plan are reinvested in additional shares
at the next determined net asset value. If periodic withdrawals continuously
exceed reinvested dividends and capital gains distributions, the shareholder's
original investment will be correspondingly reduced and ultimately exhausted.
Withdrawals made concurrently with purchases of additional shares ordinarily
will be disadvantageous to the shareholder because of the duplication of sales
charges. Any taxable gain or loss will be recognized by the shareholder upon
redemption of shares.
SHAREHOLDER SERVICES APPLICABLE TO CLASS A SHAREHOLDERS ONLY
CHECK WRITING PRIVILEGE. A Class A shareholder holding shares of the Fund for
which certificates have not been issued and which are in a non-escrow status may
appoint ACCESS as agent by completing the AUTHORIZATION FOR REDEMPTION BY CHECK
form and the appropriate section of the application and returning the form and
the application to ACCESS. Once the form is properly completed, signed and
returned to the agent, a supply of checks drawn on State Street Bank and Trust
Company ("State Street Bank") will be sent to the Class A shareholder. These
checks may be made payable by the Class A shareholder to the order of any person
in any amount of $100 or more.
When a check is presented to State Street Bank for payment, full and
fractional Class A shares required to cover the amount of the check are redeemed
from the shareholder's Class A account by ACCESS at the next determined net
asset value. Check writing redemptions represent the sale of Class A shares. Any
gain or loss realized on the sale of Class A shares is a taxable event. See
"Redemption of Shares."
Checks will not be honored for redemption of Class A shares held less than 15
calendar days, unless such Class A shares have been paid for by bank wire. Any
Class A shares for which there are outstanding certificates may not be redeemed
by check. If the amount of the check is greater than the proceeds of all
uncertificated shares held in the shareholder's Class A account, the check will
be returned and the shareholder may be subject
36
<PAGE> 37
to additional charges. A Class A shareholder may not liquidate the entire
account by means of a check. The check writing privilege may be terminated or
suspended at any time by the Fund or State Street Bank. Retirement Plans and
accounts that are subject to backup withholding are not eligible for the
privilege. A "stop payment" system is not available on these checks. See the
Statement of Additional Information for further information regarding the
establishment of the privilege.
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REDEMPTION OF SHARES
- ------------------------------------------------------------------------------
REGULAR REDEMPTIONS. Shareholders may redeem for cash some or all of their
shares of the Fund at any time. To do so, a written request in proper form must
be sent directly to ACCESS, P. O. Box 418256, Kansas City, Missouri 64141-9256.
Shareholders may also place redemption requests through an authorized dealer.
Orders received from dealers must be at least $500 unless transmitted via the
FUNDSERV network. The redemption price for such shares is the net asset value
next calculated after an order is received by a dealer provided such order is
transmitted to the Distributor prior to the Distributor's close of business on
such day. It is the responsibility of dealers to transmit redemption requests
received by them to the Distributor so they will be received prior to such time.
As described herein under "Purchase of Shares," redemptions of Class B and
Class C shares are subject to a contingent deferred sales charge. In addition, a
contingent deferred sales charge of one percent may be imposed on certain
redemptions of Class A shares made within one year of purchase for investments
of $1 million or more and for certain qualified 401(k) retirement plans. The
contingent deferred sales charge incurred upon redemption is paid to the
Distributor in reimbursement for the distribution-related expenses. See
"Purchase of Shares." A custodian of a retirement plan account may charge fees
based on the custodian's fee schedule.
The request for redemption must be signed by persons in whose names the shares
are registered. Signatures must conform exactly to the account registration. If
the proceeds of the redemption would exceed $50,000, or if the proceeds are not
to be paid to the record owner at the record address, or if the record address
has changed within the previous 60 days, signature(s) must be guaranteed by one
of the following: a bank or trust company; a broker-dealer; a credit union; a
national securities exchange, registered securities association or clearing
agency; a savings and loan association; or a federal savings bank.
Generally, a properly signed written request with any required signature
guarantee is all that is required for a redemption. In some cases, however,
other documents may be necessary. For example, although the Fund normally does
not issue certificates for shares, it does so if a special request is made to
ACCESS. In the case of shareholders holding certificates, the certificates for
the shares being redeemed must accompany the redemption request. In the event
the redemption is requested by a corporation, partnership, trust, fiduciary,
executor or administrator, and the name and title of the individual(s)
authorizing such redemption is not shown in the account registration, a copy of
the corporate resolution or other legal documentation appointing the authorized
signer
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<PAGE> 38
and certified within the prior 60 days must accompany the redemption request.
IRA redemption requests should be sent to the IRA custodian to be forwarded to
the shareholder service agent. Where Van Kampen American Capital Trust Company
serves as IRA custodian, special IRA, 403(b)(7), or Keogh distribution forms
must be obtained from and be forwarded to Van Kampen American Capital Trust
Company, P.O. Box 944, Houston, Texas 77001-0944. Contact the custodian for
information.
In the case of redemption requests sent directly to ACCESS, the redemption
price is the net asset value per share next determined after the request is
received in proper form. Payment for shares redeemed will be made by check
mailed within seven days after acceptance by ACCESS of the request and any other
necessary documents in proper order. Such payments may be postponed or the right
of redemption suspended as provided by the rules of the SEC. If the shares to be
redeemed have been recently purchased by check, ACCESS may delay mailing a
redemption check until it confirms that the purchase check has cleared, usually
a period of up to 15 days. Any taxable gain or loss will be recognized by the
shareholder upon redemption of shares.
The Fund may redeem any shareholder account with a net asset value of less
than $250 if this results from shareholder withdrawals and not from market
decline. Three months advance notice of any such involuntary redemption is
required, and the shareholder is given an opportunity to purchase the required
value of additional shares at the next determined net asset value without sales
charge. Any applicable contingent deferred sales charge will be deducted from
the proceeds of this redemption.
TELEPHONE REDEMPTIONS. In addition to the regular redemption procedures set
forth above, the Fund permits shareholders and the dealer representative of
record to redeem shares by telephone and to have redemption proceeds sent to the
address of record for the account or to the bank account of record as described
below. To establish such privilege, a shareholder must complete the appropriate
section of the application form in this Prospectus or call the Fund at (800)
421-5666 to request that a copy of the Telephone Redemption Authorization form
be sent to them for completion. To redeem shares, contact the telephone
transaction line at (800) 421-5684. Van Kampen American Capital and the Fund
employ procedures considered by them to be reasonable to confirm that
instructions communicated by telephone are genuine. Such procedures requiring
certain personal identification information prior to acting upon telephone
instructions, tape recording telephone communications, and providing written
confirmation of instructions communicated by telephone. If reasonable procedures
are employed, neither Van Kampen American Capital nor the Fund will be liable
for following instructions which it reasonably believes to be genuine. Van
Kampen American Capital and the Fund may be liable for any losses due to
unauthorized or fraudulent instructions if reasonable procedures are not
followed. Telephone redemptions may not be available if the shareholder cannot
reach ACCESS by telephone, whether because all telephone lines are busy or for
any other reason; in such case, a shareholder would have to use the Fund's
regular redemption procedure previously described. Requests received by ACCESS
prior to 4:00 p.m., New York time, on a regular business day will be processed
at the net asset value per share determined that day. These privileges are
available for all accounts other than retirement accounts. The telephone
redemption privilege is not available for shares
38
<PAGE> 39
represented by certificates. If an account has multiple owners, ACCESS may rely
on the instructions of any one owner.
For redemptions authorized by telephone, amounts of $50,000 or less may be
redeemed once in each 30-day period. The proceeds must be payable to the
shareholder(s) of record and sent to the address of record for the account or
wired directly to their predesignated bank account. This privilege is not
available if the address of record has been changed within 60 days prior to a
telephone redemption request. Proceeds from redemptions are expected to be wired
on the next business day following the date of redemption. The Fund reserves the
right at any time to terminate, limit or otherwise modify this redemption
privilege.
REINSTATEMENT PRIVILEGE. A Class A or Class B shareholder who has redeemed
shares of the Fund may reinstate any portion or all of the net proceeds of such
redemption in Class A shares of the Fund. A Class C shareholder who has redeemed
shares of the Fund may reinstate any portion or all of the net proceeds of such
redemption in Class C shares of the Fund with credit given for any contingent
deferred sales charge paid upon such redemption. Such reinstatement is made at
the net asset value (without sales charge except as described under "Shareholder
Services -- Exchange Privilege") next determined after the order is received,
which must be within 120 days after the date of the redemption. See "Purchase of
Shares -- Waiver of Contingent Deferred Sales Charge" and the Statement of
Additional Information. Reinstatement at net asset value is also offered to
participants in those eligible retirement plans held or administered by Van
Kampen American Capital Trust Company for repayment of principal (and interest)
on their borrowings on such plans.
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DIVIDENDS, DISTRIBUTIONS AND TAXES
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DIVIDENDS AND DISTRIBUTIONS. Income dividends are paid each business day, and
distributed monthly. The daily dividend is a fixed amount determined at least
monthly which is expected not to exceed the net income of the Fund for the month
divided by the number of business days in the month. Shares (other than shares
acquired through an exchange) become entitled to dividends on the day ACCESS
receives payment for the shares, and remain entitled to dividends through the
day such shares are processed for payment on redemption. With respect to shares
acquired through an exchange, such shares become entitled to dividends on the
day after ACCESS receives payment for the shares, and remain entitled to
dividends through the day such shares are processed for payment on redemption.
Therefore, if a dealer delays forwarding to ACCESS payment for shares which an
investor has made to the dealer, this will in effect cost the investor money
because it will delay the date upon which he becomes entitled to dividends.
Unless the shareholder instructs otherwise, dividends and capital gains
distributions are automatically applied to purchase additional shares of the
Fund at the next determined net asset value. See "Shareholder
Services -- Reinvestment Plan."
The per share dividends on Class B and Class C shares will be lower than the
per share dividends on Class A shares as a result of the distribution fees and
higher incremental transfer agency fees applicable to such classes of shares.
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<PAGE> 40
Any taxable net realized short-term or long-term capital gains will be
distributed to shareholders at least annually. Since the capital loss carry
forward and unrealized depreciation of securities totaled about $2.96 per share
at December 31, 1994, no capital gain distributions are presently anticipated.
In computing interest income the Fund does not amortize premiums paid on the
purchase of debt securities. Thus in the case of mortgage-related and other U.S.
Government securities purchased at a premium, interest income is greater than it
would be if the premiums were amortized.
Dividends and distributions paid by the Fund have the effect of reducing net
asset value per share on the record date by the amount of the payment.
Therefore, a dividend or distribution of record shortly after the purchase of
shares by an investor represents, in substance, a return of capital to the
investor even though subject to income taxes as discussed below.
TAXES. The Fund has qualified and intends to continue to qualify as a
regulated investment company under the Code. By qualifying as a regulated
investment company, the Fund is not subject to federal income taxes to the
extent it distributes its net investment income and net realized capital gains.
Shareholders not subject to tax on their income will not, however, be required
to pay tax on amounts distributed to them. However, shareholders normally are
subject to federal income tax, and any applicable state or local income taxes,
on the dividends and distributions received from the Fund.
There are differences between federal income tax regulations and the generally
accepted accounting principles adopted by the Fund. For example, year-end
marking to market on certain options and futures contracts generally are
recognized for tax purposes but not for accounting purposes and certain
adjustments are made for tax purposes for repayments on mortgage-related
securities. Since dividends and distributions may, from time to time, be paid by
the Fund based on earnings recognized for accounting purposes, a portion of such
dividends and distributions may constitute a return of capital for federal
income tax purposes. If the amount of distributions paid by the Fund for any
fiscal year exceeds its investment company taxable income plus net realized
capital gains for the year, the excess is treated as a return of capital. Each
distribution paid for that year would be treated, in the same proportion, in
part as a distribution of taxable income and in part as a return of capital.
Shareholders are not subject to a current federal income tax on the part which
is treated as a return of capital, but their basis in Fund shares would be
reduced by that amount. This reduction of basis would operate to increase
capital gain (or decrease capital loss) upon subsequent sale or redemption of
shares.
Current federal tax law requires that a holder, such as the Fund, of a
stripped security accrue a portion of the discount at which the security was
purchased as income each year even though the Fund receives no interest payment
in cash on the security during the year. As an investment company, the Fund must
pay out substantially all of its net investment income each year. Accordingly,
the Fund may be required to pay out as an income distribution each year an
amount which is greater than the total amount of cash interest the Fund actually
received. Such distributions will be made from the cash assets of the Fund or by
liquidation of portfolio securities, if necessary. If a distribution of cash
necessitates the liquidation of portfolio securities, the Adviser will select
which securities to
40
<PAGE> 41
sell. The Fund may realize a gain or loss from such sales. In the event the Fund
realizes net capital gains from such transactions, its shareholders may receive
a larger capital gain distribution, if any, than they would in the absence of
such transactions.
Shareholders are notified annually of the federal tax status of dividends and
any capital gains distributions. Long-term capital gains distributions
constitute long-term capital gains for federal income tax purposes.
To avoid being subject to a 31% federal backup withholding on dividends,
distributions and redemption payments, shareholders must furnish the Fund with a
certification of their correct taxpayer identification number.
Gains or losses on the Fund's transactions in listed options on securities,
futures and options on futures generally are treated as 60% long-term and 40%
short-term, and positions held by the Fund at the end of its fiscal year
generally are required to be marked to market, with the result that unrealized
gains and losses are treated as realized. Gains and losses realized by the Fund
from writing over-the-counter options constitute short-term capital gains or
losses, unless the option is exercised, in which case the character of the gain
or loss is determined by the holding period of the underlying security. The Code
contains certain "straddle" rules which require deferral of losses incurred in
certain transactions involving hedged positions to the extent the Fund has
unrealized gains in offsetting positions and generally terminate the holding
period of the subject position. Additional information is set forth in the
Statement of Additional Information.
The foregoing is a brief summary of some of the federal income tax
considerations affecting the Fund and its investors who are U.S. residents and
U.S. corporations. Investors should consult their tax advisers for more detailed
tax advice including state and local tax considerations. Foreign investors
should consult their own counsel for further information as to the U.S. and
their country of residence or citizenship tax consequences of receipt of
dividends and distributions from the Fund.
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PRIOR PERFORMANCE INFORMATION
- ------------------------------------------------------------------------------
From time to time, the Fund may advertise its total return for prior periods.
Any such advertisement would include at least average annual total return
quotations for one year, five years and for the life of the Fund. Other total
return quotations, aggregate or average, over other time periods may also be
included.
The total return of the Fund for a particular period represents the increase
(or decrease) in the value of a hypothetical investment in the Fund from the
beginning to the end of the period. Total return is calculated by subtracting
the value of the initial investment from the ending value and showing the
difference as a percentage of the initial investment; the calculation assumes
the initial investment is made at the current maximum public offering price
(which includes a maximum sales charge of 3.25%); that all income dividends or
capital gains distributions during the period are reinvested in Fund shares at
net asset value; and that any applicable contingent deferred sales charge has
been paid. The Fund's total return will vary depending on market conditions, the
securities comprising the Fund's portfolio, the Fund's operating expenses and
unrealized net
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<PAGE> 42
capital gains or losses during the period. Since Class A shares of the Fund were
offered at a maximum sales charge at four percent prior to May 10, 1993, and
2.25% from such date to April 28, 1995, actual Fund total return would fluctuate
during those periods, being somewhat less when higher sales charges were in
effect. Total return is based on historical earnings and asset value
fluctuations and is not intended to indicate future performance. No adjustments
are made to reflect any income taxes payable by shareholders on dividends and
distributions paid by the Fund.
Average annual total return quotations for periods of two or more years are
computed by finding the average annual compounded rate of return over the period
that would equate the initial amount invested to the ending redeemable value.
In addition to total return information, the Fund may also advertise its
current "yield." Yield figures are based on historical earnings and are not
intended to indicate future performance. Yield is determined by analyzing the
Fund's net income per share for a 30-day (or one-month) period (which period
will be stated in the advertisement), and dividing by the maximum offering price
per share on the last day of the period. A "bond equivalent" annualization
method is used to reflect a semiannual compounding.
For purposes of calculating yield quotations, net income is determined by a
standard formula prescribed by the SEC to facilitate comparison with yields
quoted by other investment companies. Net income computed for this formula
differs from net income reported by the Fund in accordance with generally
accepted accounting principles and from net income computed for federal income
tax reporting purposes. Thus the yield computed for a period may be greater or
less than the Fund's then current dividend rate.
The Fund's yield is not fixed and will fluctuate in response to prevailing
interest rates and the market value of portfolio securities, and as a function
of the type of securities owned by the Fund, portfolio maturity and the Fund's
expenses.
Yield quotations should be considered relative to changes in the net asset
value of the Fund's shares, the Fund's investment policies, and the risks of
investing in shares of the Fund. The investment return and principal value of an
investment in the Fund will fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their original cost.
To increase the yield of the Fund, the Adviser, may from time to time, limit
its management fee. A yield quotation which reflects an expense reimbursement or
subsidization by the Adviser will be higher than a yield quotation without such
expense reimbursement or subsidization. The Adviser may stop limiting its
management fees at any time without prior notice.
Yield and total return are calculated separately for Class A, Class B and
Class C shares. Class A total return figures include the maximum sales charge of
3.25% and Class B and Class C total return figures include any applicable
contingent deferred sales charge. Because of the differences in sales charges
and distribution fees, the total returns for each of the classes will differ.
In reports or other communications to shareholders or in advertising material,
the Fund may compare its performance with that of other mutual funds as listed
in the rank-
42
<PAGE> 43
ings or ratings prepared by Lipper Analytical Services, Inc., CDA, Morningstar
Mutual Funds or similar independent services which monitor the performance of
mutual funds, with the Consumer Price Index, the Dow Jones Industrial Average
Index, Standard & Poor's, NASDAQ, other appropriate indicies of investment
securities, or with investment or savings vehicles. The performance information
may also include evaluations of the Fund published by nationally recognized
ranking services and by financial publications that are nationally recognized,
such as Business Week, Forbes, Fortune, Institutional Investor, Investor's
Business Daily, Kiplinger's Personal Finance Magazine, Money, Mutual Fund
Forecaster, Stanger's Investment Adviser, U.S. News and World Report, USA Today
and The Wall Street Journal. Such comparative performance information will be
stated in the same terms in which the comparative data or indices are stated.
Any such advertisement would also include the standard performance information
required by the SEC as described above. For these purposes, the performance of
the Fund, as well as the performance of other mutual funds or indices, do not
reflect sales charges, the inclusion of which would reduce Fund performance. The
Fund will include performance data for Class A, Class B and Class C shares of
the Fund in any advertisement or information including performance data of the
Fund.
The Fund may also utilize performance information in hypothetical
illustrations provided in narrative form. These hypotheticals will be
accompanied by the standard performance information required by the SEC as
described above.
The Fund's Annual Report contains additional performance information. A copy
of the Annual Report may be obtained without charge by calling or writing the
Fund at the telephone number and address printed on the cover of this
Prospectus.
- ------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- ------------------------------------------------------------------------------
ORGANIZATION OF THE FUND. The Fund was organized on September 9, 1985, under
the laws of the Commonwealth of Massachusetts and is a business entity commonly
known as a "Massachusetts business trust." It is authorized to issue an
unlimited number of Class A, Class B and Class C shares of beneficial interest
of $0.01 par value. Other classes of shares may be established from time to time
in accordance with provisions of the Fund's Declaration of Trust. Shares issued
by the Fund are fully paid, non-assessable and have no preemptive or conversion
rights.
Shareholders are entitled to one vote for each full share held and to
fractional votes for fractional shares held in the election of Trustees (to the
extent hereafter provided) and on other matters submitted to the vote of
shareholders. Each class of shares represents interests in the assets of the
Fund and has identical voting, dividend, liquidation and other rights on the
same terms and conditions except that the distribution fees and/or service fees
related to each class of shares are borne solely by that class, and each class
of shares has exclusive voting rights with respect to provisions of the Fund's
Class A Plan, Class B Plan and Class C Plan which pertain to that class. An
order has been received from the SEC permitting the issuance and sale of
multiple classes of shares representing interests in the Fund's existing
portfolio. Shares issued are fully paid, non-assessable and have no preemptive
or conversion rights. There will normally be no annual meetings of share-
43
<PAGE> 44
holders for the purpose of electing Trustees unless and until such time as less
than a majority of the Trustees holding office have been elected by the
shareholders, at which time the Trustees then in office will call a
shareholders' meeting for the election of Trustees. Shareholders may, in
accordance with the Declaration of Trust, cause a meeting of shareholders to be
held for the purpose of voting on the removal of Trustees. Except as set forth
above, the Trustees shall continue to hold office and appoint successor
Trustees.
The Declaration of Trust establishing the Fund, dated September 9, 1985, a
copy of which together with all amendments thereto (the "Declaration") is on
file in the office of the Secretary of the Commonwealth of Massachusetts,
provides that the name "American Capital Federal Mortgage Trust" refers to the
Trustees under the Declaration collectively as Trustees, not as individuals or
personally; and provides that no Trustee, officer or shareholder of the Fund
shall be held to any personal liability, nor shall resort be had to their
private property for the satisfaction of any obligation or liability of the Fund
but the assets of the Fund only shall be liable.
PERSONAL INVESTING POLICIES. The Fund and the Adviser have adopted Codes of
Ethics designed to recognize the fiduciary relationship between the Fund and the
Adviser and its employees. The Codes permit directors, officers and employees to
buy and sell securities for their personal accounts subject to certain
restrictions. Persons with access to certain sensitive information are subject
to pre-clearance and other procedures designed to prevent conflicts of interest.
SHAREHOLDER INQUIRIES. Shareholder inquiries should be directed to the Fund
at 2800 Post Oak Boulevard, Houston, Texas 77056, (800) 421-5666.
SHAREHOLDER SERVICE AGENT. ACCESS, P. O. Box 418256, Kansas City, Missouri
64141-9256, serves as transfer agent, shareholder service agent and dividend
disbursing agent for the Fund. ACCESS, a wholly owned subsidiary of the
Adviser's parent, provides these services at cost plus a profit.
LEGAL COUNSEL. O'Melveny & Myers, 400 South Hope Street, Los Angeles,
California 90071, is legal counsel to the Fund.
INDEPENDENT ACCOUNTANTS. Price Waterhouse LLP, 1201 Louisiana, Suite 2900,
Houston, Texas 77002, are the independent accountants for the Fund.
44
<PAGE> 45
BACKUP WITHHOLDING INFORMATION
STEP 1. Please make sure that the social security number or taxpayer
identification number (TIN) which appears on the Application complies with
the following guidelines:
<TABLE>
<S> <C>
- --------------------------------------------------------------------------------
Account Type Give Social Security Number or Tax
Identification Number of:
- --------------------------------------------------------------------------------
Individual Individual
- --------------------------------------------------------------------------------
Joint (or Joint Tenant) Owner who will be paying tax
- --------------------------------------------------------------------------------
Uniform Gifts to Minors Minor
- --------------------------------------------------------------------------------
Legal Guardian Ward, Minor or Incompetent
- --------------------------------------------------------------------------------
Sole Proprietor Owner of Business
- --------------------------------------------------------------------------------
Trust, Estate, Pension
Plan Trust Trust, Estate, Pension Plan Trust (NOT
personal TIN of fiduciary)
- --------------------------------------------------------------------------------
Corporation, Partnership,
Other Organization Corporation, Partnership, Other
Organization
- --------------------------------------------------------------------------------
Broker/Nominee Broker/Nominee
- --------------------------------------------------------------------------------
</TABLE>
STEP 2. If you do not have a TIN or you do not know your TIN, you must obtain
Form SS-5 (Application for Social Security Number) or Form SS-4 (Application
for Employer Identification Number) from your local Social Security or IRS
office and apply for one. Write "Applied For" in the space on the application.
STEP 3. If you are one of the entities listed below, you are exempt from
backup withholding and should not check the box on the Application in Section
2, Taxpayer Identification.
* A corporation
* Financial institution
* Section 501 (a) exempt organization (IRA, Corporate Retirement Plan,
403(b), Keogh)
* United States or any agency or instrumentality thereof
* A State, the District of Columbia, a possession of the United States, or
any subdivision or instrumentality thereof
* International organization or any agency or instrumentality thereof
* Registered dealer in securities or commodities registered in the U.S. or
a possession of the U.S.
* Real estate investment trust
* Common trust fund operated by a bank under section 584 (a)
* An exempt charitable remainder trust, or a non-exempt trust described in
section 4947 (a) (1)
If you are in doubt as to whether you are exempt, please contact the Internal
Revenue Service.
STEP 4. IRS PENALTIES -- If you do not supply us with your TIN, you will be
subject to an IRS $50 penalty unless your failure is due to reasonable cause
and not willful neglect. If you fail to report interest, dividend or
patronage dividend income on your federal income tax return, you will be
treated as negligent and subject to an IRS 5% penalty tax on any resulting
underpayment of tax unless there is clear and convincing evidence to the
contrary. If you falsify information on this form or make any other false
statement resulting in no backup withholding on an account which should be
subject to backup withholding, you may be subject to an IRS $500 penalty and
certain criminal penalties including fines and imprisonment.
<PAGE> 46
AMERICAN CAPITAL
FEDERAL MORTGAGE TRUST
PROSPECTUS
May 1, 1995
NATIONAL DISTRIBUTOR
Van Kampen American Capital Distributors, Inc.
One Parkview Plaza
Oakbrook Terrace, IL 60181
INVESTMENT ADVISER
Van Kampen American Capital
Asset Management, Inc.
2800 Post Oak Blvd.
Houston, TX 77056
TRANSFER, DISBURSING, REDEMPTION
AND SHAREHOLDER SERVICE AGENT
ACCESS Investor Services, Inc.
P.O. Box 418256
Kansas City, MO 64141-9256
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1201 Louisiana
Houston, TX 77002
CUSTODIAN
State Street Bank and Trust Company
225 Franklin Street
Boston, MA 02110
Inquiries concerning transfer of
registration, distributions, redemptions
and shareholder service should be
directed to the Shareholder Service Agent,
ACCESS Investor Services, Inc.
(ACCESS), P.O. Box 418256,
Kansas City, MO 64141-9256.
Inquiries concerning sales should be
directed to the Distributor,
Van Kampen American Capital Distributors, Inc.,
One Parkview Plaza
Oakbrook Terrace, IL 60181
American Capital C/O ACCESS
Federal Mortgage P.O. Box 418256
Trust Kansas City, MO 64141-9256
For investors seeking high current
return and relative safety of capital
from a portfolio of mortgage-related
securities, including adjustable rate
mortgage securities (ARMS).
[AMERICAN CAPITAL LOGO]
PRINTED MATTER
Printed in U.S.A./030 PRO-001
<PAGE> 47
PART B: STATEMENT OF ADDITIONAL INFORMATION
AMERICAN CAPITAL FEDERAL MORTGAGE TRUST
MAY 1, 1995
This Statement of Additional Information is not a Prospectus but contains
information in addition to and more detailed than that set forth in the
Prospectus and should be read in conjunction with the Prospectus. The Statement
of Additional Information and the related Prospectus are both dated May 1, 1995.
A Prospectus may be obtained without charge by calling or writing Van Kampen
American Capital Distributors, Inc. at One Parkview Plaza, Oakbrook Terrace,
Illinois 60181 at (800) 421-5666.
TABLE OF CONTENTS
<TABLE>
<S> <C>
GENERAL INFORMATION................................................................... 2
INVESTMENT OBJECTIVE AND POLICIES..................................................... 2
INVESTMENT RESTRICTIONS............................................................... 12
TRUSTEES AND EXECUTIVE OFFICERS....................................................... 14
INVESTMENT ADVISORY AGREEMENT......................................................... 16
DISTRIBUTOR........................................................................... 17
DISTRIBUTION PLANS.................................................................... 18
TRANSFER AGENT........................................................................ 19
PORTFOLIO TURNOVER.................................................................... 19
PORTFOLIO TRANSACTIONS AND BROKERAGE.................................................. 20
DETERMINATION OF NET ASSET VALUE...................................................... 21
PURCHASE AND REDEMPTION OF SHARES..................................................... 21
EXCHANGE PRIVILEGE.................................................................... 25
CHECK WRITING PRIVILEGE............................................................... 26
DIVIDENDS, DISTRIBUTIONS AND FEDERAL TAXES............................................ 26
PRIOR PERFORMANCE INFORMATION......................................................... 29
OTHER INFORMATION..................................................................... 30
FINANCIAL STATEMENTS.................................................................. 30
</TABLE>
<PAGE> 48
GENERAL INFORMATION
The Fund was organized as a trust under the laws of Massachusetts on
September 9, 1985.
Van Kampen American Capital Asset Management, Inc. (the "Adviser"), Van
Kampen American Capital Distributors, Inc. (the "Distributor"), and ACCESS
Investor Services, Inc. ("ACCESS") are wholly owned subsidiaries of Van Kampen
American Capital, Inc. ("VKAC"), which is a wholly owned subsidiary of VK/AC
Holding, Inc. VK/AC Holding, Inc. is controlled, through the ownership of a
substantial majority of its common stock, by The Clayton & Dubilier Private
Equity Fund IV Limited Partnership ("C&D L.P."), a Connecticut limited
partnership. C&D L.P. is managed by Clayton, Dubilier & Rice, Inc. a New York
based private investment firm. The General Partner of C&D L.P. is Clayton &
Dubilier Associates IV Limited Partnership ("C&D Associates L.P."). The general
partners of C&D Associates L.P. are Joseph L. Rice, III, B. Charles Ames,
Alberto Cribiore, Donald J. Gogel and Hubbard C. Howe, each of whom is a
principal of Clayton, Dubilier & Rice, Inc. In addition, certain officers,
directors and employees of VKAC own, in the aggregate, not more than six percent
of the common stock of VK/AC Holding, Inc. and have the right to acquire, upon
the exercise of options, approximately an additional 10% of the common stock of
VK/AC Holding, Inc. Advantage Capital Corporation, a retail broker-dealer
affiliate of the Distributor, is a wholly owned subsidiary of VK/AC Holding,
Inc. See "The Fund and Its Management" in the Prospectus.
As of April 12, 1995, no person was known to hold of record or beneficially
five percent or more of the outstanding Class A, Class B or Class C shares of
the Fund except the following:
<TABLE>
<CAPTION>
PERCENTAGE
NAME AND ADDRESS CLASS OF AMOUNT OF RECORD OF
OF HOLDER SHARES OWNERSHIP OWNERSHIP
- ------------------------------------------------- -------- ---------------- ------------
<S> <C> <C> <C>
Smith Barney Inc. Class A 190,898 5.28%
11th Floor
388 Greenwich Street Class C 57,165 11.30%
New York, NY 10013-2375
First Union Brokerage Class B 168,611 12.82%
Services, Inc.
5th Floor
301 S. College St.
Charlotte, NC 28202-6000
National Financial Services, Inc. Class B 117,212 8.91%
200 Liberty One World Financial Center Class C 32,300 6.38%
New York, NY 10281-1003
Merrill Lynch Pierce Fenner Class C 63,153 12.48%
P.O. Box 45286
Jacksonville, FL 32232-5286
(1)Bear Stearns & Co. Inc. Class C 166,472 32.90%
One Metrotech Center North
Brooklyn, NY 11201-3872
Donaldson Lufkin Class C 28,974 5.73%
1 Pershing Plaza, 5th Floor
Jersey City, NJ 07399-0001
Van Kampen American Capital Trust Company Class A 626,759.453 17.35%
2800 Post Oak Blvd. Class B 174,829.655 13.29%
Houston, TX 77056
(2)Amalgamated Bank of NY Cust.
NY Hotel Trades Council Pension Fund
Amivest Discretionary Investment Manager Class A 193,456.158 5.36%
P.O. Box 0370
New York, NY 10276-0370
</TABLE>
- ---------------
(1) Represents the aggregate of a number of accounts held of record by Bear
Stearns & Co. Inc. Certain individual accounts also represent the beneficial
ownership of over five percent of the outstanding shares of the class.
(2) Such shares could also be deemed to be beneficially owned by the NY Hotel
Trades Counsel Pension Fund and its investment adviser, Amivest Corporation,
a Delaware corporation, 767 5th Avenue, 50th Floor, New York, New York
10153.
2
<PAGE> 49
INVESTMENT OBJECTIVE AND POLICIES
The following disclosures supplement disclosures set forth under the same
caption in the Prospectus and do not, standing alone, present a complete or
accurate explanation of the matters disclosed. Readers must refer also to this
caption in the Prospectus for a complete presentation of the matters discussed.
One type of mortgage-related securities in which the Fund invests are those
which are issued or guaranteed by an agency or instrumentality of the U.S.
Government, though not necessarily by the U.S. Government itself. One such type
of mortgage-related security is a Government National Mortgage Association
("GNMA") Certificate. GNMA Certificates are backed as to principal and interest
by the full faith and credit of the U.S. Government. Another type is a Federal
National Mortgage Association ("FNMA") Certificate. Principal and interest
payments of FNMA Certificates are guaranteed only by FNMA itself, not by the
full faith and credit of the U.S. Government. A third type of mortgage-related
security in which the Fund may invest is a Federal Home Loan Mortgage
Association ("FHLMC") Participation Certificate. This type of security is backed
by FHLMC as to payment of principal and interest but, like a FNMA security, it
is not backed by the full faith and credit of the U.S. Government.
The Fund will seek to obtain return from the following sources:
- interest paid on the Fund's portfolio securities;
- premiums received from expired call and put options;
- net profits from closing transactions; and
- net gains from the sale of portfolio securities on the exercise of
options or otherwise.
The Fund is not designed for investors seeking capital appreciation.
Moreover, varying economic and market conditions may affect the value of and
yields on mortgage-related securities and opportunities for gains from an option
writing program. Accordingly, there is no assurance that the Fund's investment
objective will be achieved.
GNMA Certificates
Government National Mortgage Association. The Government National Mortgage
Association is a wholly-owned corporate instrumentality of the United States
within the U.S. Department of Housing and Urban Development. GNMA's principal
programs involve its guarantees of privately issued securities backed by pools
of mortgages.
Nature of GNMA Certificates. GNMA Certificates are mortgage-backed
securities. The Certificates evidence part ownership of a pool of mortgage
loans. The Certificates which the Fund purchases are of the modified
pass-through type. Modified pass-through Certificates entitle the holder to
receive all interest and principal payments owed on the mortgage pool, net of
fees paid to the GNMA Certificate issuer and GNMA, regardless of whether or not
the mortgagor actually makes the payment.
GNMA Certificates are backed by mortgages and, unlike most bonds, their
principal amount is paid back by the borrower over the length of the loan rather
than in a lump sum at maturity. Principal payments received by the Fund will be
reinvested in additional GNMA Certificates or in other permissible investments.
GNMA Guarantee. The National Housing Act authorizes GNMA to guarantee the
timely payment of principal of and interest on securities backed by a pool of
mortgages insured by the Federal Housing Administration ("FHA") or the Farmers
Home Administration or guaranteed by the Veterans Administration ("VA"). The
GNMA guarantee is backed by the full faith and credit of the United States. GNMA
is also empowered to borrow without limitation from the U.S. Treasury if
necessary to make any payments required under its guarantee.
Life of GNMA Certificates. The average life of a GNMA Certificate is
likely to be substantially less than the original maturity of the mortgage pools
underlying the securities. Prepayments of principal by
3
<PAGE> 50
mortgagors and mortgage foreclosures will result in the return of a portion of
principal invested before the maturity of the mortgages in the pool.
As prepayment rates of individual mortgage pools will vary widely, it is
not possible to predict accurately the average life of a particular issue of
GNMA Certificates. However, statistics published by the FHA are normally used as
an indicator of the expected average life of GNMA Certificates. These statistics
indicate that the average life of single-family dwelling mortgages with 25-30
year maturities (the type of mortgages backing the vast majority of GNMA
Certificates) is approximately twelve years. For this reason, it is customary
for pricing purposes to consider GNMA Certificates as 30-year mortgage-backed
securities which prepay fully in the twelfth year.
Yield Characteristics of GNMA Certificates. The coupon rate of interest of
GNMA Certificates is lower than the interest rate paid on the VA-guaranteed or
FHA-insured mortgages underlying the Certificates, but only by the amount of the
fees paid to GNMA and the GNMA Certificate issuer. For the most common type of
mortgage pool, containing single-family dwelling mortgages, GNMA receives an
annual fee of 0.06 of one percent of the outstanding principal for providing its
guarantee, and the GNMA Certificate issuer is paid an annual servicing fee of
0.44 of one percent for assembling the mortgage pool and for passing through
monthly payments of interest and principal to Certificate holders.
The coupon rate by itself, however, does not indicate the yield which will
be earned on the Certificates for the following reasons:
1. Certificates are usually issued at a premium or discount, rather than at
par.
2. After issuance, Certificates usually trade in the secondary market at a
premium or discount.
3. Interest is paid monthly rather than semi-annually as is the case for
traditional bonds. Monthly compounding has the effect of raising the
effective yield earned on GNMA Certificates.
4. The actual yield of each GNMA Certificate is influenced by the
prepayment experience of the mortgage pool underlying the Certificate.
If mortgagors prepay their mortgages, the principal returned to
Certificate holders may be reinvested at higher or lower rates.
In quoting yields for GNMA Certificates, the customary practice is to
assume that the Certificates will have a twelve-year life. Compared on this
basis, GNMA Certificates have historically yielded roughly one-quarter of one
percent more than high grade corporate bonds and one-half of one percent more
than U.S. Government and U.S. Government agency bonds. As the life of individual
pools may vary widely, however, the actual yield earned on any issue of GNMA
Certificates may differ significantly from the yield estimated on the assumption
of a twelve-year life.
Market for GNMA Certificates. Since the inception of the GNMA
mortgage-backed securities program in 1970, the amount of GNMA Certificates
outstanding has grown rapidly. The size of the market and the active
participation in the secondary market by securities dealers and many types of
investors make GNMA Certificates highly liquid instruments. Quotes for GNMA
Certificates are readily available from securities dealers and depend on, among
other things, the level of market rates, the Certificate's coupon rate and the
prepayment experience of the pool of mortgages backing each Certificate.
FNMA Securities
The Federal National Mortgage Association ("FNMA") was established in 1938
to create a secondary market in mortgages insured by the FHA. FNMA issues
guaranteed mortgage pass-through certificates ("FNMA Certificates"). FNMA
Certificates resemble GNMA Certificates in that each FNMA Certificate represents
a pro rata share of all principal and interest payments made and owed on the
underlying pool. FNMA guarantees timely payment of interest and principal on
FNMA Certificates. The FNMA guarantee is not backed by the full faith and credit
of the United States.
4
<PAGE> 51
FHLMC Securities
The Federal Home Loan Mortgage Corporation ("FHLMC") was created in 1970 to
promote development of a nationwide secondary market in conventional residential
mortgages. The FHLMC issues two types of mortgage pass-through securities
("FHLMC Certificates"): mortgage participation certificates ("PCs") and
guaranteed mortgage certificates ("GMCs"). PCs resemble GNMA Certificates in
that each PC represents a pro rata share of all interest and principal payments
made and owned on the underlying pool. The FHLMC guarantees timely monthly
payment of interest on PCs and the ultimate payment of principal. GMCs also
represent a pro rata interest in a pool of mortgages. However, these instruments
pay interest semi-annually and return principal once a year in guaranteed
minimum payments. The expected average life of these securities is approximately
ten years. The FHLMC guarantee is not backed by the full faith and credit of the
United States.
Collateralized Mortgage Obligations
Collateralized mortgage obligations are debt obligations issued generally
by finance subsidiaries or trusts which are secured by mortgage-backed
certificates, including GNMA Certificates, FHLMC Certificates and FNMA
Certificates, together with certain funds and other collateral. Scheduled
distributions on the mortgage-backed certificates pledged to secure the
collateralized mortgage obligations, together with certain funds and other
collateral and reinvestment income thereon at an assumed reinvestment rate, will
be sufficient to make timely payments of interest on the obligations and to
retire the obligations not later than their stated maturity. Since the rate of
payment of principal of any collateralized mortgage obligation will depend on
the rate of payment (including prepayments) of the principal of the mortgage
loans underlying the mortgage-backed certificates; the actual maturity of the
obligation could occur significantly earlier than its stated maturity.
Collateralized mortgage obligations may be subject to redemption under certain
circumstances. The rate of interest borne by collateralized mortgage obligations
may be either fixed or floating. In addition, certain collateralized mortgage
obligations do not bear interest and are sold at a substantial discount (e.g., a
price less than the principal amount). Purchases of collateralized mortgage
obligations at a substantial discount involves a risk that the anticipated yield
on the purchase may not be realized if the underlying mortgage loans prepay at a
slower than anticipated rate, since the yield depends significantly on the rate
of prepayment of the underlying mortgages. Conversely, purchases of
collateralized mortgage obligations at a premium involve additional risk of loss
of principal in the event of unanticipated prepayments of the mortgage loans
underlying the mortgage-backed certificates since the premium may not have been
fully amortized at the time the obligation is repaid. The market value of
collateralized mortgage obligations purchased at a substantial premium or
discount is extremely volatile and the effects of prepayments on the underlying
mortgage loans may increase such volatility.
Although payment of the principal of and interest on the mortgage-backed
certificates pledged to secure collateralized mortgage obligations may be
guaranteed by GNMA, FHLMC or FNMA, the collateralized mortgage obligations
represent obligations solely of their issuers and are not insured or guaranteed
by GNMA, FHLMC, FNMA or any other governmental agency or instrumentality, or by
any other person or entity. The issuers of collateralized mortgage obligations
typically have no significant assets other than those pledged as collateral for
the obligations.
ASSET-BACKED SECURITIES
The Fund may invest a portion of its assets in asset-backed securities
rated at the time of purchase in the two highest grades by a
nationally-recognized rating agency. The rate of principal payment generally
depends on the rate of principal payments received on the underlying assets.
Such rate of payments may be affected by economic and various other factors.
Therefore, the yield may be difficult to predict and actual yield to maturity
may be more or less than the anticipated yield to maturity. The credit quality
of most asset-backed securities depends primarily on the credit quality of the
assets underlying such securities, how well the entity issuing the security is
insulated from the credit risk of the originator or affiliated entities, and the
amount of credit support provided to the securities.
5
<PAGE> 52
Asset-backed securities are often backed by a pool of assets representing
the obligations of a number of different parties. To lessen the effect of
failures by obligors on underlying assets to make payments, such securities may
contain elements of credit support. Such credit support falls into two
categories: (i) liquidity protection and (ii) protection against losses
resulting from ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances, generally by the
entity administering the pool of assets, to ensure that the receipt of payments
due on the underlying pool is timely. Protection against losses resulting from
ultimate default enhances the likelihood of payment of the obligations on at
least some 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 support, although the existence of credit
support may increase the price of a security.
Examples of credit support 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 "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 exceeds that required to make payment of the
securities and pay any servicing or other fees). The degree of credit support
provided for each issue is generally based on historical information respecting
the level of credit risk associated with the underlying assets. Delinquencies or
losses in excess of those anticipated could adversely affect the return on an
investment in such issue.
LENDING OF SECURITIES
Consistent with applicable regulatory requirements, the Fund may lend its
portfolio securities to broker-dealers and other financial institutions provided
that such loans are callable at any time by the Fund, and are at all times
secured by cash collateral that is at least equal to the market value,
determined daily, of the loaned securities. The advantage of such loans is that
the Fund continues to receive the interest on the loaned securities, while at
the same time earning interest on the collateral which will be invested in
short-term obligations. The Fund pays lending fees and custodial fees in
connection with loans of its securities. There is no assurance as to the extent
to which securities loans can be effected.
A loan may be terminated by the borrower on one business day's notice, or
by the Fund at any time. If the borrower fails to maintain the requisite amount
of collateral, the loan automatically terminates, and the Fund could use the
collateral to replace the securities while holding the borrower liable for any
excess of replacement cost over collateral. As with any extensions of credit,
there are risks of delay in recovery and in some cases even loss of rights in
the collateral should the borrower of the securities fail financially. However,
these loans of portfolio securities will only be made to firms deemed by the
Fund's management to be creditworthy and when the consideration which can be
earned from such loans is believed to justify the attendant risks. The Fund
would not lend any portfolio securities to brokers affiliated with the Adviser.
On termination of the loan, the borrower is required to return the securities to
the Fund; any gain or loss in the market price during the loan would inure to
the Fund.
When voting or consent rights which accompany loaned securities pass to the
borrower, the Fund will follow the policy of calling the loan, whole or in part
as may be appropriate, to permit the exercise of such rights if the matters
involved would have a material effect on the Fund's investment in the securities
which are the subject of the loan.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with domestic banks or
broker-dealers. A repurchase agreement is a short-term investment in which the
purchaser (e.g., the Fund) acquires ownership of a debt security and the seller
agrees to repurchase the obligation at a future time and set price, usually not
more than seven days from the date of purchase, thereby determining the yield
during the purchaser's holding period.
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Repurchase agreements are collateralized by the underlying debt securities and
may be considered to be loans under the Investment Company Act of 1940 as
amended (the "1940 Act"). The Fund will make payment for such securities only
upon physical delivery or evidence of book entry transfer to the account of a
custodian or bank acting as agent. The seller under a repurchase agreement will
be required to maintain the value of the underlying securities marked to market
daily at not less than the repurchase price. The underlying securities
(securities of the U.S. Government, or its agencies and instrumentalities), may
have maturity dates exceeding one year. The Fund does not bear the risk of a
decline in value of the underlying security unless the seller defaults under its
repurchase obligation. See "Investment Practices and Restrictions -- Repurchase
Agreements" in the Prospectus for further information.
FORWARD COMMITMENTS
Relative to a Forward Commitment purchase, the Fund maintains a segregated
account (which is marked to market daily) of cash or U.S. Government securities
(which may have maturities which are longer than the term of the Forward
Commitment) with the Fund's custodian in an aggregate amount equal to the amount
of its commitment as long as the obligation to purchase continues. Since the
market value of both the securities subject to the Forward Commitment and the
securities held in the segregated account may fluctuate, the use of Forward
Commitments may magnify the impact of interest rate changes on the Fund's net
asset value.
A Forward Commitment sale is covered if the Fund owns or has the right to
acquire the underlying securities subject to the Forward Commitment. A Forward
Commitment sale is for cross-hedging purposes if it is not covered but is
designed to provide a hedge against or decline in value of a security which the
Fund owns or has the right to acquire. In either circumstance, the Fund
maintains in a segregated account (which is marked to market daily) either the
security covered by the Forward Commitment or cash or U.S. Government securities
(which may have maturities which are longer than the term of the Forward
Commitment) with the Fund's custodian in an aggregate amount equal to the amount
of its commitment as long as the obligation to sell continues. By entering into
a Forward Commitment sale transaction, the Fund forgoes or reduces the potential
for both gain and loss in the security which is being hedged by the Forward
Commitment sale.
INTEREST RATE TRANSACTIONS
The Fund may enter into interest rate swaps, caps, floors and collars on
either an asset-based or liability-based basis and will usually enter into
interest rate swaps on a net basis, e.g., 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. The net amount of the excess, if any, of the Fund's
obligations over its entitlements with respect to each interest rate swap will
be accrued on a daily basis and an amount of cash or high-quality liquid debt
securities having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by the Fund's custodian. If
the Fund enters into an interest rate swap on other than a net basis, the Fund
would maintain a segregated account in the full amount accrued on a daily basis
of the Fund's obligations with respect to the swap. Interest rate transactions
do not constitute senior securities under the 1940 Act when the Fund segregates
assets to cover the obligations under the transactions. The Fund will enter into
interest rate swap, cap or floor transactions only with counterparties approved
by the Trustees. The Adviser will monitor the creditworthiness of counterparties
to its interest rate swap, cap, floor and collar transactions on an ongoing
basis. If there is a default by the other party to such a transaction, the Fund
will have contractual remedies pursuant to the agreements related to the
transaction. To the extent the Fund sells (e.g., writes) caps, floors and
collars, it will maintain in a segregated account cash or high-quality liquid
debt securities having an aggregate net asset value at least equal to the full
amount, accrued on a daily basis, of the Fund's net obligations with respect to
the caps, floors or collars. The use of interest rate swaps is a highly
specialized activity which involves investment techniques and risks different
from those associated with ordinary portfolio securities transactions. If the
Adviser is incorrect in its forecasts of the market values, interest rates and
other applicable factors, the investment performance of the Fund would diminish
compared with what it would have been if these investment techniques were not
used. The use of interest rate swaps,
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caps, collars and floors may also have the effect of shifting the recognition of
income between current and future periods.
These transactions do not involve the delivery of securities or other
underlying assets or principal. Accordingly, the risk of loss with respect to
interest rate swaps is limited to the net amount of interest payments that the
Fund is contractually obligated to make. If the other party to an interest rate
swap defaults, the Fund's risk of loss consists of the net amount of interest
payments that the Fund contractually is entitled to receive.
OPTIONS, FUTURES CONTRACTS AND RELATED OPTIONS
CALL AND PUT OPTIONS
Call and put options on various U.S. Treasury notes and U.S. Treasury bonds
are listed and traded on Exchanges, and are written in over-the-counter
transactions. Call and put options on mortgage-related securities are currently
written or purchased only in over-the-counter transactions.
WRITING CALL AND PUT OPTIONS
Purpose. The principal reason for writing options is to obtain, through
receipt of premiums, a greater current return than would be realized on the
underlying securities alone. Such current return could be expected to fluctuate
because premiums earned from an option writing program and interest income
yields on portfolio securities vary as economic and market conditions change.
Actively writing options on portfolio securities is likely to result in a
substantially higher portfolio turnover rate than that of most other investment
companies. Higher portfolio turnover involves correspondingly greater brokerage
commissions and other transaction costs, which are borne directly by the Fund.
Writing Options. The purchaser of a call option pays a premium to the
writer (e.g., the seller) for the right to buy the underlying security from the
writer at a specified price during a certain period. The Fund writes call
options either on a covered basis, or for cross-hedging purposes. A call option
is covered if the Fund owns or has the right to acquire the underlying
securities subject to the call option at all times during the option period.
Thus the Fund may write options on forward commitments or on mortgage-related or
other U.S. Government securities. An option is for cross-hedging purposes if it
is not covered, but is designed to provide a hedge against a security which the
Fund owns or has the right to acquire. In such circumstances, the Fund
collaterized the option by maintaining in a segregated account with the Fund's
Custodian, cash or U.S. Government securities in an amount not less than the
market value of the underlying security, marked to market daily, while the
option is outstanding.
The purchaser of a put option pays a premium to the writer (e.g., the
seller) for the right to sell the underlying security to the writer at a
specified price during a certain period. The Fund would write put options only
on a secured basis, which means that, at all times during the option period, the
Fund would maintain in a segregated account with its Custodian cash, cash
equivalents or high grade debt securities in an amount of not less than the
exercise price of the option, or would hold a put on the same underlying
security at an equal or greater exercise price.
Closing Purchase Transactions and Offsetting Transactions. In order to
terminate its position as a writer of a call or put option, the Fund could enter
into a "closing purchase transaction," which is the purchase of a call (put) on
the same underlying security and having the same exercise price and expiration
date as the call (put) previously written by the Fund. The Fund would realize a
gain (loss) if the premium plus commission paid in the closing purchase
transaction is less (greater) than the premium it received on the sale of the
option. The Fund would also realize a gain if an option it has written lapses
unexercised.
The Fund could write options that are listed on an exchange as well as
options which are privately negotiated in over-the-counter transactions. A Fund
could close out its position as a writer of an option only if a liquid secondary
market exists for options of that series, but there is no assurance that such a
market will exist, particularly in the case of over-the-counter options, since
they can be closed out only with the other party to the transaction.
Alternatively, the Fund could purchase an offsetting option, which would not
close out
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its position as a writer, but would provide an asset of equal value to its
obligation under the option written. If the Fund is not able to enter into a
closing purchase transaction or to purchase an offsetting option with respect to
an option it has written, it will be required to maintain the securities subject
to the call or the collateral securing the option until a closing purchase
transaction can be entered into (or the option is exercised or expires), even
though it might not be advantageous to do so.
The exercise price of call options may be below ("in-the-money"), equal to
("at-the-money"), or above ("out-of-the-money") the current market value of the
underlying securities or futures contracts at the time the options are written.
The converse applies to put options.
Risks of Writing Options. By writing a call option, the Fund loses the
potential for gain on the underlying security above the exercise price while the
option is outstanding; by writing a put option a Fund might become obligated to
purchase the underlying security at an exercise price that exceeds the then
current market price.
PURCHASING CALL AND PUT OPTIONS
The Fund could purchase call options to protect (e.g., hedge) against
anticipated increases in the prices of securities it wishes to acquire. Since
the premium paid for a call option is typically a small fraction of the price of
the underlying security, a given amount of funds will purchase call options
covering a much larger quantity of such security than could be purchased
directly. By purchasing call options, the Fund could benefit from any
significant increase in the price of the underlying security to a greater extent
than had it invested the same amount in the security directly. However, because
of the very high volatility of option premiums, the Fund would bear a
significant risk of losing the entire premium if the price of the underlying
security did not rise sufficiently, or if it did not do so before the option
expired.
Conversely, put options could be purchased to protect (e.g., hedge) against
anticipated declines in the market value of either specific portfolio securities
or of the Fund's assets generally. The Fund will not purchase call or put
options on securities if as a result, more than ten percent of its net assets
would be invested in premiums on such options.
The Fund may purchase either listed or over-the-counter options.
INTEREST RATE FUTURES CONTRACTS
The Fund could engage in transactions involving futures contracts and
related options in accordance with the rules and interpretations of the
Commodity Futures Trading Commission ("CFTC") under which the Fund would be
exempt from registration as a "commodity pool."
An interest rate futures contract is an agreement pursuant to which a party
agrees to take or make delivery of a specified debt security (such as U.S.
Treasury bonds, U.S. Treasury notes, U.S. Treasury bills and GNMA Certificates)
at a specified future time and at a specified price. Interest rate futures
contracts also include cash settlement contracts based upon a specified interest
rate such as the London interbank offering rate for dollar deposits, or LIBOR.
Initial and Variation Margin. In contrast to the purchase or sale of a
security, no price is paid or received upon the purchase or sale of a futures
contract. Initially, the Fund will be required to deposit with its Custodian in
an account in the brokers' name an amount of cash, cash equivalents or liquid
high-grade debt securities equal to not more than five percent of the contract
amount. This amount is known as initial margin. The nature of initial margin in
futures transactions is different from that of margin in securities transactions
in that futures contract margin does not involve the borrowing of funds by the
customer to finance the transaction. Rather, the initial margin is in the nature
of a performance bond or good faith deposit on the contract, which is returned
to the Fund upon termination of the futures contract and satisfaction of its
contractual obligations. Subsequent payments to and from the broker, called
variation margin, will be made on a daily basis as the price of the underlying
security fluctuates, making the long and short positions in the futures contract
more or less valuable, a process known as marking to market.
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For example, when the Fund has purchased a futures contract and the price
of the underlying security has risen, that position will have increased in
value, and the Fund will receive from the broker a variation margin payment
equal to that increase in value. Conversely, where the Fund has purchased a
futures contract and the value of the underlying security has declined, the
position would be less valuable, and the Fund would be required to make a
variation margin payment to the broker.
At any time prior to expiration of the futures contract, the Fund may elect
to terminate the position by taking an opposite position. A final determination
of variation margin is then made, additional cash is required to be paid by or
released to the Fund, and the Fund realizes a loss or a gain.
Futures Strategies. When the Fund anticipates a significant market or
market sector advance, the purchase of a futures contract affords a hedge
against not participating in the advance at a time when the Fund is not fully
invested ("anticipatory hedge"). Such purchase of a futures contract would serve
as a temporary substitute for the purchase of individual securities, which may
be purchased in an orderly fashion once the market has stabilized. As individual
securities are purchased, an equivalent amount of futures contracts could be
terminated by offsetting sales. The Fund may sell futures contracts in
anticipation of or in a general market or market sector decline that may
adversely affect the market value of the Fund's securities ("defensive hedge").
To the extent that the Fund's portfolio of securities changes in value in
correlation with the underlying security, the sale of futures contracts would
substantially reduce the risk to the Fund of a market decline and, by so doing,
provide an alternative to the liquidation of securities positions in the Fund.
Ordinarily commissions on futures transactions are lower than transaction costs
incurred in the purchase and sale of mortgage-related and U.S. Government
securities.
In the event of the bankruptcy of a broker through which the Fund engages
in transactions in listed options, futures or related options, the Fund could
experience delays and/or losses in liquidating open positions purchased and/or
incur a loss of all or part of its margin deposits with the broker. Transactions
are entered into by the Fund only with brokers or financial institutions deemed
creditworthy by the Adviser.
Special Risks Associated with Futures Transactions. There are several
risks connected with the use of futures contracts as a hedging device. These
include the risk of imperfect correlation between movements in the price of the
futures contracts and of the underlying securities, the risk of market
distortion, the illiquidity risk and the risk of error in anticipating price
movement.
There may be an imperfect correlation (or no correlation) between movements
in the price of the futures contracts and of the securities being hedged. The
risk of imperfect correlation increases as the composition of the securities
being hedged diverges from the securities upon which the futures contract is
based. If the price of the futures contract moves less than the price of the
securities being hedged, the hedge will not be fully effective. To compensate
for the imperfect correlation, the Fund could buy or sell futures contracts in a
greater dollar amount than the dollar amount of securities being hedged if the
historical volatility of the securities being hedged is greater than the
historical volatility of the securities underlying the futures contract.
Conversely, the Fund could buy or sell futures contracts in a lesser dollar
amount than the dollar amount of securities being hedged if the historical
volatility of the securities being hedged is less than the historical volatility
of the securities underlying the futures contract. It is also possible that the
value of futures contracts held by the Fund could decline at the same time as
portfolio securities being hedged; if this occurred, the Fund would lose money
on the futures contract in addition to suffering a decline in value in the
portfolio securities being hedged.
There is also the risk that the price of futures contracts may not
correlate perfectly with movements in the securities underlying the futures
contract due to certain market distortions. First, all participants in the
futures market are subject to margin depository and maintenance requirements.
Rather than meet additional margin depository requirements, investors may close
futures contracts through offsetting transactions, which could distort the
normal relationship between the futures market and the securities underlying the
futures contract. Second, from the point of view of speculators, the deposit
requirements in the futures markets are less onerous than margin requirements in
the securities markets. Therefore, increased participation by speculators in the
futures markets may cause temporary price distortions. Due to the possibility of
price distortion in the futures markets and because of the imperfect correlation
between movements in futures contracts and movements in
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the securities underlying them, a correct forecast of general market trends by
the Adviser may still not result in a successful hedging transaction judged over
a very short time frame.
There is also the risk that futures markets may not be sufficiently liquid.
Futures contracts may be closed out only on an exchange or board of trade that
provides a market for such futures contracts. Although the Fund intends to
purchase or sell futures only on exchanges and boards of trade where there
appears to be an active secondary market, there can be no assurance that an
active secondary market will exist for any particular contract or at any
particular time. In the event of such illiquidity, it might not be possible to
close a futures position and, in the event of adverse price movement, the Fund
would continue to be required to make daily payments of variation margin. Since
the securities being hedged would not be sold until the related futures contract
is sold, an increase, if any, in the price of the securities may to some extent
offset losses on the related futures contract. In such event, the Fund would
lose the benefit of the appreciation in value of the securities.
Successful use of futures is also subject to the Adviser's ability to
correctly predict the direction of movements in the market. For example, if the
Fund hedges against a decline in the market, and market prices instead advance,
the Fund will lose part or all of the benefit of the increase in value of its
securities holdings because it will have offsetting losses in futures contracts.
In such cases, if the Fund has insufficient cash, it may have to sell portfolio
securities at a time when it is disadvantageous to do so in order to meet the
daily variation margin.
CFTC regulations require, among other things, (i) that futures and related
options be used solely for bona fide hedging purposes (or meet certain
conditions as specified in CFTC regulations) and (ii) that the Fund not enter
into futures and related options for which the aggregate initial margin and
premiums exceed five percent of the fair market value of the Fund's assets. In
order to minimize leverage in connection with the purchase of futures contracts
by the Fund, an amount of cash, cash equivalents or liquid high grade debt
securities equal to the market value of the obligation under the futures
contracts (less any related margin deposits) will be maintained in a segregated
account with the Custodian.
OPTIONS ON FUTURES CONTRACTS
The Fund could also purchase and write options on futures contracts. An
option on a futures contract gives the purchaser the right, in return for the
premium paid, 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), at a specified
exercise price at any time during the option period. As a writer of an option on
a futures contract, the Fund would be subject to initial margin and maintenance
requirements similar to those applicable to futures contracts. In addition, net
option premiums received by the Fund are required to be included as initial
margin deposits. When an option on a futures contract is exercised, delivery of
the futures position is accompanied by cash representing the difference between
the current market price of the futures contract and the exercise price of the
option. The Fund could purchase put options on futures contracts in lieu of, and
for the same purpose as it could sell, a futures contract. The purchase of call
options on futures contracts would be intended to serve the same purpose as the
actual purchase of the futures contract.
Risks of Transactions in Options on Futures Contracts. In addition to the
risks described above which apply to all options transactions, there are several
special risks relating to options on futures. The Adviser will not purchase
options on futures on any exchange unless in the Adviser's opinion, a liquid
secondary exchange market for such options exists. Compared to the use of
futures, the purchase of options on futures involves less potential risk to the
Fund because the maximum amount at risk is the premium paid for the options
(plus transaction costs). However, there may be circumstances, such as when
there is no movement in the price of the underlying security, when the use of an
option on a future would result in a loss to the Fund when the use of a future
would not.
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ADDITIONAL RISKS TO OPTIONS AND FUTURES TRANSACTIONS
Each of the Exchanges has established limitations governing the maximum
number of call or put options on the same underlying security or futures
contract (whether or not covered) which may be written by a single investor,
whether acting alone or in concert with others (regardless of whether such
options are written on the same or different Exchanges or are held or written on
one or more accounts or through one or more brokers). Option positions of all
investment companies advised by the Adviser are combined for purposes of limits.
An Exchange may order the liquidation of positions found to be in violation of
these limits and it may impose other sanctions or restrictions. These position
limits may restrict the number of listed options which the Fund may write.
Although the Fund intends to enter into futures contracts only if there is
an active market for such contracts, there is no assurance that an active market
will exist for the contracts at any particular time. Most U.S. futures exchanges
and boards of trade limit the amount of fluctuation permitted in futures
contract prices during a single trading day. Once the daily limit has been
reached in a particular contract, no trades may be made that day at a price
beyond that limit. It is possible that futures contract prices would move to the
daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of futures positions and subjecting some
futures traders to substantial losses. In such event, and in the event of
adverse price movements, the Fund would be required to make daily cash payments
of variation margin. In such circumstances, an increase in the value of the
portion of the portfolio being hedged, if any, may partially or completely
offset losses on the futures contract. However, there is no guarantee that the
price of the securities being hedged will, in fact, correlate with the price
movements in a futures contract and thus provide an offset to losses on the
futures contract.
Certain additional risks relate to the fact that the Fund will purchase and
sell options on mortgage-related securities. Since the remaining principal
balance of mortgage-related securities declines each month as a result of
mortgage payments, if the Fund has written a call and is holding such securities
as "cover" to satisfy its delivery obligation in the event of exercise, it may
find that the securities it holds no longer have a sufficient remaining
principal balance for this purpose. Should this occur, the Fund would purchase
additional mortgage-related securities from the same pool (if obtainable) or
replacements in the cash market in order to maintain its cover. A
mortgage-related security held by the Fund to cover an option position in any
but the nearest expiration month may cease to represent cover for the option in
the event of a decrease in the coupon rate at which new pools are originated. If
this should occur, the option would no longer be covered, and the Fund would
either enter into a closing purchase transaction or replace the mortgage-related
security with one which represents cover. In either case, the Fund may realize
an unanticipated loss and incur additional transaction costs.
INVESTMENT RESTRICTIONS
The Fund's investment objective and the following restrictions may not be
changed without the approval of the holders of a majority of its outstanding
shares. Such majority is defined as the lesser of (i) 67% or more of the voting
securities present at a meeting, if the holders of more than 50% of the
outstanding voting securities of the Fund are present or represented by proxy;
or (ii) more than 50% of the Fund's outstanding voting securities. The
percentage limitations need only be met at the time the investment is made or
other relevant action taken. In addition to the fundamental investment
limitations set forth in the Fund's Prospectus, the Fund shall not:
1. Invest in securities of other investment companies except as part of a
merger, consolidation or other acquisition.
2. Make any investment in real estate, commodities or commodities
contracts, except that the Fund will invest in mortgage-related and
mortgage-backed securities and engage in transactions in futures
contracts and related options, as described in the Prospectus and
elsewhere in this Statement of Additional Information.
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3. Make any investment which would cause more than 25% of the market or
other fair value of its total assets to be invested in the securities
of issuers all of which conduct their principal business activities in
the same industry. This restriction does not apply to obligations
issued or guaranteed by the U.S. Government, its agencies or
instrumentalities.
4. Make loans of money or securities, except (a) by investment in
repurchase agreements in accordance with applicable requirements set
forth in the Fund's Prospectus or (b) by lending its portfolio
securities in amounts not to exceed ten percent of the Fund's total
assets, provided that such loans are secured by cash collateral that is
at least equal to the market value. See "Repurchase Agreements" and
"Lending of Securities" herein and "Investment Practices and
Restrictions" in the Prospectus.
5. Make short sales of securities, unless at the time of the sale the Fund
owns an equal amount of such securities. Notwithstanding the foregoing,
the Fund may make short sales by entering into forward commitments for
hedging or cross-hedging purpose and engage in transactions in options,
futures contracts and related options.
6. Purchase securities on margin, except that the Fund may obtain such
short-term credits as may be necessary for the clearance of purchases
and sales of securities. Transactions in forward commitments, options,
interest rate futures contracts and options on such contracts,
including deposits or payments of initial or maintenance margin in
connection with any such transaction, are not considered to be
purchases of securities on margin within the meaning of this
limitation.
7. Invest in securities of any company if, to the knowledge of the Fund,
any of its officers or trustees, or any officer or director of the
Adviser, owns more than one-half of one percent of the outstanding
securities of such company, and such officers, trustees, and directors
who individually own more than such amount together own more than five
percent of the outstanding securities of such issuer.
8. Invest in interests in oil, gas, or other mineral exploration or
development programs.
9. Underwrite securities of other companies, except insofar as the Fund
might be deemed to be an underwriter for purposes of the Securities Act
of 1933 in the resale of any securities owned by the Fund.
10. With respect to 75% of its assets, invest more than five percent of its
assets in the securities of any one issuer (except obligations of the
U.S. Government, its agencies or instrumentalities) or purchase more
than ten percent of the outstanding voting securities of any one
issuer.
11. Borrow in excess of five percent of the market or other fair value of
its total assets, or pledge its assets to an extent greater than five
percent of the market or other fair value of its total assets. Any such
borrowings shall be from banks and shall be undertaken only as a
temporary measure for extraordinary or emergency purposes. Deposits in
escrow in connection with the writing of covered or fully
collateralized call or secured put options, or in connection with the
purchase or sale of futures contracts and related options, are not
deemed to be a pledge or other encumbrance.
12. Purchase an illiquid security if, as a result of such purchase, more
than ten percent of the Fund's net assets would be invested in such
securities. Illiquid securities are securities subject to legal or
contractual restrictions on resale, which include repurchase agreements
maturing in more than seven days and any over-the-counter options or
other restricted securities purchased by the Fund.
13. Write, purchase or sell puts, calls or combinations thereof, except
that the Fund may (a) write covered or fully collateralized call
options, write secured put options, and enter into closing or
offsetting purchase transactions with respect to such options, (b)
purchase and sell options to the extent that the premiums paid for all
such options owned at the time do not exceed ten percent of its total
assets and (c) engage in transactions in interest rate futures
contracts and related options provided that such transactions are
entered into for bona fide hedging purposes (or that the underlying
commodity value of the Fund's long positions do not exceed the sum of
certain identified liquid investments as specified in CFTC
regulations), provided further that the aggregate initial
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margin and premiums do not exceed five percent of the fair market value of the
Fund's total assets, and provided further that the Fund may not purchase futures
contracts or related options if more than 30% of the Fund's total assets would
be so invested.
TRUSTEES AND EXECUTIVE OFFICERS
The Fund's Trustees and executive officers and their principal occupations
for the past five years are listed below. All persons named as Trustees also
serve in similar capacities for other mutual funds advised by the Adviser, as
indicated below.
FERNANDO SISTO, Chairman of the Board and Trustee. Stevens Institute of
Technology, Castle Point Station, Hoboken, New Jersey 07030-5991. Dean of
Graduate School, George M. Bond Professor and formerly Dean of Graduate School
and Chairman, Department of Mechanical Engineering, Stevens Institute of
Technology; Director, Dynalysis of Princeton (engineering research).(1)
J. MILES BRANAGAN, Trustee. 2300 205th Street, Torrance, California
90501-1452. Co-Founder, Chairman and President, MDT Corporation (medical
equipment).(1)
RICHARD E. CARUSO, Trustee. Two Radnor Station, Suite 314, 290 King of
Prussia Road, Radnor, Pennsylvania, 19087. Chairman and Chief Executive Officer,
Integra LifeSciences Corporation (biotechnology/life sciences); Trustee,
Susquehanna University; Trustee and First Vice President, The Baum School of Art
(community art school); Founder and Director, Uncommon Individual Foundation
(youth development); Director, International Board of Business Performance
Group, London School of Economics; formerly Director, First Sterling Bank;
formerly Director and Executive Vice President, LFC Financial Corporation
(leasing financing).(1)
ROGER HILSMAN, Trustee. 251-1 Hamburg Cove, Lyme, Connecticut 06371.
Formerly Professor of Government and International Affairs, Columbia
University.(1)
*DON G. POWELL, President and Trustee. 2800 Post Oak Blvd., 45th Floor,
Houston, Texas 77056. President, Chief Executive Officer and Director of VK/AC
Holding, Inc., VKAC and the Adviser; Chairman, Chief Executive Officer and
Director of the Distributor.(1)(2)(4)
DAVID REES, Trustee. 1601 Country Club Drive, Glendale, California 91208.
Senior Editor, Los Angeles Business Journal.(1)(3)
**LAWRENCE J. SHEEHAN, Trustee. 1999 Avenue of the Stars, Suite 700, Los
Angeles, California 90067-6035. Of Counsel to, and formerly Partner (1969-1994)
of the law firm of O'Melveny & Myers, legal counsel to the Fund.(1)(3)(5)
WILLIAM S. WOODSIDE, Trustee. 712 Fifth Avenue, 40th Floor, New York, New
York 10019. Vice Chairman of the Board, Sky Chefs, Inc. (airline food catering);
formerly Director, Primerica Corporation (currently known as The Travelers
Inc.); formerly Chairman of the Board and Chief Executive Officer, old Primerica
Corporation (American Can Company); formerly Director, James River Corporation
(paper products); Trustee and formerly President, Whitney Museum of American
Art; Chairman, Institute for Educational Leadership, Inc., Board of Visitors,
Graduate School of The City University of New York, Academy of Political
Science; Committee for Economic Development; Director, Public Education Fund
Network, Fund for New York City Public Education; Trustee, Barnard College;
Member, Dean's Council, Harvard School of Public Health; Member, Mental Health
Task Force, Carter Center.(1)
NORI L. GABERT, Vice President and Secretary. 2800 Post Oak Blvd., Houston
Texas 77056. Vice President, Associate General Counsel and Corporate Secretary
of the Adviser.(4)
TANYA M. LODEN, Vice President and Controller. 2800 Post Oak Blvd.,
Houston, Texas 77056. Vice President and Controller of most of the investment
companies advised by the Adviser; formerly Tax Manager/Assistant Controller.(4)
DENNIS J. MCDONNELL, Vice President. One Parkview Plaza, Oakbrook Terrace,
IL 60181. Director of VK/AC Holding, Inc. and Van Kampen American Capital, Inc.,
President, Chief Operating
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<PAGE> 61
Officer and Director of Van Kampen American Capital Investment Advisory Corp.;
and Director of McCarthy, Crisanti & Maffei, Inc.(4)
CURTIS W. MORELL, Vice President and Treasurer. 2800 Post Oak Blvd.,
Houston, Texas 77056. Vice President and Treasurer of most of the investment
companies advised by the Adviser.(4)
TED MUNDY, Vice President. 2800 Post Oak Blvd., Houston, Texas 77056.
Portfolio Manager with the Adviser. From September, 1990 to June, 1994, Mr.
Mundy was a portfolio manager with AMR Investment Services, Inc. Prior to that
he was a trader with Howard, Weil, Labouisse and Friedrichs. (4)
RONALD A. NYBERG, Vice President, One Parkview Plaza, Oakbrook Terrace, IL
60181. Executive Vice President, General Counsel and Secretary of VK/AC Holding,
Inc., Vice President of ACCESS Investor Services, Inc. and Van Kampen American
Services Inc., Vice President, General Counsel and Assistant Secretary of Van
Kampen American Capital Investment Advisory Corp., Senior Vice President and
General Counsel of the Adviser, Executive Vice President and General Counsel and
Director of VKAC Distributors, Inc.(4)
ROBERT C. PECK, JR., Vice President. 2800 Post Oak Blvd. Houston, Texas
77056. Senior Vice President - Chief Investment Officer/Fixed Income Department
and Director of the Adviser; Executive Vice President and Director of VKAC.(4)
J. DAVID WISE, Vice President and Assistant Secretary. 2800 Post Oak Blvd.,
Houston, Texas 77056. Vice President, Associate General Counsel and Compliance
Review Officer of the Adviser.(4)
PAUL R. WOLKENBERG, Vice President. 2800 Post Oak Blvd., Houston, Texas
77056. Senior Vice President of the Adviser; President, Chief Operating Officer
and Director of Van Kampen American Capital Services, Inc.; Executive Vice
President, Chief Operating Officer and Director of Van Kampen American Capital
Trust Company; Executive Vice President and Director of ACCESS.(4)
- ---------------
* Trustee who is an interested person of the Adviser and of the Fund within
the meaning of the 1940 Act by virtue of his affiliation with the Adviser.
** Trustee who is an interested person of the Fund and may be an interested
person of the Adviser within the meaning of the 1940 Act by virtue of his
affiliation with legal counsel of the Fund.
(1) A director or trustee of American Capital Comstock Fund, Inc., American
Capital Corporate Bond Fund, Inc., American Capital Emerging Growth Fund,
Inc., American Capital Enterprise Fund, Inc., American Capital Equity Income
Fund, Inc., American Capital Federal Mortgage Trust, American Capital Global
Managed Assets, Inc., American Capital Government Securities, Inc., American
Capital Government Target Series, American Capital Growth and Income Fund,
Inc., American Capital Harbor Fund, Inc., American Capital High Yield
Investments, Inc., American Capital Life Investment Trust, American Capital
Municipal Bond Fund, Inc., American Capital Pace Fund, Inc., American
Capital Reserve Fund, Inc., American Capital Small Capitalization Fund,
Inc., American Capital Tax-Exempt Trust, American Capital Texas Municipal
Securities, Inc., American Capital U.S. Government Trust for Income,
American Capital Utilities Income Fund, Inc. and American Capital World
Portfolio Series, Inc.
(2) A director/trustee/managing general partner of American Capital Bond Fund,
Inc., American Capital Convertible Securities, Inc., and American Capital
Income Trust, American Capital Exchange Fund, investment companies advised
by the Adviser, and a trustee of Common Sense Trust, an open-end investment
company which the Adviser serves as adviser for nine of the Portfolios.
(3) A director of Source Capital, Inc., a closed-end investment company not
advised by the Adviser.
(4) An officer and/or director/trustee of other investment companies advised or
subadvised by the Adviser.
(5) A director of FPA Capital Fund, Inc., FPA New Income, Inc., and FPA
Perennial Fund, Inc., investment companies not advised by the Adviser and
TCW Convertible Securities Fund, Inc., a closed-end investment company not
advised by the Adviser.
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<PAGE> 62
The Executive Committee, consisting of Messrs. Hilsman, Powell, Sheehan and
Sisto, may act for the Trustees between meetings except where board action is
required by law.
The Trustees and officers of the Fund as a group own less than one percent
of the outstanding shares of the Fund. During the last fiscal year, the Trustees
who were not affiliated with the Adviser or its parent received as a group
$9,556 in trustees' fees from the Fund in addition to certain out-of-pocket
expenses. Such Trustees also received compensation for serving as trustees or
directors of other investment companies advised by the Adviser as identified in
the notes to the foregoing table. For legal services rendered during the fiscal
year, the Fund paid legal fees of $7,034 to the law firm of O'Melveny & Myers,
of which Mr. Sheehan is Of Counsel. The firm also serves as legal counsel to the
American Capital Funds listed in Footnote 1 above.
Additional information regarding compensation paid by the Fund and the
related mutual funds for which the Trustees serve as directors or trustees noted
in Footnote 1 above. The compensation shown for the Fund and the total
compensation shown for the Fund and other related mutual funds are for the year
ended December 31, 1994, is set forth below. Mr. Powell is not compensated for
his service as Director because of his affiliation with the Adviser.
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
PENSION OR COMPENSATION
AGGREGATE RETIREMENT FROM REGISTRANT
COMPENSATION BENEFITS ACCRUED AND FUND
FROM AS PART OF FUND COMPLEX PAID TO
NAME OF PERSONS REGISTRANT EXPENSES DIRECTORS(1)(5)
- --------------- ------------ ---------------- ---------------
<S> <C> <C> <C>
J. Miles Branagan................................ $1,410 -0- $64,000
Dr. Richard E. Caruso(2)(3)...................... 1,410 -0- 64,000
Dr. Roger Hilsman................................ 1,460 -0- 66,000
David Rees(3).................................... 1,410 -0- 64,000
Lawrence J. Sheehan.............................. 1,480 -0- 67,000
Dr. Fernando Sisto(2)(3)......................... 1,820 -0- 82,000
William S. Woodside(4)........................... 1,200 -0- 54,000
</TABLE>
- ---------------
(1) Represents 29 investment company portfolios in the fund complex.
(2) Amount reflects deferred compensation of $1,370 for Dr. Caruso and $960 for
Dr. Sisto.
(3) The cumulative deferred compensation paid by the Fund is as follows: Dr.
Caruso, $4,291; Mr. Rees, $5,378; and Dr. Sisto, $4,236.
(4) Prior to October 6, 1994, Mr. Woodside's compensation was paid by the
Adviser. As a result, of the amounts reflected in the second and fourth
columns, $340 and $17,000, respectively, were paid by the registrant or the
registrant and the fund complex, as the case may be.
(5) Includes the following amounts for which the various funds were reimbursed
by the Adviser -- Branagan, $2,000; Caruso, $2,000; Hilsman, $1,000; Rees,
$2,000; Sheehan, $2,000; Sisto, $2,000; Woodside, $1,000 (Mr. Woodside was
paid $36,000 directly by the Adviser as discussed in footnote 4 above).
INVESTMENT ADVISORY AGREEMENT
The Fund and the Adviser are parties to an investment advisory agreement,
dated December 20, 1994 (the "Advisory Agreement"). Under the Advisory
Agreement, the Fund retains the Adviser to manage the investment of the Fund's
assets, including the placing of orders for the purchase and sale of portfolio
securities. The Adviser obtains and evaluates economic, statistical and
financial information to formulate and implement the Fund's investment programs.
The Adviser also furnishes the services of the Fund's President and such
other executive and clerical personnel as are necessary to prepare the various
reports and statements and conduct the Fund's day-to-day operations. The Fund,
however, bears the cost of its accounting services, which include maintaining
its financial books and records and calculating its net asset value. The costs
of such accounting services include
16
<PAGE> 63
the salaries and overhead expenses of the Fund's Treasurer and the personnel
operating under his direction. Charges are allocated among the investment
companies advised or subadvised by the Adviser. A portion of these amounts were
paid to the Adviser or its parent in reimbursement of personnel, facilities and
equipment costs attributable to the provision of accounting services to the
Fund. The services provided by the Adviser are at cost. The Fund also pays
shareholder service agency fees, distribution fees, service fees, custodian
fees, legal and auditing fees, the costs of reports to shareholders, and all
other ordinary business expenses not specifically assumed by the Adviser. The
Agreement also provides that the Adviser shall not be liable to the Fund for any
actions or omissions if it acted without bad faith, negligence or reckless
disregard of its obligations.
Under the Advisory Agreement, the Fund pays to the Adviser, as compensation
for the services rendered, facilities furnished, and expenses paid by it, a fee
payable monthly, computed at the following annual rates: (a) 0.50% of the first
$1 billion of average daily net assets; (b) 0.475% of the next $1 billion of
average daily net assets; (c) 0.45% of the next $1 billion of average daily net
assets; (d) 0.40% of the next $1 billion of average daily net assets; and (e)
0.35% of the average daily net assets in excess of $4 billion.
The Fund's average net assets are determined by taking the average of all
determinations of the net assets during a given calendar month. Such fee is
payable for each calendar month as soon as practicable after the end of that
month. The fee payable to the Adviser will be reduced by any commissions, tender
solicitation and other fees, brokerage or similar payments received by the
Adviser or any other direct or indirect majority owned subsidiary of VK/AC
Holding, Inc. in connection with the purchase and sale of portfolio investments
less any direct expenses incurred by such subsidiary of VK/AC Holding, Inc., in
connection with obtaining such commissions, fees, brokerage or similar payments.
The Adviser agrees to use its best efforts to recapture tender solicitation fees
and exchange offer fees for the Fund's benefit and to advise the Trustees of the
Fund of any other commissions, fees, brokerage or similar payments which may be
possible for the Adviser or any other direct or indirect majority owned
subsidiary of VK/AC Holding, Inc. to receive in connection with the Fund's
portfolio transactions or other arrangements which may benefit the Fund.
The Advisory Agreement also provides that, in the event the ordinary
business expenses of the Fund for any fiscal year exceed 1.5% of the first $30
million of the Fund's average net assets, plus one percent of any excess over
$30 million, the Adviser's monthly compensation will be reduced by the amount of
such excess and that, if the amount of such excess exceeds the Adviser's monthly
compensation, the Adviser will pay the Fund an amount sufficient to make up the
deficiency, subject to readjustment during the Fund's fiscal year. Ordinary
business expenses do not include (1) interest and taxes, (2) brokerage
commissions, (3) certain litigation and indemnification expenses as described in
the Advisory Agreement, and (4) payments made by the Fund pursuant to the
distribution plans (described herein). The Advisory Agreement also limits the
extent to which the Adviser shall be liable to the Fund for acts or omissions.
The Advisory Agreement may be continued from year to year if specifically
approved at least annually (a)(i) by the Trustees, or (ii) by vote of a majority
of the Fund's outstanding voting securities; and (b) by the vote of a majority
of the Trustees who are not parties to the agreement or interested persons of
any such party by votes cast in person at a meeting called for such purpose. The
Advisory Agreement provides that it shall terminate automatically if assigned
and that it may be terminated without penalty by either party on 60 days'
notice.
During the fiscal years ended December 31, 1992, 1993 and 1994 the Adviser
received $424,048, $463,588 and $280,713 respectively, in advisory fees from the
Fund. For such periods the Fund paid $66,713, $91,249 and $75,309 respectively,
for accounting services.
DISTRIBUTOR
The Distributor acts as the principal underwriter of the Fund's shares
pursuant to a written agreement, dated December 20, 1994, the ("Underwriting
Agreement"). The Distributor has the exclusive right to distribute shares of the
Fund through dealers. The Distributor's obligation is an agency or "best
efforts" arrangement under which the Distributor is required to take and pay for
only such shares of the Fund as may be sold to the public. The Distributor is
not obligated to sell any stated number of shares. The Distributor bears the
cost of printing (but not typesetting) prospectuses used in connection with this
offering and certain
17
<PAGE> 64
other costs, including the cost of sales literature and advertising. The
Underwriting Agreement is renewable from year to year if approved (a) by the
Trustees or by a vote of a majority of the Fund's outstanding voting securities,
and (b) by the affirmative vote of a majority of the Trustees who are not
parties to the Underwriting Agreement or interested persons of any party, by
votes cast in person at a meeting called for such purpose. The Underwriting
Agreement provides that it will terminate if assigned, and that it may be
terminated without penalty by either party on 60 days' written notice. Total
underwriting commissions on the sale of shares of the Fund for the last three
fiscal periods are shown in the chart below. Advantage Capital Corporation is an
affiliated dealer of the Distributor.
<TABLE>
<CAPTION>
DEALER REALLOWANCES
RECEIVED BY
TOTAL UNDERWRITING AMOUNT RETAINED ADVANTAGE CAPITAL
CAPITAL COMMISSIONS BY DISTRIBUTOR CORPORATION
- ------------------------------------------ ------------------ --------------- -------------------
<S> <C> <C> <C>
Fiscal Year Ended December 31, 1992 $ 557,607 $18,203 $ 76,019
Fiscal Year Ended December 31, 1993 $ 132,779 $16,515 $ 27,511
Fiscal Year Ended December 31, 1994 $ 55,691 $ 2,321 $ 6,301
</TABLE>
DISTRIBUTION PLANS
The Fund adopted a Class A distribution plan, a Class B distribution plan
and a Class C distribution plan (the "Class A Plan," "Class B Plan" or "Class C
Plan," respectively) to permit the Fund directly or indirectly to pay expenses
associated with servicing shareholders and in the case of the Class B Plan and
Class C Plan the distribution of its shares (the Class A Plan, the Class B Plan
and the Class C Plan are sometimes referred to herein collectively as "Plans"
and individually as a "Plan").
The Trustees have authorized payments by the Fund under the Plans to
reimburse the Distributor for its payments to certain financial institutions
(which may include banks), securities dealers and other industry professionals
(collectively, "Service Organizations") for administration, for servicing Fund
shareholders who are also their clients and/or for distribution. Such payments
are based on an annual percentage of the value of Fund shares held in
shareholder accounts for which such Service Organizations are responsible. With
respect to the Class A Plan, the Distributor intends to make payments thereunder
only to compensate Service Organizations for personal service and/or the
maintenance of shareholder accounts. With respect to the Class B and Class C
Plans, authorized payments by the Fund include payments at an annual rate of up
to 0.25% of the net assets of the shares of the respective class to reimburse
the Distributor for payments for personal service and/or the maintenance of
shareholder accounts. With respect to the Class B Plan, authorized payments by
the Fund also include payments at an annual rate of up to 0.75% of the net
assets of the Class B shares to reimburse the Distributor for (1) commissions
and transaction fees of up to three percent of the purchase price of Class B
shares purchased by the clients of broker-dealers and other Service
Organizations, (2) out-of-pocket expenses of printing and distributing
prospectuses and annual and semi-annual shareholder reports to other than
existing shareholders, (3) out-of-pocket and overhead expenses for preparing,
printing and distributing advertising material and sales literature, (4)
expenses for promotional incentives to broker-dealers and financial and industry
professionals, and (5) advertising and promotion expenses, including conducting
and organizing sales seminars, marketing support salaries and bonuses, and
travel-related expenses. With respect to the Class C Plan, authorized payments
by the Fund also include payments at an annual rate of up to 0.75% of the net
assets of the Class C shares to reimburse the Distributor for (1) upfront
commissions and transaction fees of up to 0.75% of the purchase price of Class C
shares purchased by the clients of broker-dealers and other Service
Organizations and ongoing commissions and transaction fees paid to
broker-dealers and other Service Organizations in an amount up to 0.25% of the
average daily net assets of the Fund's Class C shares, (2) out-of-pocket
expenses of printing and distributing prospectuses and annual and semi-annual
shareholder reports to other than existing shareholders, (3) out-of-pocket and
overhead expenses for preparing, printing and distributing advertising material
and sales literature, (4) expenses for promotional incentives to broker-dealers
and financial and industry professionals, and (5) advertising and promotion
expenses, including conducting and organizing sales seminars, marketing support
salaries and bonuses, and travel-related expenses. Such reimbursements are
subject to the maximum sales charge limits specified by the National Association
of Securities Dealers, Inc. for asset-based charges.
18
<PAGE> 65
Banks are currently prohibited under the Glass-Steagall Act from providing
certain underwriting or distribution services. If banking firms were prohibited
from acting in any capacity or providing any of the described services, the
Distributor would consider what action, if any, would be appropriate. The
Distributor does not believe that termination of a relationship with a bank
would result in any material adverse consequences to the Fund. In addition,
state securities laws on this issue may differ from the interpretations of
federal law expressed herein and banks and financial institutions may be
required to register as dealers pursuant to state law.
As required by Rule 12b-1 under the 1940 Act, each Plan and the forms of
servicing agreements were approved by the Trustees, including a majority of the
Trustees who are not affiliated persons (as defined in the 1940 Act) of the Fund
and who have no direct or indirect financial interest in the operation of any of
the Plans or in any agreements related to each Plan ("Independent Trustees"). In
approving each Plan in accordance with the requirements of Rule 12b-1, the
Trustees determined that there is a reasonable likelihood that each Plan will
benefit the Fund and its shareholders.
Each Plan requires the Distributor to provide the Trustees at least
quarterly with a written report of the amounts expended pursuant to each Plan
and the purposes for which such expenditures were made. Unless sooner terminated
in accordance with its terms, the Plans will continue in effect for a period of
one year and thereafter will continue in effect so long as such continuance is
specifically approved at least annually by the Trustees, including a majority of
Independent Trustees.
Each Plan may be terminated by vote of a majority of the Independent
Trustees, or by vote of a majority of the outstanding voting securities of the
Fund. Any change in any of the Plans that would materially increase the
distribution or service expenses borne by the Fund requires shareholder
approval, voting separately by class; otherwise, it may be amended by a majority
of the Trustees, including a majority of the Independent Trustees, by vote cast
in person at a meeting called for the purpose of voting upon such amendment. So
long as the Plans are in effect, the selection or nomination of the Independent
Trustees is committed to the discretion of the Independent Trustees.
For the fiscal year ended December 31, 1994, the Fund's aggregate expenses
under the Class A Plan were $132,613 or 0.24% of the Class A shares' average
daily net assets. Such expenses were paid to reimburse the Distributor for
payments to Service Organizations for servicing Fund shareholders and for
administering the Class A Plan. For the fiscal year ended December 31, 1994, the
Fund's aggregate expenses under the Class B Plan were $222,471 or 1.00% of the
Class B shares' average net assets. Such expenses were paid to reimburse the
Distributor for the following payments: $166,853 for commissions and transaction
fees paid to broker-dealers and other Service Organizations in respect of sales
of Class B shares of the Fund and $55,618 for fees paid to Service Organizations
for servicing Class B shareholders and administering the Class B Plan. For the
fiscal year ended December 31, 1994, the Fund's aggregate expenses under the
Class C Plan were $76,165 or 1.00% of the Class C shares' average net assets.
Such expenses were paid to reimburse the Distributor for the following payments:
$57,124 for commissions and transaction fees paid to broker-dealers and other
Service Organizations in respect of sales of Class C shares of the Fund and
$19,041 for fees paid to Service Organizations for servicing Class C
shareholders and administering the Class C Plan.
TRANSFER AGENT
During the fiscal year ended December 31, 1994, ACCESS, shareholder service
agent and dividend disbursing agent for the Fund, received fees aggregating
$150,547 for these services. These services are provided at cost plus a profit.
PORTFOLIO TURNOVER
The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for a fiscal year by the average
monthly value of the Fund's portfolio securities during such fiscal year.
Securities which mature in one year or less at the time of acquisition are not
included in this computation. The turnover rate may vary greatly from year to
year as well as within a year. The Fund's portfolio turnover rate for prior
years is shown under "Financial Highlights" in the Prospectus. The annual
turnover rate is expected to
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<PAGE> 66
exceed 100%, which is higher than that of many other investment companies. A
100% turnover rate would occur if all the Fund's portfolio securities were
replaced during one year.
The Fund's portfolio turnover rate increased significantly from 1993 to
1994 because of increased trading activity resulting from a sharp increase in
short-term interest rates. This heightened volatility created additional trading
opportunities to manage treasury curve exposure. Additionally, late in the year,
dislocations among sectors (prices of adjustable rate mortgages were especially
favorable) presented opportunities which led to increased turnover.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Adviser is responsible for decisions to buy and sell securities for the
Fund, as well as for the placement of its portfolio business and the negotiation
of any commissions, if any, paid on such transactions. It is the policy of the
Adviser to seek the best security price available with respect to each
transaction. In over-the-counter transactions, orders are placed directly with a
principal market maker unless the Adviser believes that a better price and
execution can be obtained by using a broker. Except to the extent that the Fund
may pay higher brokerage commissions for brokerage and research services, as
described below, on a portion of its transactions executed on securities
exchanges, the Adviser seeks the best security price at the most favorable
commission rate. In selecting broker-dealers and in negotiating commissions, the
Adviser considers the firm's reliability, the quality of its execution services
on a continuing basis and its financial condition. When more than one firm is
believed to meet these criteria, preference may be given to firms which also
provide research services to the Fund or the Adviser. Consistent with the Rules
of Fair Practice of the National Association of Securities Dealers, Inc. and
subject to seeking best execution and such other policies as the Trustees may
determine, the Adviser may consider sales of shares of the Fund as a factor in
the selection of firms to execute portfolio transactions for the Fund.
Section 28(e) of the Securities Exchange Act of 1934 ("Section 28(e)")
permits an investment adviser, under certain circumstances, to cause an account
to pay a broker or dealer who supplies brokerage and research services, a
commission for effecting a securities transaction in excess of the amount of
commission another broker or dealer would have charged for effecting the
transaction. Brokerage and research services include (a) furnishing advice as to
the value of securities, the advisability of investing in, purchasing or selling
securities, and the availability of securities or purchasers or sellers of
securities, (b) furnishing analyses and reports concerning issuers, industries,
securities, economic factors and trends, portfolio strategy, and the performance
of accounts, and (c) effecting securities transactions and performing functions
incidental thereto (such as clearance, settlement and custody).
Pursuant to provisions of the Advisory Agreement, the Trustees have
authorized the Adviser to cause the Fund to incur brokerage commissions in an
amount higher than the lowest available rate in return for research services
provided to the Adviser. The Adviser intends that such higher commissions will
not be paid by the Fund unless (a) the Adviser determines in good faith that the
amount is reasonable in relation to the services in terms of the particular
transaction or in terms of the Adviser's overall responsibilities with respect
to the accounts as to which it exercises investment discretion, (b) such payment
is made in compliance with the provisions of Section 28(e) and other applicable
state and federal laws, and (c) in the opinion of the Adviser, the total
commissions paid by the Fund are reasonable in relation to the expected benefits
to the Fund over the long term. The investment advisory fee paid by the Fund
under the Advisory Agreement is not reduced as a result of the Adviser's receipt
of research services.
The Adviser places portfolio transactions for other advisory accounts,
including other mutual funds. Research services furnished by firms through which
the Fund effects its securities transactions may be used by the Adviser in
servicing all of their accounts; not all of such services may be used by the
Adviser in connection with the Fund. In the opinion of the Adviser, the benefits
from research services to each of the accounts, including the Fund, managed by
the Adviser cannot be measured separately. Because the volume and nature of the
trading activities of the accounts are not uniform, the amount of commissions in
excess of the lowest available rate paid by each account for brokerage and
research services may vary. In the opinion of the
20
<PAGE> 67
Adviser, however, such costs to the Fund will not be disproportionate to the
benefits received by the Fund on a continuing basis.
The Adviser seeks to allocate portfolio transactions equitably whenever
concurrent decisions are made to purchase or sell securities by the Fund and
another advisory account. In some cases, this procedure could have an adverse
effect on the price or the amount of securities available to the Fund. In making
such allocations among the Fund and other advisory accounts, the main factors
considered by the Adviser are the respective investment objectives, the relative
size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held, and opinions of the persons responsible for recommending the
investment.
The Adviser's brokerage practices are monitored on a quarterly basis by the
Brokerage Review Committee comprised of Fund Trustees who are not affiliated
persons.
Brokerage commissions paid by the Fund on portfolio transactions for the
fiscal years ended December 31, 1992, 1993 and 1994 totalled $54,143, $12,080
and $-0-, respectively. No commissions were paid for research services during
the last fiscal year and no commissions were paid to affiliated brokers during
the last three years.
DETERMINATION OF NET ASSET VALUE
The net asset value per share is determined as of the close of the New York
Stock Exchange (the "Exchange") (currently 4:00 p.m., New York time) on each
business day on which the Exchange is open. The Exchange is currently closed on
weekends and on the following holidays: New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day.
The types of mortgage-related and asset-backed securities in which the Fund
invests, as well as U.S. Government securities, are traded in the
over-the-counter market and are valued at the last available bid price. Such
valuations are based on quotations of one or more dealers that make markets in
the securities as obtained from such dealers or from a pricing service. Listed
options and options on futures contracts are valued at the last reported sale
price as of the close of the exchange or, if no sales are reported, at the mean
between the last reported bid and asked prices. Securities with a remaining
maturity of 60 days or less are valued on an amortized costs basis, which
approximates market value.
Securities (as well as over-the-counter options) and any other assets for
which market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Trustees. Such
valuations and procedures are reviewed periodically by the Trustees.
The assets belonging to the Class A shares, the Class B shares and the
Class C shares will be invested together in a single portfolio. The net asset
value of each class will be determined separately by subtracting the expenses
and liabilities allocated to that class from the assets belonging to that class
pursuant to an order issued by the Securities and Exchange Commission ("SEC").
PURCHASE AND REDEMPTION OF SHARES
The following information supplements that set forth in the Fund's
Prospectus under the heading "Purchase of Shares."
PURCHASE OF SHARES
Class A shares and Class C shares of the Fund are sold in a continuous
offering and may be purchased on any business day through authorized dealers,
including Advantage Capital Corporation.
At this time, the Fund offers Class B shares only to current Fund Class B
shareholders who have elected or may elect the option to reinvest dividends
and/or capital gains distributions in shares of the Fund (other share purchases
by such shareholders must be of Class A or Class C shares), and Class B
shareholders of other American Capital funds exchanging their Class B shares for
Class B shares of the Fund.
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<PAGE> 68
MULTIPLE PRICING SYSTEM
The Fund issues three classes of shares: Class A shares are subject to an
initial sales charge; Class B and Class C shares are sold at net asset value and
are subject to a contingent deferred sales charge. The three classes of shares
each represent interests in the same portfolio of investments of the Fund, have
the same rights and are identical in all respects, except that Class B and Class
C shares bear the expenses of the deferred sales arrangements, distribution
fees, and any expenses (including higher transfer agency costs) resulting from
such sales arrangements, and have exclusive voting rights with respect to the
Rule 12b-1 distribution plan pursuant to which the distribution fee is paid. As
set forth above, Class B shares are not currently being offered for sale to the
general public.
During special promotions, the entire sales charge on Class A shares may be
reallowed to dealers, and at such times dealers may be deemed to be underwriters
for purposes of the Securities Act of 1933.
INVESTMENTS BY MAIL
A shareholder investment account may be opened by completing the
application included in the Prospectus and forwarding the application, through
the designated dealer, to ACCESS, P.O. Box 419319, Kansas City, Missouri
64141-6319. The account is opened only upon acceptance of the application by
ACCESS. The minimum initial investment of $500 or more, in the form of a check
payable to the Fund, must accompany the application. This minimum may be waived
by the Distributor for plans involving continuing investments. Subsequent
investments of $25 or more may be mailed directly to ACCESS. All such
investments are made at the public offering price of Fund shares next computed
following receipt of payment by ACCESS. Confirmations of the opening of an
account and of all subsequent transactions in the account are forwarded by
ACCESS to the investor's dealer of record, unless another dealer is designated.
In processing applications and investments, ACCESS acts as agent for the
investor and for the dealer named thereon, and also as agent for the
Distributor, in accordance with the terms of the Prospectus. If ACCESS ceases to
act as such, a successor company named by the Fund will act in the same
capacities so long as the account remains open.
CUMULATIVE PURCHASE DISCOUNT
The reduced sales charge reflected in the sales charge table as shown in
the Prospectus under "Purchase of Shares -- Sales Charge Table" apply to
purchases of Class A shares of the Fund where the aggregate investment is
$25,000 or more. For purposes of determining eligibility for volume discounts,
spouses and their minor children are treated as a single purchaser, as is a
director or other fiduciary purchasing for a single fiduciary account. An
aggregate investment includes all shares of the Fund and all shares of certain
other participating American Capital mutual funds described in the Prospectus
(the "Participating Funds"), which have been previously purchased and are still
owned, plus the shares being purchased. The current offering price is used to
determine the value of all such shares. If, for example, an investor has
previously purchased and still holds shares of the Fund and shares of other
Participating Funds having a current offering price of $40,000, and that person
purchases $65,000 of additional Class A shares of the Fund, the charge
applicable to the $65,000 purchase would be 2.75% of the offering price. The
same reduction is applicable to purchases under a Letter of Intent as described
in the next paragraph. THE DEALER MUST NOTIFY THE DISTRIBUTOR AT THE TIME AN
ORDER IS PLACED FOR A PURCHASE WHICH WOULD QUALIFY FOR THE REDUCED CHARGE ON THE
BASIS OF PREVIOUS PURCHASES. SIMILAR NOTIFICATION MUST BE GIVEN IN WRITING WHEN
SUCH AN ORDER IS PLACED BY MAIL. The reduced sales charge may not be applied if
such notification is not furnished at the time of the order. The reduced sales
charge will also not be applied should a review of the records of the
Distributor or ACCESS fail to confirm the investor's representations concerning
his holdings.
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<PAGE> 69
LETTER OF INTENT
Purchases of Class A shares of the funds described above under "Cumulative
Purchase Discount" made pursuant to the Letter of Intent and the value of all
shares of such Participating Funds previously purchased and still owned are also
included in determining the applicable quantity discount. A Letter of Intent
permits an investor to establish a total investment goal to be achieved by any
number of investments over a 13-month period. Each investment made during the
period receives the reduced sales charge applicable to the amount represented by
the goal as if it were a single investment. Escrowed shares totaling five
percent of the dollar amount of the Letter of Intent are held by ACCESS in the
name of the shareholder. A Letter of Intent may be back-dated up to 90 days in
order that any investments made during this 90-day period, valued at the
investor's cost, can become subject to the Letter of Intent. The Letter of
Intent does not obligate the investor to purchase the indicated amount. In the
event the Letter of Intent goal is not achieved within the 13-month period, the
investor is required to pay the difference between sales charges otherwise
applicable to the purchases made during this period and sales charges actually
paid. Such payment may be made directly to the Distributor or, if not paid, the
Distributor will liquidate sufficient escrowed shares to obtain such difference.
If the goal is exceeded in an amount which qualifies for a lower sales charge, a
price adjustment is made by refunding to the investor in shares of the Fund, the
amount of excess sales charges, if any, paid during the 13-month period.
VOLUME DISCOUNTS
The schedule of volume discounts in the Prospectus applies to purchases of
Class A shares made at one time by any purchaser, which term includes (1) an
individual -- or an individual, his or her spouse and children under the age of
21 -- purchasing securities for his or her or their own account; (2) a trustee
or other fiduciary of a single trust estate or a single fiduciary account
(including a pension, profit-sharing or other employee benefit trust created
pursuant to a plan qualified under Section 401 of the Internal Revenue Code (the
"Code")), although more than one beneficiary is involved; and (3) tax-exempt
organizations enumerated in Section 501(c)(3) or (13) of the Code.
CONTINGENT DEFERRED SALES CHARGE -- CLASS A
For certain full service participant directed profit sharing and money
purchase plans and qualified 401(k) retirement plans and for investments in the
amount of $1,000,000 or more of Class A shares of the Fund ("Qualified
Purchaser"), the front-end sales charge will be waived and a contingent deferred
sales charge ("CDSC--Class A") of one percent is imposed in the event of certain
redemptions within one year of the purchase. If a CDSC--Class A is imposed upon
redemption, the amount of the CDSC--Class A will be equal to the lesser of one
percent of the net asset value of the shares at the time of purchase, or one
percent of the net asset value of the shares at the time of redemption.
The CDSC--Class A will only be imposed if a Qualified Purchaser redeems an
amount which causes the value of the account to fall below the total dollar
amount of purchase payments made by the Qualified Purchaser without an initial
sales charge during the one year period prior to the redemption. The CDSC--Class
A will be waived in connection with redemptions by certain Qualified Purchasers
(e.g., in retirement plans qualified under Section 401(a) of the Code and
deferred compensation plans under Section 457 of the Code) required to obtain
funds to pay distributions to beneficiaries pursuant to the terms of the plans.
Such payments include, but are not limited to, death, disability, retirement, or
separation from service. No CDSC--Class A will be imposed on exchanges between
funds. For purposes of the CDSC--Class A, when shares of one fund are exchanged
for shares of another fund, the purchase date for the shares of the fund
exchanged into will be assumed to be the date on which shares were purchased in
the fund from which the exchange was made. If the exchanged shares themselves
are acquired through an exchange, the purchase date is assumed to carry over
from the date of the original election to purchase shares subject to a
CDSC--Class A rather than a front-end load sales charge. In determining whether
a CDSC--Class A is payable, it is assumed that shares held the longest are the
first to be redeemed.
23
<PAGE> 70
Cumulative Purchase Discounts and Letters of Intent will apply to the net
asset value privilege. Also, in order to establish an amount of $1,000,000 or
more, a Qualified Purchaser may aggregate shares of American Capital Reserve
Fund, Inc. with shares of certain other participating American Capital funds
described as "Participating Funds" in the Prospectus.
As described in the Prospectus under "Redemption of Shares," redemptions of
Class B and Class C shares will be subject to a contingent deferred sales
charge.
WAIVER OF CLASS B AND CLASS C CONTINGENT DEFERRED SALES CHARGE ("CDSC--CLASS B
AND C")
The CDSC--Class B and C may be waived on redemptions of Class B and Class C
shares in the circumstances described below:
(a) Redemption Upon Disability or Death
The Fund will waive the CDSC--Class B and C on redemptions following the
death or disability of a Class B and Class C shareholder. An individual will be
considered disabled for this purpose if he or she meets the definition thereof
in Section 72(m)(7) of the Code, which in pertinent part defines a person as
disabled if such person "is unable to engage in any substantial gainful activity
by reason of any medically determinable physical or mental impairment which can
be expected to result in death or to be of long-continued and indefinite
duration." While the Fund does not specifically adopt the balance of the Code's
definition which pertains to furnishing the Secretary of Treasury with such
proof as he or she may require, the Distributor will require satisfactory proof
of death or disability before it determines to waive the CDSC--Class B and C.
In cases of death or disability, the CDSC--Class B and C will be waived
where the decedent or disabled person is either an individual shareholder or
owns the shares as a joint tenant with right of survivorship or is the
beneficial owner of a custodial or fiduciary account, and where the redemption
is made within one year of the death or initial determination of disability.
This waiver of the CDSC--Class B and C applies to a total or partial redemption,
but only to redemptions of shares held at the time of the death or initial
determination of disability.
(b) Redemption in Connection with Certain Distributions from Retirement
Plans
The Fund will waive the CDSC--Class B and C when a total or partial
redemption is made in connection with certain distributions from Retirement
Plans. The charge may be waived upon the tax-free rollover or transfer of assets
to another Retirement Plan invested in one or more of American Capital Funds; in
such event, as described below, the Fund will "tack" the period for which the
original shares were held onto the holding period of the shares acquired in the
transfer or rollover for purposes of determining what, if any, CDSC--Class B and
C is applicable in the event that such acquired shares are redeemed following
the transfer or rollover. The charge also may be waived on any redemption which
results from the return of an excess contribution pursuant to Section 408(d)(4)
or (5) of the Code, the return of excess deferral amounts pursuant to Code
Section 401(k)(8) or 402(g)(2), or from the death or disability of the employee
(see Code Section 72(m)(7) and 72(t)(2)(A)(ii)). In addition, the charge will be
waived on any minimum distribution required to be distributed in accordance with
Code Section 401(a)(9).
The Fund does not intend to waive the CDSC--Class B and C for any
distributions from IRAs or other Retirement Plans not specifically described
above.
(c) Redemption Pursuant to a Fund's Systematic Withdrawal Plan
A shareholder may elect to participate in a systematic withdrawal plan (the
"Plan") with respect to the shareholder's investment in the Fund. Under the
Plan, a dollar amount of a participating shareholder's investment in the Fund
will be redeemed systematically by the Fund on a periodic basis, and the
proceeds mailed to the shareholder. The amount to be redeemed and frequency of
the systematic withdrawals will be specified by the shareholder upon his or her
election to participate in the Plan. The CDSC--Class B and C will be waived on
redemptions made under the Plan.
The amount of the shareholder's investment in a Fund at the time the
election to participate in the Plan is made with respect to the Fund is
hereinafter referred to as the "initial account balance." The amount to be
24
<PAGE> 71
systematically redeemed from such Fund without the imposition of a CDSC--Class B
and C may not exceed a maximum of 12% annually of the shareholder's initial
account balance. The Fund reserves the right to change the terms and conditions
of the Plan and the ability to offer the Plan.
(d) Involuntary Redemptions of Shares in Accounts that Do Not Have the
Required Minimum Balance
The Fund reserves the right to redeem shareholder accounts with balances of
less than a specified dollar amount as set forth in the Prospectus. Prior to
such redemptions, shareholders will be notified in writing and allowed a
specified period of time to purchase additional shares to bring the account up
to the required minimum balance. Any involuntary redemption may only occur if
the shareholder account is less than the amount specified in the Prospectus due
to shareholder redemptions. The Fund will waive the CDSC--Class B and C upon
such involuntary redemption.
(e) Reinvestment of Redemption Proceeds in Shares of the Same Fund Within
120 Days After Redemption
A shareholder who has redeemed Class C shares of a Fund may reinvest at net
asset value, with credit for any CDSC--Class C paid on the redeemed shares, any
portion or all of his or her redemption proceeds (plus that amount necessary to
acquire a fractional share to round off his or her purchase to the nearest full
share) in Class C shares of the Fund, provided that the reinvestment is effected
within 120 days after such redemption and the shareholder has not previously
exercised this reinvestment privilege with respect to Class C shares of the
Fund. Shares acquired in this manner will be deemed to have the original cost
and purchase date of the redeemed shares for purposes of applying the
CDSC--Class C to subsequent redemptions.
(f) Redemption by Adviser
The Fund may waive the CDSC--Class B and C when a total or partial
redemption is made by the Adviser with respect to its investments in the Fund.
REDEMPTION OF SHARES
Redemptions are not made on days during which the Exchange is closed,
including those holidays listed under "Determination of Net Asset Value." The
right of redemption may be suspended and the payment therefor may be postponed
for more than seven days during any period when (a) the Exchange is closed for
other than customary weekends or holidays; (b) trading on the Exchange is
restricted; (c) an emergency exists as a result of which disposal by the Fund of
securities owned by it is not reasonably practicable or it is not reasonably
practical for the Fund to fairly determine the value of its net assets; or (d)
the Securities and Exchange Commission, by order, so permits.
The Fund may amend the signature guarantee procedures set forth in the
Prospectus under "Redemption of Shares" if a viable signature guarantee program
is established.
EXCHANGE PRIVILEGE
The following supplements the discussion of "Shareholder
Services -- Exchange Privilege" in the Prospectus:
By use of the exchange privilege, the investor authorizes ACCESS to act on
telephonic, telegraphic or written exchange instructions from any person
representing himself to be the investor or the agent of the investor and
believed by ACCESS to be genuine. VKAC and its subsidiaries, including ACCESS
(collectively, "Van Kampen American Capital"), and the Fund employ procedures
considered by them to be reasonable to confirm that instructions communicated by
telephone are genuine. Such procedures include requiring certain personal
identification information prior to acting upon telephone instructions, tape
recording telephone communications, and providing written confirmation of
instructions communicated by telephone. If reasonable procedures are employed,
neither Van Kampen American Capital nor the Fund will be liable for following
telephone instructions which it reasonably believes to be genuine. Van Kampen
American Capital and the Fund may be liable for any losses due to unauthorized
or fraudulent instructions if reasonable procedures are not followed.
25
<PAGE> 72
For purposes of determining the sales charge rate previously paid on Class
A shares, all sales charges paid on the exchanged security and on any security
previously exchanged for such security or for any of its predecessors shall be
included. If the exchanged security was acquired through reinvestment, that
security is deemed to have been sold with a sales charge rate equal to the rate
previously paid on the security on which the dividend or distribution was paid.
If a shareholder exchanges less than all of his securities, the security upon
which the highest sales charge rate was previously paid is deemed exchanged
first.
Exchange requests received on a business day prior to the time shares of
the funds involved in the request are priced will be processed on the date of
receipt. "Processing" a request means that shares in the fund from which the
shareholder is withdrawing an investment will be redeemed at the net asset value
per share next determined on the date of receipt. Shares of the new fund into
which the shareholder is investing will also normally be purchased at the net
asset value per share, plus any applicable sales charge, next determined on the
date of receipt. Exchange requests received on a business day after the time
shares of the funds involved in the request are priced will be processed on the
next business day in the manner described herein.
A prospectus of any of these mutual funds may be obtained from any
authorized dealer or the Distributor. An investor considering an exchange to one
of such funds should refer to the prospectus for additional information
regarding such fund.
CHECK WRITING PRIVILEGE
To establish the check writing privilege for Class A shares, a shareholder
must complete the appropriate section of the application and the Authorization
for Redemption form and return both documents to ACCESS before checks will be
issued. All signatures on the authorization card must be guaranteed if any of
the signatures are persons not referenced in the account registration or if more
than 30 days have elapsed since the shareholder service agent established the
account on its records. Moreover, if the shareholder is a corporation,
partnership, trust, fiduciary, executor or administrator, the appropriate
documents appointing authorized signers (corporate resolutions, partnerships or
trust agreements) must accompany the authorization card. The documents must be
certified in original form, and the certificates must be dated within 60 days of
their receipt by ACCESS.
The privilege does not carry over to accounts established through exchanges
or transfers. It must be requested separately for each fund account.
DIVIDENDS, DISTRIBUTIONS AND FEDERAL TAXES
DIVIDENDS AND DISTRIBUTIONS
The Fund declares dividends each business day on Class A shares, Class B
shares and Class C shares and distributes monthly substantially all of its net
investment income to shareholders of Class A shares, Class B shares and Class C
shares. The daily dividends are a fixed amount determined for each class at
least monthly. The per share dividends on Class B and Class C shares will be
lower than the per share dividends on Class A shares as a result of the
distribution fees and higher transfer agency fees applicable to the Class B and
Class C shares. The total of the Class A, Class B and Class C dividends is
expected not to exceed the net income of the Fund for the month divided by the
number of business days in the month. Net investment income for dividend
purposes consists of interest earned less expenses of the Fund accrued for that
dividend period. Dividends and distributions are automatically reinvested in
shares of the Fund at the next determined net asset value without sales charge,
except that any shareholder may elect in writing to receive any such dividends
or distributions, or both, in cash. Dividends and distributions are taxable to
shareholders as discussed below whether they are reinvested in shares of the
Fund or received in cash.
As described below under "Tax Treatment of Option and Futures
Transactions," 60% of any gain or loss realized by the Fund from transactions in
listed options, futures, and options on futures generally constitutes long-term
capital gains or losses and the balance constitutes short-term capital gains or
losses. The Fund may designate up to the entire amount of any net long-term
capital gains realized during the Fund's fiscal year as
26
<PAGE> 73
being paid in the last quarterly distribution of gains during such fiscal year
or in the first quarterly distribution of gains after the close of such fiscal
year.
Dividends and distributions declared to shareholders of record after
September 30 of any year and paid before February 1 of the following year, are
considered taxable income to shareholders on the record date even though paid in
the next year.
TAX STATUS OF THE FUND
Through payment of all or substantially all of its taxable net investment
income and net realized capital gains to shareholders and by meeting certain
diversification of assets and other requirements of the Code, the Fund expects
to qualify as a regulated investment company under Sections 851-855 of the Code.
This enables the Fund to be relieved from payment of income taxes on that
portion of its taxable net investment income and net realized capital gains
distributed to shareholders.
If for any taxable year the Fund does not qualify for the special tax
treatment afforded regulated investment companies, all of its taxable income,
including any net realized capital gains, would be subject to tax at regular
corporate rates (without any deduction for distributions to shareholders).
Dividends paid by the Fund from its net investment income, and
distributions of the Fund's net realized short-term capital gains, are taxable
to shareholders as ordinary income. Any distributions designated as being made
from the Fund's net realized long-term capital gains are taxable to shareholders
as long-term capital gains, regardless of the length of the period that a
shareholder has held his shares. Not later than 60 days after the end of each
fiscal year, the Fund will send to its shareholders a written notice required by
the Code designating the amount of any distributions made during such year which
are long-term capital gains distributions. Such notice may be included in the
annual report to shareholders. A dividend or capital gains distribution received
after the purchase of the Fund's shares reduces the net asset value of the
shares by the amount of the dividend or distribution and will be subject to
income taxes. A loss on the sale of shares held for less than six months
attributable to a long-term capital gains distribution is treated as a long-term
capital loss for federal income tax purposes.
If for any fiscal year of the Fund, the amount of distributions paid or
deemed paid for such year exceeds its net investment income plus net realized
capital gains for such year, the amount of such excess is expected to be treated
as a return of capital to all those shareholders who held shares of the Fund
during the year. In such case, each distribution paid or deemed paid for that
year would be treated, in the same proportion, in part as a distribution of
taxable income and in part as a return of capital. Shareholders would incur no
current federal income tax on the portion of such distributions which are
treated as a return of capital, but each shareholder's basis in the Fund's
shares would be reduced by that amount. This reduction of basis would operate to
increase the shareholder's capital gain, or decrease its capital loss, upon
redemption of Fund shares.
One of the requirements for qualification as a regulated investment company
is that less than 30% of the Fund's gross income be derived from gains from the
sale or other disposition of securities held for less than three months.
Accordingly, the Fund may be restricted in the writing of options on securities
which have been held less than three months, in the writing of options which
expire in less than three months, in effecting closing purchase transactions
with respect to options which have been written less than three months prior to
such transactions and in effecting closing transactions in futures contracts
which have been open for less than three months. Another requirement for
qualification is that at least 90% of the Fund's gross income in each fiscal
year be derived from dividends, interest and gains from the sale or other
disposition of securities.
The Fund is subject to a four percent excise tax to the extent it fails to
distribute to its shareholders at least 98% of its ordinary taxable income for
the twelve-months ended December 31, plus 98% of its capital gain net income for
the twelve-months ended October 31 of such year. The Fund intends to distribute
sufficient amounts to avoid liability for the excise tax.
If shares of the Fund are sold or exchanged within 90 days of acquisition,
and shares of the same or a related mutual fund are acquired, to the extent the
sales charge is reduced or waived on the subsequent acquisition, the sales
charge may not be used to determine the basis in the disposed shares for
purposes of
27
<PAGE> 74
determining gain or loss. To the extent the sales charge is not allowed in
determining gain or loss on the initial shares, it is capitalized on the basis
of the subsequent shares.
Since none of the Fund's net investment income arises from dividends on
common or preferred stock, none of its distributions are eligible for the 70%
dividends received deduction for corporations.
Dividends to shareholders who are non-resident aliens may be subject to a
United States withholding tax at a rate of up to 30% under existing provisions
of the Code applicable to foreign individuals and entities unless a reduced rate
of withholding or a withholding exemption is provided under applicable treaty
law. Non-resident shareholders are urged to consult their own tax advisers
concerning the applicability of the United States withholding tax.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury Regulations promulgated thereunder. The Code and the Treasury
Regulations are subject to change by legislative or administrative action either
prospectively or retroactively.
Dividends and capital gains distributions may also be subject to state and
local taxes.
Shareholders are urged to consult their attorneys or tax advisers regarding
specific questions as to federal, state or local taxes.
BACK-UP WITHHOLDING
The Fund is required to withhold and remit to the United States Treasury
31% of (i) reportable taxable dividends and distributions and (ii) the proceeds
of any redemptions of Fund shares with respect to any shareholder who is not
exempt from withholding and who fails to furnish the Fund with a correct
taxpayer identification number, who fails to report fully dividend or interest
income, or who fails to certify to the Fund that he has provided a correct
taxpayer identification number and that he is not subject to withholding. (An
individual's taxpayer identification number is his social security number.) The
31% "back-up withholding tax" is not an additional tax and may be credited
against a taxpayer's regular federal income tax liability.
TAX TREATMENT OF OPTION AND FUTURES TRANSACTIONS
The Code includes special rules applicable to listed options, futures
contracts, and options on futures contracts which the Fund may write, purchase
or sell. Such options and contracts are classified as Section 1256 contracts
under the Code. The character of gain or loss resulting from the sale,
disposition, closing out, expiration or other terminations of Section 1256
contracts is generally treated as long-term capital gain or loss to the extent
of 60% thereof and short-term capital gain or loss to the extent of 40% thereof
("60/40 gain or loss"). Such contracts, when held by the Fund at the end of a
fiscal year, generally are required to be treated as sold at market value on the
last day of such fiscal year for federal income tax purposes
("marked-to-market"). Over-the-counter options are not classified as Section
1256 contracts and are not subject to the mark-to-market rule or to 60/40 gain
or loss treatment. Any gains or losses recognized by the Fund from transactions
in over-the-counter options generally constitute short-term capital gains or
losses. If over-the-counter call options written, or over-the-counter put
options purchased, by the Fund are exercised, the gain or loss realized on the
sale of the underlying securities may be either short-term or long-term,
depending on the holding period of the securities. In determining the amount of
gain or loss, the sales proceeds are reduced by the premium paid for
over-the-counter puts or increased by the premium received for over-the-counter
calls.
A substantial portion of the Fund's transactions in options, futures
contracts and options on futures contracts, particularly its hedging
transactions, may constitute "straddles" which are defined in the Code as
offsetting positions with respect to personal property. A straddle in which at
least one, but not all, of the positions are Section 1256 contracts is a "mixed
straddle" under the Code if certain identification requirements are met.
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<PAGE> 75
The Code generally provides with respect to straddles (i) "loss deferral"
rules which may postpone recognition for tax purposes of losses from certain
closing purchase transactions or other dispositions of a position in the
straddle to the extent of unrealized gains in the offsetting position, (ii)
"wash sale" rules which may postpone recognition for tax purposes of losses
where a position is sold and a new offsetting position is acquired within a
prescribed period and, (iii) "short sale" rules which may terminate the holding
period of securities owned by the Fund when offsetting positions are established
and which may convert certain losses from short-term to long-term.
The Code provides that certain elections may be made for mixed straddles
that can alter the character of the capital gain or loss recognized upon
disposition of positions which form part of a straddle. Certain other elections
are also provided in the Code. No determination has been reached to make any of
these elections.
PRIOR PERFORMANCE INFORMATION
The Fund's average annual total return, computed in the manner described in
the Prospectus, for Class A shares of the Fund for the one-year, five-year, and
eight-and-one-half year (period since initial public offering of Fund) periods
ended December 31, 1994 was -2.12%, 4.59% and 5.36%, respectively. The average
annual total return, computed in the manner described in the Prospectus, for
Class B shares of the Fund for the one-year, and three-years-and-one month (the
initial offering of Class B shares) period ended December 31, 1994 was -3.50%
and 1.40%, respectively. The average annual total return, computed in the manner
described in the Prospectus, for Class C shares of the Fund for the one-year,
and seventeen-month (the initial offering of Class C shares) period ended
December 31, 1994, was -1.50% and 0.29%, respectively. These results are based
on historical earnings and asset value fluctuations and are not intended to
indicate future performance. Such information should be considered in light of
the Fund's investment objective and policies as well as the risks incurred in
the Fund's investment practices.
The annualized current yield, both subsidized and non-subsidized, for Class
A, Class B and Class C shares of the Fund for the 30 day period ending December
31, 1994 is listed below.
<TABLE>
<CAPTION>
NON-SUBSIDIZED
--------------
<S> <C>
Class A 4.75%
Class B 4.04%
Class C 4.04%
</TABLE>
The yield for any class of shares of the Fund is not fixed and will
fluctuate in response to prevailing interest rates and the market value of
portfolio securities, and as a function of the type of securities owned by the
Fund, portfolio maturity and the Fund's expenses.
Yield and total return are computed separately for Class A, Class B and
Class C shares.
From time to time VKAC will announce the results of their monthly polls of
U.S. investor intentions -- the Van Kampen American Capital Index of Investor
Intentions and the Van Kampen American Capital Mutual Fund Index -- which polls
measure how Americans plan to use their money.
From time to time, in reports or other communications, or in advertising or
sales materials, the Adviser may announce the results of actual tests performed
by DALBAR Financial Securities, Inc., an independent research firm, as they
relate to the level of services for mutual fund investors, and may refer to the
Missouri Quality Award received by ACCESS, the Fund's transfer agent, in 1993.
In addition, the Adviser may also refer to the Houston Awards for Quality
received by American Capital in 1994.
The Fund may, from time to time: (1) illustrate the benefits of
tax-deferral by comparing taxable investments to investments made through
tax-deferred retirement plans; (2) illustrate in graph or chart form, or
otherwise, the benefits of dollar cost averaging by comparing investments made
pursuant to a systematic investment plan to investments made in a rising market;
(3) illustrate allocations among different types of mutual funds for investors
at different stages of their lives; and (4) in reports or other communications
to shareholders or in advertising material, illustrate the benefits of
compounding at various assumed rates of
29
<PAGE> 76
return. Such illustrations may be in the form of charts or graphs and will not
be based on historical returns experienced by the Funds.
OTHER INFORMATION
CUSTODY OF ASSETS -- All securities owned by the Fund and all cash, including
proceeds from the sale of shares of the Fund and of securities in the Fund's
investment portfolio, are held by State Street Bank and Trust Company, 225
Franklin Street, Boston, Massachusetts 02110, as Custodian.
SHAREHOLDER REPORTS -- Semi-annual statements are furnished to shareholders, and
annually such statements are audited by the independent accountants.
INDEPENDENT ACCOUNTANTS -- Price Waterhouse LLP, 1201 Louisiana, Houston, Texas
77002, the independent accountants for the Fund, perform an annual audit of the
Fund's financial statements.
FINANCIAL STATEMENTS
Financial statements, including Investment Portfolio, Statement of Assets
and Liabilities, Statement of Operations, Statement of Changes in Net Assets,
Notes to Financial Statements, Financial Highlights and Report of Independent
Accountants on such financial statements, are hereby incorporated by reference
to the Fund's Annual Report to shareholders for the year ended December 31,
1994, previously filed with the SEC on or about March 10, 1995. The Fund will
furnish, without charge, a copy of such Annual Report on request by calling or
writing the Fund at 2800 Post Oak Boulevard, Houston, Texas 77056, (800)
421-5666.
The following information is not included in the Annual Report. This
example assumes a purchase of Class A shares of the Fund aggregating less than
$100,000 subject to the schedule of sales charges set forth in the Prospectus at
a price based upon the net asset value of Class A shares of the Fund.
<TABLE>
<CAPTION>
DECEMBER 31,
1994
------------
<S> <C>
Net Asset Value per Class A Share $11.90
Class A Per Share Sales Charge -- 3.25% of offering price
(2.30% of net asset value per share) $ .27
------------
Class A Per Share Offering Price to the Public $12.17
</TABLE>
30
