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MainStay Strategic Value Fund Prospectus October 22, 1997
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MainStay Strategic Value Fund, a separate series of The MainStay Funds, seeks to
provide maximum long-term total return from a combination of common stocks,
convertible securities and high yield securities.
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Read This!
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This Fund is not federally insured or guaranteed by the U.S. government--even if
you're investing through a bank. Shares of the Fund are not deposits or
obligations of, or guaranteed or insured by any financial institution, the
Federal Deposit Insurance Corporation or any other government agency.
Investments in the Fund are subject to investment risks, including possible loss
of principal. Certain of the Fund's investments are speculative.
No guarantees. There are no guarantees that the Fund will meet its objective.
All mutual funds involve risk, including the potential to lose some or all of
your original investment. Except for money market funds, the price of a mutual
fund share will fluctuate and, when sold, may be higher or lower than your
original purchase price.
These securities have not been approved or disapproved by the Securities and
Exchange Commission or any state securities commission, nor has the Securities
and Exchange Commission or any state securities commission passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is a
criminal offense.
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Please read this Prospectus carefully before you invest and keep it for future
reference. It includes information you should know before investing. We hope you
will easily find and understand the information you need but if you have any
suggestions for improvement--or if you need any help--please ask your Registered
Representative.
For even more details, write to NYLIFE Distributors Inc., 300 Interpace Parkway,
Building A, Parsippany, N.J. 07054, call 1-800-MAINSTAY (1-800-624-6782), or
visit our website at http://www.mainstayfunds.com.
The Statement of Additional Information (SAI) is incorporated by reference into
this Prospectus and also has been filed with the Securities and Exchange
Commission (SEC). For a free copy of the current SAI write to NYLIFE
Distributors Inc. or call 1-800-MAINSTAY. The SEC maintains a website
(http://www.sec.gov) that contains the SAI, material incorporated by reference,
and other information regarding registrants that file electronically with the
SEC.
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MainStay offers 14 additional mutual funds.
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Growth
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Capital Appreciation Fund
Equity Index Fund
International Equity Fund
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Growth & Income
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Convertible Fund
Total Return Fund
Value Fund
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Income
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Government Fund
High Yield Corporate Bond Fund
International Bond Fund
Money Market Fund
Strategic Income Fund
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Tax Free
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California Tax Free Fund
New York Tax Free Fund
Tax Free Bond Fund
[LOGO] MainStay(R) Funds
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What's Inside?
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Tell Me Quickly page
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The Fund ......................................................................1
A Quick Overview...Understanding MainStay Funds ...............................4
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Tell Me the Key Facts
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Analyze the Costs of Investing: Two Kinds of Fees .............................6
If You Invest $1,000, You Might Pay ...........................................6
Sales Charges and Operating Expenses ..........................................7
Description of the Fund .......................................................8
General Investment Considerations .............................................9
Decide Whether to Pay a Sales Charge Now, Later...or Maybe Never .............10
Consider Reducing Your Sales Charge ..........................................11
Open an Account and Buy Shares ...............................................12
Know How to Sell and Exchange Shares .........................................14
Decide How to Receive Your Earnings ..........................................16
Understand the Tax Consequences ..............................................17
Know With Whom You're Investing ..............................................18
Know Your Rights as a Shareholder ............................................20
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Tell Me the Details
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The Trust ....................................................................21
Other Information about the Fund .............................................21
Description of Investments and Investment Practices ..........................22
Investment Restrictions ......................................................25
Manager, Sub-Adviser and Distributor .........................................26
How to Purchase Shares of the Fund ...........................................27
Alternative Sales Arrangements ...............................................29
Redemptions and Exchanges ....................................................31
Tax-Deferred Retirement Plans ................................................32
Net Asset Value ..............................................................32
Portfolio Transactions .......................................................32
Tax Information ..............................................................33
Appendix A: Description of Securities Ratings ................................34
3
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Tell Me Quickly
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A Quick Overview...
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Investing in a mutual fund may seem complicated; but it may be easier when you
go through a Registered Representative. He or she can do many of the
administrative tasks--and help you confidently manage the rest.
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1
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Set your investment priorities
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Decide if they are:
o protecting what you have
o receiving income from dividends
o participating in the potential for greater investment returns
o a combination of any of the above.
How much risk of losing money are you willing to take; how aggressive are you
willing to be to try to make money? This two-part question may be the most
difficult question in the world of investing. Start with your gut feeling--then
talk it over with your registered representative. This is also an appropriate
time to talk about your investment goals. Your Registered Representative may
have some ideas you haven't considered.
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2
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Study the Fund's objective, policies and risks
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Focus on the Fund in relation to your objectives. Read about the people who
manage the Fund. Understand the types of securities in which the Fund invests
and the risks associated with those investments.
Talk with your registered representative.
For key facts about and risks of the Fund, see page 8. For more detailed
information, see "Tell Me the Details" in this prospectus and see the SAI.
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3
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Evaluate the Fund's fees and expenses
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Understand one-time and ongoing fees.
See the tables on page 7 for the Fund's one-time and ongoing fees and the impact
of those costs on a $1,000 investment.
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7
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Open an account/Buy shares
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To open an account, fill out an application, and have your Registered
Representative place the order. He or she can be invaluable here.
Make sure to provide complete information, including who will own the account,
and certify your Social Security Number or Taxpayer I.D. Number. This is also
the time to decide how you want to receive earnings (in cash or additional
shares) and whether you want telephone privileges and to make other choices that
will affect how you access your investments. (You may also place the order
directly with MainStay.)
For more on opening an account (including opening an account directly) see pages
12-13.
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8
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See how many shares your money will buy
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You can calculate the number of shares of the Fund your money buys using a
simple equation: (1) subtract the amount of any sales charge; then (2) divide
the remaining amount of your investment by the price of one share of the Fund.
The Fund's share price ("NAV" or "net asset value") is calculated at the close
of business of the New York Stock Exchange, normally 4:00 PM Eastern time, each
business day. The number of shares you receive is based on the NAV next
calculated after your order is received. You'll receive written confirmation of
your purchase.
To learn more, see pages 13 and 32.
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9
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Ongoing fees
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Every mutual fund pays fees for services. These may include distribution and
marketing, investment management and shareholder services. Fees may be charged
on different schedules but the Fund accrues for these expenses daily. You're not
charged directly; the Fund pays the fees to the firms who provide the services,
and then deducts the amounts from the Fund's assets. This, consequently, reduces
the NAV of your shares.
To learn more, see page 7.
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4
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...Understanding MainStay Funds
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4
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Decide how much to invest
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You may invest in as many Mainstay Funds as you want. Your initial investment in
the Fund must be at least $500, then $50 thereafter. For information on other
series of the Trust, including charges and expenses, call 1-800-MAINSTAY for a
free prospectus.
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5
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Decide when to pay the sales charge: now or later
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There may be a sales charge on share purchases. You may choose to pay it when
you invest (and you'll own "Class A" shares); or defer it until you sell,
according to a sliding scale based on the number of years you own the shares
(you'll own "Class B" shares). The sliding scale drops from 5% in the first year
to 0% after six years.
Deferring the sales charge allows you to buy more shares; but you'll pay higher
ongoing fees than Class A shareholders, which will reduce any earnings paid to
you.
For a list of the pros and cons of each choice, see page 10.
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6
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Consider reducing the sales charge
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There are also many ways to reduce or eliminate your sales charges, including
combining purchases, signing up for a letter of intent or others. There are no
sales charges for reinvesting earnings.
See page 11 for details.
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10
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Earn dividends and capital gains
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The Fund may earn money primarily through interest payments or capital
appreciation of the securities it owns. The Fund distributes these earnings to
you on a quarterly basis, based on the number of shares you own.
You may elect to have earnings sent to you or have them automatically reinvested
in more shares (with no sales charge).
To learn more, see page 16.
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11
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Exchange shares/ Redeem shares
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You generally may redeem your shares on any business day. The Fund will redeem
shares at the current NAV and send you a check. If you wish, you may exchange
shares of one MainStay Fund for shares of another. You can only exchange shares
of the same class. An exchange is considered a sale of one Fund and a purchase
of another and may have tax consequences.
If you own Class B shares you may pay a charge when you redeem your shares,
depending on the length of time you've held the shares. MainStay provides a
number of convenient ways to redeem your shares.
If you buy $1 million or more of Class A shares and redeem them within a year of
the purchase, you may pay a sales charge.
To learn more, see pages 14-15.
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12
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Manage your taxes/ Align your goals
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If you've made a profit on your investment--either through dividends,
distributions or capital gains, you may have to pay taxes at tax time (consult
your tax adviser).
Be aware that the Fund may earn 1997 income that will be paid to you in January,
1998, but will apply to your 1997 tax return.
To learn more, see page 17.
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13
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Know your rights/ Stay informed
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Most of all, you have the right to ask questions-- and have them answered
intelligently. You may call your Registered Representative at any time.
MainStay will send you a quarterly statement, a confirmation of each transaction
and an annual and semiannual report on the Fund's status and investments.
To learn more, see page 20.
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5
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Tell Me The Key Facts
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Analyze the Costs of Investing: Two Kinds of Fees
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To help you understand the costs of investing in the Fund, we've provided
expense information based on the Fund's anticipated expenses for its first year
of operation, some of which are estimated. Because some expenses are estimated,
you should only use these figures as hypothetical examples of what you might
actually pay.
One-time fees. You may pay one-time transaction fees: a sales charge
(commission) for each separate investment or redemption, as applicable. See
pages 10 and 29-31 for more details.
Ongoing fees. The Fund pays ongoing operating fees to the manager, custodian and
other professionals who provide services to the Fund. These fees are billed to
the Fund and then factored into the share price. They're not billed to you
separately; but they do reduce the value of each share you own. See pages 18 and
26-27 for more details.
The Rule 12b-1 fees shown on page 7 pay, for example, commissions and
marketing/promotional expenses. Management fees go to the manager for providing
administrative and advisory services; the manager also pays a portion of these
fees to the sub-adviser for providing portfolio management services. See pages
26-27 for more details. "Other" includes legal, auditing, custodian and other
fees. See pages 26-27 for more details on fees.
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Why read about costs? Costs are important: they lower your earnings. For
example, a fund with higher costs must perform better just to equal the return
of a fund with lower costs. All things being equal, therefore, a lower-cost fund
will begin with an advantage.
Lower fees alone, however, will not guarantee better total return performance.
For example, a fund with no up-front sales charge may actually have higher
ongoing expenses. It may also leave you without a registered representative to
advise you. You should be sure you understand the nature of different costs.
Investing a million? The up-front sales charge is waived on investments of $1
million or more in Class A shares of the Fund. But, there may be a contingent
deferred sales charge of 1% on redemptions (sales of shares) made within a year
of the purchase date.
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If You Invest $1,000, You Might Pay...
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The "Examples" on the following page are provided to help you understand the
various costs and expenses that an investor in the Fund will bear directly or
indirectly.
The examples are based on a hypothetical 5% annual return on an investment of
$1,000 and redemption at the end of each period; and the estimated annual fund
operating expenses reflected in the chart under "Sales Charges and Operating
Expenses." Each pie chart illustrates the expenses that would be paid by a
shareholder for shares held for a period of five years with the same
assumptions.
The actual return on your investment, of course, may be more or less than 5%;
and the actual expenses may also be more or less than those shown, depending on
a variety of factors, including the performance of the Fund. The figures in the
following chart, therefore, do not represent how your investment will perform.
They are strictly hypothetical examples.
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[GRAPHIC] Take Note: The lowest sales charge won't always
be the least expensive option.
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The deferred sales charge (Class B shares) declines the longer you stay invested
in the Fund (from 5% in year one to 0% after six years). However, if your sales
charge drops to 0%, your cost over time might be more than the cost of paying
the full up-front sales charge. Take a look at the examples on the following
page: you pay higher 12b-1 fees (which are ongoing fees) if you defer the sales
charge.
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6
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<TABLE>
<CAPTION>
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Sales Charges and Operating Expenses Examples
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STRATEGIC VALUE FUND CLASS A CLASS B CLASS A CLASS B
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Assuming Redemption
Shareholder Transaction Expenses Assuming No at the End of
Redemption Each Period
----------- -------------------
<S> <C> <C> <C> <C> <C>
Maximum Sales Charge Imposed on Purchase of Expenses after 1 year $ 73 $26 $ 76
Shares (as a percentage of offering price) 5.50% None Expenses after 3 years $109 $80 $110
Deferred Sales Charge
(as a percentage of redemption proceeds)/1/ None 5.00% [GRAPHIC] [GRAPHIC]
Annual Fund Operating Expenses
(as a percentage of average net assets)
Management Fees 0.75% 0.75%
12b-1 Fees/2/ 0.25% 1.00% $ 55 up-front sales charge $ 30 deferred sales charge
Other Expenses 0.83% 0.83% 22 management fees 23 management fees
------- ------- 7 12b-1 fees 31 12b-1 fees
25 other expenses 26 other expenses
Total Fund Operating Expenses 1.83% 2.58% -------------------------- --------------------------
======= ======= $109 total sales charges $110 total sales charges
and expenses and expenses
</TABLE>
1 Generally, Class A shares of the Fund are not subject to a contingent
deferred sales charge upon redemption. However, because front-end sales
charges are waived on investments in Class A shares of $1 million or more,
a contingent deferred sales charge of 1.00% may be imposed on redemptions
of such investments effected within one year of the date of purchase. With
respect to Class B shares, the amount of the contingent deferred sales
charge will depend on the number of years since the shareholder made the
purchase payment from which an amount is being redeemed. See "Alternative
Sales Arrangements--Deferred Sales Charge Alternative--Class B
Shares--Contingent Deferred Sales Charge, Class B."
2 Under rules of the National Association of Securities Dealers, Inc. (the
"NASD"), a distribution fee of up to 0.75% of average annual net assets is
treated as a sales charge for certain purposes under those rules. Because
the distribution fee is an annual fee charged against the assets of the
Fund, long-term shareholders may indirectly pay an amount that is more than
the economic equivalent of the maximum front-end sales charge permitted by
rules of the NASD. For a description of the distribution plans adopted by
the Fund, see "The Distributor."
7
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Strategic Value Fund
The Fund's objective is:
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to seek maximum long-term total return from a combination of common stocks,
convertible securities and high yield securities. Certain of the Fund's
investments are speculative.
Who should invest? Investors who seek maximum total return by investing in
multiple market sectors.
See page 21 for more details about the Fund.
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The Fund invests in:
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Under normal market conditions, foreign and domestic securities in three asset
classes, limited by the following:
...30% to 80% of net assets in common stocks which:
o the Sub-Adviser believes are "undervalued" (selling below their value) when
purchased;
o typically pay dividends, although there may be non-dividend-paying stocks
if they meet the "undervalued" criteria;
o are listed on a national securities exchange or are traded in the
Over-the-Counter (OTC) market.
...10% to 40% of net assets in corporate debt securities: all types of debt
securities ordinarily in the lower rating categories of Moody's (Baa to B) and
S&P (BBB to B) or judged to be of comparable creditworthiness by the Fund's
Sub-Adviser.
...10% to 40% of net assets in convertible securities (such as preferred stocks,
bonds, debentures, corporate notes, and others which can be converted into
common stock or the cash value of a single equity security or a basket or index
of equity securities), which may be in any rating category or unrated.
Within these limitations, the Fund may also invest in:
...not more than 20% of net assets in securities that are:
rated CCC or below by Moody's or S&P or judged by the Sub-Adviser to be of
comparable quality.
...U.S. government securities, cash or cash equivalents;
...other investments suitable for most or all MainStay Funds. (See page 9,
"General Investment Considerations" and pages 22-25, "Description of Investments
and Investment Practices," for details.)
At times, the actual allocation for each asset class may differ from the
limitations set forth above, due to market fluctuations or cash entering or
leaving the Fund. This could happen for instance, if the Sub-Adviser has
positioned the assets close to a minimum or maximum for one or more asset
classes, and the Fund's cash position changes because of investors buying or
selling the Fund's shares. To correct the situation, the Sub-Adviser intends to
move cash or reallocate assets within seven days.
Generally, the Sub-Adviser seeks out undervalued securities in all asset
classes. Usually, stocks deemed to be at full value will be replaced with new,
"undervalued" stocks. When assessing whether a stock is undervalued, the
Sub-Adviser considers many factors and will compare the market price to the
company's "book" value, estimated value of the company's assets (liquidating
value), and cash flow. To a lesser extent, the Sub-Adviser will also look at
trends and forecasts such as growth rates and future earnings.
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WHO'S MANAGING YOUR MONEY?
DENIS LAPLAIGE, STEVEN TANANBAUM AND NEIL FEINBERG OF MACKAY-SHIELDS FINANCIAL
CORPORATION.
Denis Laplaige, who is primarily responsible for the value portion of the Fund's
portfolio is President, Senior Managing Director and Chief Investment Officer of
MacKay-Shields. Mr. Laplaige joined MacKay-Shields in 1982, became a Director in
1988, Managing Director in 1991, a member of the Board of Directors in 1993 and
Senior Managing Director and Chief Investment Officer in 1996.
Steven Tananbaum, who is primarily responsible for the high yield portion of the
Fund's portfolio, is a Managing Director of MacKay-Shields. Mr. Tananbaum joined
MacKay-Shields in 1989. Previously, he worked as a high yield and merger
associate intern in the corporate finance department of Kidder Peabody.
Neil Feinberg, who is primarily responsible for the convertible portion of the
Fund's portfolio, is a Director of MacKay-Shields and has been a portfolio
manager since he joined the firm in 1992. For the previous three years, he was
an analyst for National Securities and Research Corporation; and for the prior
four years he worked as a CPA/auditor for Peat Marwick Main & Company.
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Risks? The NAV of the Fund's shares will fluctuate depending on a number of
factors, including the Sub-Adviser's ability to consistently and correctly
determine the relative attractiveness of the asset classes. Prices change not
only in response to economic factors but to psychological factors as well and
these factors are difficult to interpret and quantify. It is therefore possible
for the Fund to have a lower overall investment in stocks during a period of
rising stock prices, or a small investment in bonds during a period of rising
bond prices.
The risks of investing in particular types of debt securities also may vary. For
example, securities rated below BBB or Baa (sometimes called "junk bonds") are
not considered "investment grade" and run greater risks of price fluctuations,
loss of principal and interest, default or bankruptcy by the issuer, and other
risks which is why these securities are considered speculative.
Investments in foreign securities could be more volatile and more difficult to
sell than U.S. securities, and involve additional risks, including currency
fluctuations and political and economic instabilities.
For additional information regarding risks associated with investment in the
Fund, see pages 22 - 25, Description of Investments and Investment Practices.
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8
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General Investment Considerations
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SOME IMPORTANT POINTS TO UNDERSTAND ABOUT INVESTING IN MUTUAL FUNDS
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[GRAPHIC] The share price of a Fund isn't always stable
The value of the securities in the Fund and the share price (NAV) of the Fund
will fluctuate. Many factors can affect the value of securities, including:
o conditions in the securities markets;
o business success of the companies that issued the securities;
o creditworthiness of the companies that issued the securities;
o interest rates;
o average maturity of the Fund's nonequity or debt investments;
o foreign currency exchange rates (where applicable); and
o other factors.
Funds aren't guaranteed
Remember, mutual funds are not guaranteed or federally insured, even if you buy
them through a bank. MainStay recommends that you speak with your Registered
Representative to learn about other smart ways to help protect your money based
on the level of risk you are willing to take.
Fundamental investment objective
The investment objective of the Fund is fundamental, which means it can't be
changed without shareholder approval.
Read the prospectus
You need to consider as many factors as possible when making an investment
decision--which is why it's important to read the prospectus.
TEMPORARY DEFENSIVE MEASURES
In times of unusual or adverse market conditions, for
temporary defensive purposes, the Fund may invest without limit in cash and cash
equivalents (as defined on page 22 under "Description of Investments and
Investment Practices-- Cash Equivalents").
FUND DIVERSIFICATION
The Fund is "diversified" for the purposes of the Investment Company Act of
1940, as amended ("1940 Act").
INVESTMENTS IN ILLIQUID AND RESTRICTED SECURITIES
The Fund has a nonfundamental policy that it will not invest more than 15% of
its net assets in "illiquid" securities. These are securities subject to legal
or contractual restrictions on resale (other than restricted securities eligible
for resale pursuant to Rule 144A under the Securities Act of 1933), repurchase
agreements maturing in more than seven days, certain options traded over the
counter or other securities which legally or in the opinion of the Sub-Adviser
are deemed illiquid. There may be undesirable delays and added costs in selling
restricted securities.
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The effects of trading costs on your total return
"Portfolio turnover" is the term used in the industry for measuring the amount
of trading activity that occurs in a fund's portfolio during the year. A 100%
turnover rate, for example, means that, on average, every security in the
portfolio has been replaced once during the year. The Fund estimates that its
annual portfolio turnover rate will not exceed 130%.
Funds with high turnover rates (over 100%) often have higher transaction costs
(which are paid by the fund) and may generate short-term capital gains (on which
you'll pay taxes, even if you don't sell any shares by year-end).
A fund with consistently higher total returns and higher turnover rates than
another fund may actually be achieving better performance precisely because the
managers are active traders. You should be aware that the "total return" figure
(also found as a line item in a fund's "Financial Highlights" table) already
includes portfolio turnover costs.
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9
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Decide Whether to Pay a Sales Charge Now, Later...or Maybe Never
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MainStay gives you the choice to either pay a sales charge up-front (Class A
shares), or pay a sales charge at the "back-end" when you sell (Class B shares).
Your Registered Representative can help you determine which type of sales charge
would work better for you, based on how much and how long you wish to invest,
and other factors listed in the table below.
MOST OF THE CHARACTERISTICS ARE THE SAME
Both Class A and Class B shares represent an interest in the same investments,
give you the same rights, and are identical in all other respects, except each
bears its own service and distribution expenses (Rule 12b-1 fees), and any other
specific class expenses the Board may approve.
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WHAT ARE THE DIFFERENCES IF YOU...
...PAY UP-FRONT (CLASS A SHARES)?
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Since some of your investment goes to pay a sales charge up-front, you start off
owning fewer shares. But, you're usually better off paying up front if you:
o plan to own the shares for an extended period of time, since the Rule 12b-1
fees on Class B shares will eventually exceed the cost of the up-front
sales charge; or
o qualify for a reduced sales charge (see page 11, "Consider Reducing Your
Sales Charge," for details).
You pay lower ongoing Rule 12b-1 fees--which means there's more net income to
pay you higher dividends per share.
You pay no sales charge when you redeem/sell your shares (except if you bought
more than $1 million of shares and redeemed within 1 year, see page 11).
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If there aren't enough shares...
When you sell Class B shares, the Fund is permitted to sell additional Class B
shares to cover the cost of the sales charge. If you don't own enough extra
Class B shares to do this, the sales charge will be taken from the proceeds of
your sale, reducing the amount paid to you.
If it's automatic reinvestment...
You don't pay any sales charge (Class A or Class B) on shares bought through the
automatic reinvestment of dividends or capital gains. The full amount goes
toward buying more shares.
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VS ...PAY WHEN YOU REDEEM/SELL (CLASS B SHARES)?
================================================================================
You pay no up-front sales charge; your full investment goes toward buying
shares, so you start off owning more shares.
The ongoing Rule 12b-1 fees are higher, which means:
o you receive lower dividends;
o your NAV will generally be lower; and,
o therefore, total performance per share will be lower than the Class A
shares (but you'll own more shares).
You may pay a sales charge if you sell shares within the next 6 years (there are
exceptions; see page 30, "Deferred Sales Charge Class B Shares - Contingent
Deferred Sales Charge, Class B");
o the sales charge drops from 5% in the first year to 0% after six years;
o it's assumed you're selling the shares you've owned the longest, so you pay
the lowest possible sales charge;
o if you sell the Fund's shares, the sales charge will be based on the lower
of the current NAV of Fund shares less dividends and distributions paid or
the price you originally paid for those shares.
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[GRAPHIC] Take note:
If you hold Class B shares for eight years they will be automatically converted
to Class A shares which pay lower 12b-1 fees.
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10
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Consider Reducing Your Sales Charge
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THE REINVESTMENT PRIVILEGE MAY HELP YOU AVOID SALES CHARGES
When you sell shares, you have the right--for 30 days--to reinvest any or all of
the money in any MainStay Fund without paying another sales charge (as long as
those shares haven't been reinvested once already). If you paid a sales charge
when you redeemed (Class B shares), you'll receive a pro rata credit for
reinvesting.
Note:Reinvestment won't relieve you of any tax consequences on gains realized
from the sale; the deductions for losses may, however, be denied and, in some
cases, sales charges may not be taken into account in computing gains or losses
if the reinvestment privilege is exercised.
COMBINING PURCHASES LOWERS THE CHARGE
Generally, you can reduce a sales charge on purchases of Class A shares based on
how much you've already invested. The sales charge will be calculated on the
total net asset value of all the MainStay Fund Class A shares you own (excluding
Mainstay Money Market Fund shares). This is helpful because the more you invest
with MainStay, the smaller the sales charge. (See "Alternative Sales
Arrangements," page 29.)
Make your actions known
To receive the discount, you must convey the information about the shares you
already own at the time you buy. This privilege of "Rights of Accumulation" may
be ended or altered at any time.
REGULAR WITHDRAWALS TO PAY PREMIUMS
You won't pay a sales charge upon selling (Class B shares) if you redeem shares
under the Systematic Withdrawal Plan to pay scheduled monthly premiums on
insurance issued by New York Life or an affiliate.
SIGN A LETTER OF INTENT (LOI)
If you qualify, you can sign a letter stating your intention to invest at least
$100,000 within the next 24 months in Class A shares of one or more MainStay
Funds and to pay the up-front sales charge. The current sales charge will be
based on the total amount you intend to invest (the more you invest, the smaller
the sales charge). See "Alternative Sales Arrangements," page 29. For more
information on LOIs, call your Registered Representative or MainStay Shareholder
Services, Inc. ("MSS") at 1-800-MAINSTAY.
INVEST $1,000,000 OR MORE
If you invest $1,000,000 or more in Class A shares of one or more MainStay
Funds, and don't sell the shares for at least one year, the up-front sales
charge is waived. If you sell the shares within one year, you may pay a sales
charge of 1% upon sale. See page 29, "Reduced Sales Charges on Class A
shares--Contingent Deferred Sales Charge, Class A," for details. (This rule
doesn't apply to exchanges between MainStay Funds.) Purchases of $1,000,000 or
more must be for Class A shares and will not be accepted for Class B shares.
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[GRAPHIC] Take note: Sales charges are sometimes waived
There are many other situations, including purchases by certain retirement
plans, which entitle you to a waiver of the sales charge. (For purchases at NAV,
see page 29 for the full listing.)
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11
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Open an Account and...
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RELY ON YOUR REGISTERED REPRESENTATIVE
MainStay Funds are called "load" funds, meaning you pay a sales charge for the
ongoing assistance and advice of your Registered Representative.
"No-load" (no commission) funds generally require you to buy their shares on
your own, directly from them.
HAVE YOUR REGISTERED REPRESENTATIVE PLACE THE ORDER
Your Registered Representative can enter your order immediately by calling
NYLIFE Distributors Inc. (the "Distributor"), help you complete the application
correctly and send it in for you.
The Distributor must receive payment within 3 business days or MainStay will
cancel your order. You and/or the broker/dealer may also be liable for any
losses or fees incurred.
YOU MUST INVEST AT LEAST THE MINIMUM AMOUNT
o To open an account: $500
o Each time after that: $50
The minimum initial investment is waived for purchases by Trustees of the Trust,
New York Life and its subsidiaries and their employees, officers, directors or
agents.
FILL OUT THE APPLICATION COMPLETELY...
...with your Registered Representative's help.
Be sure to include the:
o name(s) you want to appear on the account;
o choice of Class A or Class B shares;
o amount of the investment;
o your certified Social Security Number or Taxpayer I.D. Number;
o financial information;
o employer information;
o other requested information.
================================================================================
HOW TO BUY SHARES
================================================================================
[GRAPHIC] SEND A CHECK TO YOUR REGISTERED REPRESENTATIVE WITH THE APPLICATION
You'll pay the next NAV that's set after your order is received and accepted,
plus any sales charge if purchasing Class A shares. Your check must be in U.S.
dollars and drawn on a U.S. bank. Include the account number and class of shares
(Class A or Class B) you wish to buy. If the check doesn't clear, your order
will be cancelled and you could be liable for losses or fees. We also reserve
the right to limit the number of checks processed at one time.
You may send additional investments (minimum $50 each check) directly to: The
MainStay Funds, PO Box 8401, Boston, MA 02266-8401. Please include your account
number and class of shares with all checks.
[GRAPHIC] HAVE YOUR REGISTERED REPRESENTATIVE ORDER BY TELEPHONE...
... between 9:00 AM and 4:00 PM Eastern time on any day the New York Stock
Exchange is open. You'll pay the next NAV that's set after your order is
received and accepted, plus any sales charge for Class A shares. Have your
Registered Representative call the Distributor. Purchase orders effected by
telephone are subject to a purchase minimum of $5,000. The Distributor must
receive your payment (and the application, if it's your initial investment)
within the next 3 business days or the order will be cancelled. All calls are
recorded.
12
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...Buy Shares
- --------------------------------------------------------------------------------
MAKE SURE YOU ARE USING THE PROPER FORMS
Your order to buy is only accepted when received by the Shareholder Servicing
Agent with all information, signatures, documents and payments required to carry
it out. Federal law requires you to provide a certified Taxpayer I.D. Number
when you open an account.
BUY SHARES AT THE CURRENT MARKET PRICE
(known as the net asset value, or NAV) on days the New York Stock Exchange is
open.
The NAV--the price of a share that is used for buying and selling--is determined
each day that the New York Stock Exchange is open. NAV is calculated at the
close of business of the New York Stock Exchange (normally at 4:00 PM Eastern
time).
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[GRAPHIC] NAV is calculated by:
o taking the current market value of the Fund's total assets attributable to
a class of shares (either Class A shares or Class B shares);
o subtracting the liabilities attributable to that class; and
o dividing the remainder by the total number of shares outstanding of that
class. (See page 32 and the SAI for the full details on calculating NAV.)
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[GRAPHIC] Make sure your application is complete
MainStay and the Distributor each reserves the right to reject your application,
particularly if it's incomplete (for instance, if you haven't included your
certified Taxpayer I.D. Number).
Choices
If you want the ability to sell shares by telephone, or receive checks for the
dividends or capital gains you earn, you must grant authorization on the
application.
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================================================================================
================================================================================
[GRAPHIC] WIRE MONEY FROM YOUR BANK ACCOUNT
Have your Registered Representative call the Distributor for an account number
and wiring instructions. Give them to your bank, which may charge a fee for
wiring. The Distributor must receive your payment (and application, if it's your
initial investment) within the next 3 business days. If it doesn't, your order
will be cancelled, and you may be liable for losses and/or fees.
To buy shares the same day, your Registered Representative must call by noon,
Eastern time, and the wire must be received by the Shareholder Servicing Agent
before 4:00 PM Eastern time. (See page 28, "How to Purchase Shares of the
Funds--By Wire," for the wire address.) No wires are accepted on days when the
New York Stock Exchange is closed, or on Martin Luther King Day, Columbus Day or
Veterans Day, because the bank that would receive your wire is closed.
The fastest way to invest
Wiring will reduce the waiting time on selling or exchanging shares because your
money will be cleared right away. If you buy by check and quickly decide to
sell, the Fund may withold payment for up to 10 days to allow the check to
clear.
[GRAPHIC] SET UP A SYSTEMATIC INVESTMENT OR EXCHANGE PLAN
Through payroll deductions or AutoInvest, you may open an account by authorizing
your bank to automatically send money on a regular schedule to purchase shares
of the Fund or other MainStay Funds. The initial minimum is $100 per class of
share of the Fund. Subsequent minimum investments for the Fund are $50. (See
page 28, "How to Purchase Shares of the Funds--Systematic Investment Plans," for
waiving minimums and for details on AutoInvest.)
13
<PAGE>
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Know How to Sell and Exchange Shares
- --------------------------------------------------------------------------------
PLACE YOUR SALES ORDER DIRECTLY OR THROUGH YOUR REGISTERED REPRESENTATIVE, IF
ALLOWED BY THE BROKER DEALER
If you place the order through your Registered Representative:
o The transfer agent must receive the order with all the information,
signatures and documentation necessary to carry out the order ("good
order").
o Your shares are then priced at the next NAV set for the Fund (either 4:00
PM Eastern time that day; or the next day, if the order is placed too late)
after receipt of your order.
OPTION 1
USE A SYSTEMATIC WITHDRAWAL PLAN
o Requires at least $10,000 in the account at time of request [GRAPHIC]
You may arrange to make monthly redemptions of $100 or more from the Fund.
Shares will be sold automatically to cover the amount plus any applicable sales
charge.
These redemptions, like any sale, may result in a gain or loss and, therefore,
may be subject to taxation. Consult your tax adviser on the consequences.
MainStay may end this plan at any time; or begin charging up to $5 per
redemption after 30 days' written notice to you.
No sales charges
There are no deferred sales charges on systematic redemptions to pay scheduled
monthly premiums on insurance policies issued by New York Life or an affiliate.
Words to the wise
We don't recommend using this plan during times when you're regularly buying
shares: you'll be paying new sales charges just to replace the shares you're
selling.
Also remember, these redemptions aren't dividends or income. If you redeem more
than the Fund is earning for you, eventually, your account will be worth less
than your original investment and, ultimately, you will redeem all of your
shares.
Systematic withdrawal plans established by phone are subject to the procedures
applicable to telephone redemptions.
- --------------------------------------------------------------------------------
[GRAPHIC] Your shares could be redeemed involuntarily
To reduce expenses, we have the right to redeem the shares in any account valued
at less than $250, provided that the value isn't based on fluctuations in market
prices.
We'll give you 60 days' written notice to allow you to add to your account and
avoid the redemption.
To avoid paying a reporting penalty, we may also redeem your shares if you
haven't given us a certified Taxpayer I.D. Number.
- --------------------------------------------------------------------------------
IF YOU PLACE THE ORDER DIRECTLY, YOU CAN DO IT BY A WRITTEN REQUEST OR IN ONE OF
THE FOLLOWING WAYS
When you want to use one of MainStay's alternative selling privileges, call
1-800-MAINSTAY to verify that the options you want are on record--before you
need to use them.
You may also establish a Systematic Exchange Program to have a minimum of $100
exchanged periodically from any MainStay Fund (except the Mainstay Equity Index
Fund) to another MainStay Fund within the same class of shares. The Fund from
which exchanges are made must have an account value of at least $10,000 at the
time the Systematic Exchange Program is established. Before establishing a
Systematic Exchange Program, you must obtain and read the prospectus for the
MainStay Fund you wish to exchange into. (See page 31, "Redemptions and
Exchanges--Exchange Privileges," for details.)
- --------------------------------------------------------------------------------
You have help
If permitted by the broker-dealer, your Registered Representative
may sell or exchange your shares, or set up a systematic withdrawal plan for
you, by phone, unless you notify us in writing not to allow it.
- --------------------------------------------------------------------------------
14
<PAGE>
OPTION 2
MAKE A TELEPHONE REQUEST:
1-800-MAINSTAY
You may sell or exchange shares directly over the phone.
o Minimum amount: $500 for exchanges
o You automatically have this privilege unless you notify us in writing that
you do not want it.
Whether you're buying, selling, or requesting a wire transfer or a check, the
price you receive is the next price (NAV) determined for the Fund (either at
4:00 PM Eastern time that day; or at 4:00 PM the next day, if the order is
placed too late) after receipt of your order.
Your broker-dealer must receive your order by 4:00 PM, and is responsible for
sending it in by 5:00 PM the day you place it.
o Be ready to present your Social Security Number or Taxpayer I.D. Number
over the phone.
o You can only transfer by phone between accounts with identical names,
addresses and Social Security Numbers/Taxpayer I.D. Numbers. Transfers
between different accounts are only allowed if made in writing and include
the proper information--ask your Registered Representative.
Telephone redemptions are not permitted for shares:
o represented by certificates;
o bought within the previous 10 calendar days; or
o owned by someone whose address of record has changed within the previous 30
days. Telephone exchanges are not permitted for shares represented by
certificate. When using the MainStay Audio Response System, you bear the
risk of any loss from your errors in using the system.
- --------------------------------------------------------------------------------
[GRAPHIC] Convenient, yes...but not risk-free
Telephone redemption privileges are convenient, but you give up some security.
By signing an application to purchase shares, you agree that neither MainStay
Funds nor the Shareholder Servicing Agent will be liable for following
instructions via the phone that they reasonably believe are genuine. You bear
the risk of any loss, unless the Fund or the Shareholder Servicing Agent fails
to use established safeguards for your protection. These safeguards are among
those currently in place at MainStay Funds:
o all phone calls are tape recorded;
o written confirmation of every transaction is sent to your address of
record.
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- --------------------------------------------------------------------------------
We'll send your money within the next 7 days. MainStay will make the payment,
minus any deferred sales charge, within 7 days after receiving your redemption
request in "good order." You will receive the first NAV fixed after your request
is received in "good order."
Use exchange privileges. Once you open an account, you may exchange shares of
the same class (Class A shares for Class A shares; Class B shares for Class B
shares) between MainStay Funds without a sales charge. There are two exceptions:
You will pay a sales charge if you:
o exchange shares of the Mainstay Money Market Fund for Class A shares in
another Fund, unless you've already paid the sales charge on those shares;
or
o exchange Class B shares out of the Mainstay Money Market Fund into another
Fund and redeem within 6 years of the original purchase.
You may not exchange Class A shares for Class B shares, or vice versa. If you
sell Class B shares and then buy Class A shares, you may have to pay a deferred
sales charge on the Class B shares, as applicable, and pay an initial sales
charge on the Class A shares.
Before you exchange shares of the Fund for shares of another MainStay Fund, you
must first obtain and read the prospectus for the MainStay Fund you wish to
exchange into.
When exchanged shares are redeemed, any applicable sales charge will be charged.
What if you buy by check then quickly sell? We may withhold payment for up to 10
days to allow the check to clear.
- --------------------------------------------------------------------------------
If you're requesting a wire transfer by phone
o Minimum amount: $5,000
o Limit: One every 30 days
o Authorization: You must select this option on your application initially or
request it in writing at a later date
After receiving your sell order by phone, we will send the proceeds by bank wire
to your designated bank account the next business day. Your bank may charge you
a fee to receive the wire transfer.
If you're requesting a check by phone
o Maximum amount: $100,000
The check will be payable to you--as the name (or names) appear on the
account--and mailed to the address appearing on the account. (See page 31,
"Redemptions and Exchanges," for more details.)
Requests to redeem shares worth $100,000 or more must be made in writing and
require a signature guarantee.
You may change your mind
To cancel any telephone privilege, call 1-800-MAINSTAY between 8:00 AM and 6:00
PM Eastern time. We reserve the right to suspend or end telephone privileges at
any time without notice.
15
<PAGE>
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Decide How to Receive Your Earnings
- --------------------------------------------------------------------------------
TWO KINDS OF EARNINGS
DIVIDENDS AND INTEREST
Most funds earn either dividends from stocks, interest from bonds and other
securities, or both. A mutual fund, however, always pays this income to you as
"dividends." The dividends paid by the Fund will vary based on the income from
its investments and the expenses incurred by the Fund.
When the Fund pays
The Fund will declare and distribute the first dividend on or about December 19,
1997. This dividend will be for the fourth quarter only. Thereafter, the Fund
will declare and distribute any dividends quarterly.
CAPITAL GAINS
Funds earn capital gains when they sell securities in their portfolio at a
profit.
When the Fund pays
At the end of each fiscal year, the Fund matches its gains against its losses;
and, if the balance results in a gain, the Fund will distribute the gain to
shareholders.
- --------------------------------------------------------------------------------
When are you paid? On the first business day of each month after a dividend is
declared.
- --------------------------------------------------------------------------------
HOW TO TAKE YOUR EARNINGS
You may choose how to receive earnings (and change your choice as often as you
like) by notifying your Registered Representative (if permitted by the
broker-dealer) or MainStay directly. If you don't make a choice on your
application, your earnings will be automatically reinvested in the same class of
shares of the Fund. In order to reinvest dividends and/or capital gains in
another MainStay Fund, you must have an established account in that class of
shares of that Fund. Here are your choices:
REINVEST EVERYTHING IN:
o the Fund; or
o in another MainStay Fund of your choice.
TAKE THE DIVIDENDS IN CASH
Reinvest the capital gains in:
o the Fund; or
o in another MainStay Fund of your choice.
TAKE THE CAPITAL GAINS IN CASH
Reinvest the dividends in:
o the Fund; or
o in another MainStay Fund of your choice.
TAKE EVERYTHING IN CASH
16
<PAGE>
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Understand the Tax Consequences
- --------------------------------------------------------------------------------
The Fund intends to be treated as a regulated investment company under
subchapter M of the Code. As a regulated investment company, the Fund is
required to distribute at least 90% of its:
o net taxable income;
o net short-term capital gains; and
o net tax-exempt income.
"Net" means the amount remaining after tax deductible expenses (expenses reduce
"gross" earnings: in other words, the amount the Fund can pay to you.)
MOST OF YOUR DIVIDENDS ARE TAXABLE
Virtually all of the dividends you receive from the Fund are taxable, whether
you take them as cash or automatically reinvest them. Some dividends will be
taxable as long-term capital gains.
MainStay keeps track of your tax status and will mail your tax report each year
by January 31. This report will tell you which dividends and redemptions should
be treated as taxable ordinary income; which, if any, as tax-exempt income; and
which, if any, as long- and short-term capital gains.
Retirement plans
None of the dividends earned in a tax-deferred retirement plan are taxable until
distributed from the plan.
Taxes on foreign investment income
Income earned from investments in foreign countries may be withheld by those
countries as income taxes. Under certain circumstances, the Fund may elect to
pass along tax credits or deductions to you for foreign income taxes paid,
although there are no assurances that the Fund will be able to do so, or that
the credits or deductions will result in a tax benefit to you.
- --------------------------------------------------------------------------------
[GRAPHIC] Seek assistance
Your Registered Representative is always available to help you keep your
investment goals coordinated with your tax considerations. You should, however,
rely on your tax adviser for tax counsel.
For additional information on taxation, see the SAI.
Don't overlook sales charges
The amount you pay in sales charges reduces gains and increases losses for tax
purposes.
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17
<PAGE>
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Know With Whom You're Investing
- --------------------------------------------------------------------------------
================================================================================
WHO RUNS THE FUNDS DAY-TO-DAY BUSINESS?
================================================================================
MainStay Management, Inc. (the "Manager"), 300 Interpace Parkway, Building A,
Parsippany, NJ 07054, serves as the Fund's manager, handling business affairs
for the Fund. MainStay Management, Inc. is a corporation organized under the
laws of Delaware and is an indirect wholly owned subsidiary of New York Life
Insurance Company.
The Manager provides offices and conducts clerical, recordkeeping and
bookkeeping services, and keeps most of the financial and accounting records
required for the Fund. The Manager has delegated its portfolio management
responsibilities to the Sub-Adviser. The Manager pays the salaries and expenses
of all personnel affiliated with the Fund, and all the operational expenses that
aren't the responsibility of the Fund, including the fee paid to the
Sub-Adviser. (See page 26, "Manager, Sub-Adviser and Distributor," and the SAI
for more details.)
For its services, the Fund pays the Manager a monthly fee. (See page 26,
"Manager, Sub-Adviser and Distributor".)
================================================================================
WHO MANAGES YOUR MONEY
================================================================================
MacKay-Shields Financial Corporation ("MacKay-Shields"), 9 West 57th St., New
York, NY 10019, is the Sub-Adviser to the Fund. The firm was incorporated in
1969 as an independent investment advisory firm and was privately held until
1984 when it became a wholly owned but autonomously managed subsidiary of New
York Life Insurance Company. As of June 30, 1997, MacKay-Shields managed over
$26.9 billion in assets.
Under the supervision of the Fund's Trustees and the Manager, MacKay-Shields is
responsible for making the specific decisions about buying, selling and holding
securities; selecting brokers and brokerage firms to trade for them; maintaining
accurate records; and, if possible, negotiating favorable commissions and fees
with the brokers and brokerage firms. For these services, the Sub-Adviser is
paid a monthly fee by the Manager, not the Fund. (See "Manager, Sub-Adviser and
Distributor," page 26, for a breakdown of fees.)
- --------------------------------------------------------------------------------
[GRAPHIC] Who works to protect your interests?
A Board of Trustees oversees the Fund. The Trustees have financial or other
relevant experience and meet several times during the year to review contracts,
Fund activities and the quality of services provided to the Fund. Other than
serving as Trustees, most of the Board Members have no affiliation with the
Trust or its service providers.
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18
<PAGE>
- --------------------------------------------------------------------------------
Know With Whom You're Investing
- --------------------------------------------------------------------------------
WHO DISTRIBUTES THE MAINSTAY FUNDS?
NYLIFE Distributors Inc., 300 Interpace Parkway, Building A, Parsippany, NJ
07054, acts as the principal underwriter and distributor of the Fund's shares.
NYLIFE Distributors Inc. (the "Distributor") is a corporation organized under
New York laws and is an indirect wholly owned subsidiary of New York Life
Insurance Company. The Distributor offers shares of the Fund. In addition,
NYLIFE Securities Inc., an indirect wholly owned subsidiary of New York Life
Insurance Company, and other broker-dealers offer shares of the Fund pursuant to
dealer agreements with the Distributor. The Distributor and other broker-dealers
pay commissions and service fees to Registered Representatives. The Distributor
also pays for printing and mailing prospectuses and sales literature; and for
any advertising for the Fund. For its services, the Distributor is paid a
monthly fee--the Rule 12b-1 fee. (See page 26, "Manager, Sub-Adviser and
Distributor--The Distributor" for more details.)
WHO KEEPS TRACK OF YOUR ACCOUNT?
MainStay Shareholder Services Inc. (MSS) is the Fund's Transfer, Dividend
Disbursing and Shareholder Servicing Agent. MSS, whose address is 260 Cherry
Hill Road, Parsippany, NJ 07054, is an indirect wholly owned subsidiary of New
York Life Insurance Company. MSS provides customer service, is responsible for
preparing and sending statements, confirms and checks, and keeps certain
financial and accounting records. MSS has entered into an agreement with Boston
Financial Data Services (BFDS), whose address is 2 Heritage Drive, North Quincy,
MA 02171. BFDS will perform certain of the services for which MSS is
responsible. In addition, the Fund may contract with other service
organizations, including broker-dealers and other financial institutions, which
will establish a single omnibus account for their clients with the Fund. The
service organizations will provide shareholder services to the shareholders
within the omnibus accounts and receive fees for those services from the Fund.
The Bank of New York is the custodian of the investments of the Fund and has
subcustodial agreements for holding the Fund's foreign securities.
19
<PAGE>
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Know Your Rights as a Shareholder
- --------------------------------------------------------------------------------
YOU HAVE THE RIGHT TO ASK ANY QUESTIONS
Any time you have a question about your account, you should:
o ask your Registered Representative;
o call 1-800-MAINSTAY (between 8:00 AM and 6:00 PM Eastern time); or
o write to The MainStay Funds, P.O. Box 8401, Boston, Massachusetts,
02266-8401.
THE RIGHT TO RECEIVE INFORMATION ABOUT YOUR INVESTMENT -- CALL 1-800-MAINSTAY
You receive quarterly statements reviewing your investment in the Fund,
including the number and value of shares, dividends declared or paid and other
information.
Confirmations
Every time you buy or sell shares of the Fund or exchange shares between the
Fund and another MainStay Fund, you'll receive a confirmation in the mail
shortly thereafter. It summarizes all the key information: what you bought and
sold, what it cost, the sales charge (if any) and other vital data.
Financial reports
You will receive an annual financial statement for the Fund, examined by the
Fund's independent accountants. You will also receive a semiannual financial
statement which is unaudited.
Each financial report shows as of the end of the reporting period:
o the investments owned by the Fund;
o the market value of each investment; and
o other financial information.
- --------------------------------------------------------------------------------
[GRAPHIC] Keep your statements.
You may need them for tax reporting purposes.
Be alert: Mistakes can happen.
Always review your confirmations and statements immediately.
- --------------------------------------------------------------------------------
THE RIGHT TO HAVE ONE SHARE, ONE VOTE
o Every share issued by the Fund carries equal ownership rights.
o By owning shares, you're entitled to vote on certain issues and policies
regarding the Fund and the class of shares you own. You have one vote per
share you own.
o You're entitled to vote in the election of MainStay Trustees and to ratify
independent accountants.
o You're entitled to approve the adoption of any new investment advisory
agreement or plan of distribution relating to the Fund.
o You're also entitled to approve any changes in fundamental investment
restrictions or policies of the Fund.
THE RIGHT TO ATTEND MEETINGS
Although the Fund doesn't intend to hold annual shareholder meetings, you have
the right to call a meeting of shareholders for the purpose of voting on removal
of a Trustee for cause. Removing a Trustee requires the approval of two-thirds
of the outstanding shares issued for all of The MainStay Funds. Generally,
shareholder meetings are only held when the Trustees recommend an action which
requires shareholder approval.
20
<PAGE>
================================================================================
Tell Me The Details
================================================================================
================================================================================
THE TRUST
================================================================================
The Trust was established as a Massachusetts business trust on January 9, 1986
by a Declaration of Trust. The Fund commenced operations in October, 1997.
Shares have non-cumulative voting rights, do not have preemptive or subscription
rights and are transferable. No contingent deferred sales charge would be
imposed on distributions during liquidation of the Fund.
The Trust is an open-end management investment company registered under the
Investment Company Act of 1940 ("1940 Act").
================================================================================
OTHER INFORMATION ABOUT THE FUND
================================================================================
Investment in the Fund alone does not constitute a complete investment program.
The Manager has delegated its portfolio management responsibilities to the
Sub-Adviser. Investment decisions for the Fund are made independently from those
of the other accounts and investment companies that may be managed by the
Sub-Adviser. However, if such other accounts or investment companies are
prepared to invest in, or desire to dispose of, securities in which the Fund
invests at the same time as the Fund, available investments or opportunities for
sales will be allocated equitably to each. In some cases, this procedure may
adversely affect the size of the position obtained for or disposed of by the
Fund or the price paid or received by the Fund.
In managing the Fund, the Sub-Adviser conducts a rigorous, disciplined valuation
methodology to maximize the most appropriate investment levels among the three
asset classes. Fundamental economic analysis, risk and return estimations,
credit quality and interest rate trends are among the principal factors
considered by the Sub-Adviser in determining whether to increase or decrease the
emphasis placed on a particular type of security or bond within the Fund's
investment portfolio. In the event that the Sub-Adviser's analysis indicates
that the Fund should be fully invested in only one asset group, the Sub-Adviser
will still adhere to the limitations on the amount of assets which may be
allocated to each of the three asset groups.
In analyzing different securities to assess their relative attractiveness, the
Sub-Adviser's value investment process emphasizes such factors as low price to
earnings and price to cash flow ratios, financial strength and earnings
predictability. The Fund intends to purchase those securities which it believes
to be undervalued in the market relative to comparable securities based on the
foregoing analysis.
In assessing whether a stock is undervalued, the Sub-Adviser considers, among
other factors, a company's financial strength and earnings predictability. The
Fund may provide some protection on the downside through its investment in
companies whose current stock prices reflect, in the Sub-Adviser's opinion,
either unwarranted pessimism or unrecognized value.
In selecting convertible securities for purchase or sale, the Sub-Adviser takes
into account a variety of investment considerations, including credit risk,
projected interest return and the premium for the convertible security relative
to the underlying common stock.
In seeking a competitive overall return, capital appreciation may be sought by
lengthening the maturities of high yield debt securities held in the Fund's
portfolio during periods when the Sub-Adviser expects interest rates to decline.
If the Sub-Adviser is incorrect in its expectations of changes in interest
rates, or in its evaluation of the normal yield relationship between two
securities, the Fund's income, NAV and potential capital gains could decrease;
or the potential loss could increase. This and other factors may affect the
income available for distribution to shareholders.
Since available yields and yield differentials vary over time, no specific level
of income or yield differential can ever be ensured.
Debt securities in which the Fund may invest include all types of debt
obligations of both domestic and foreign issuers, such as bonds, debentures,
notes, equipment lease certificates, equipment trust certificates, conditional
sales contracts, commercial paper, foreign government securities and U.S.
government securities (including obligations, such as repurchase agreements,
secured by such instruments). For purposes of the Fund's investment policies,
the Fund considers preferred stock to be a debt obligation.
The Fund's investments may include capital notes, which are securities
representing beneficial interest in a trust for which the controlling common
stock is owned by a bank holding company. These beneficial interests are
commonly issued as preferred stock but may also be issued as other types of
instruments. The trust owns debentures issued by the bank holding company and
issues the preferred stock to investors.
In making investments in foreign securities the Sub-Adviser will determine,
using good faith and judgement, (1) country allocation; (2) currency exposure
(asset allocation across currencies); and (3) diversified security holdings
within each market. The Sub-Adviser may consider factors such as prospects for
currency exchange and interest rates, and inflation in each country, relative
economic growth,
21
<PAGE>
government policies influencing exchange rates and business conditions, and
quality of individual issuers.
To hedge the market value of securities held, proposed to be held or sold or
relating to foreign currency exchange rates, the Fund may enter into or purchase
securities or securities index options, foreign currency options, and futures
contracts and related options with respect to securities, indexes of securities,
or currencies. The Fund also may buy and sell currencies on a spot or forward
basis. Subject to compliance with applicable rules, futures contracts and
related options may be used for any legally permissible purpose, including as a
substitute for acquiring a basket of securities and to reduce transaction costs.
The Fund may also purchase and sell foreign exchange contracts for purposes of
managing portfolio risk more efficiently. The Fund may also sell short against
the box, among other reasons, to hedge against a possible market decline in the
value of the security owned or to enhance liquidity. The Fund may also use
various techniques to shorten or lengthen the dollar-weighted average maturity
of its portfolio, including transactions in futures and option on futures.
================================================================================
DESCRIPTION OF INVESTMENTS AND INVESTMENT PRACTICES
================================================================================
Information about the following types of investments, investment practices and
related risks appears below: Brady Bonds, Cash Equivalents, Convertible
Securities, Floaters and Inverse Floaters, Foreign Securities, Industrial
Development and Pollution Control Bonds, Lending of Portfolio Securities, Loan
Participation Interests, Mortgage-Backed and Asset-Backed Securities, Repurchase
Agreements, Risk Management Techniques, Short Sales Against the Box, Swap
Agreements, When-Issued Securities and Forward Commitments, Zero Coupon Bonds
and Risks of Investing in High Yield Securities ("Junk Bonds"). For more
information about the investments, investment practices and risks described in
this section, please see the SAI.
- --------------------------------------------------------------------------------
BRADY BONDS
- --------------------------------------------------------------------------------
The Fund may invest a portion of its assets in Brady Bonds, which are securities
created through the exchange of existing commercial bank loans to sovereign
entities for new obligations in connection with debt restructurings. (For more
information, see the SAI.)
- --------------------------------------------------------------------------------
CASH EQUIVALENTS
- --------------------------------------------------------------------------------
The Fund may invest in cash or cash equivalents, which include, but are not
limited to: short-term obligations issued or guaranteed as to interest and
principal by any U.S. or foreign government or government agencies or
instrumentality thereof (including repurchase agreements collateralized by such
securities); obligations of banks (certificates of deposit, bankers' acceptances
and time deposits) which at the date of investment have capital, surplus, and
undivided profits (as of the date of their most recently published financial
statements) in excess of $100,000,000, and obligations of other banks or savings
and loan associations if such obligations are federally insured; commercial
paper which at the date of investment is rated A-1 by S&P or P-1 by Moody's or,
if not rated, is issued or guaranteed as to payment of principal and interest by
companies which at the date of investment have an outstanding debt issue rated
AA or better by S&P or Aa or better by Moody's; short-term corporate obligations
which at the date of investment are rated AA or better by S&P or Aa or better by
Moody's; and other debt instruments not specifically described if such
instruments are deemed by the Trustees to be of comparable high quality and
liquidity.
- --------------------------------------------------------------------------------
CONVERTIBLE SECURITIES
- --------------------------------------------------------------------------------
The Fund may invest in securities convertible into common stock or the cash
value of a single equity security or a basket or index of equity securities.
Convertible securities eligible for inclusion in the Fund's portfolio include
convertible bonds, convertible preferred stock, warrants or notes or other debt
instruments that may be exchanged for cash payable in an amount that is linked
to the value of a particular security, basket of securities, index or indices of
securities or currencies.
- --------------------------------------------------------------------------------
FLOATERS AND INVERSE FLOATERS
- --------------------------------------------------------------------------------
The Fund may invest in floating rate debt instruments ("floaters"). The interest
rate on a floater is a variable rate which is tied to another interest rate,
such as a money-market index or Treasury bill rate. The Fund may also invest in
leveraged inverse floating rate debt instruments ("inverse floaters"). The
interest rate on an inverse floater resets in the opposite direction from the
market rate of interest to which the inverse floater is indexed. The leverage
associated with inverse floaters may result in greater volatility in their
market values. Certain inverse floaters may be determined to be illiquid
securities.
- --------------------------------------------------------------------------------
FOREIGN SECURITIES
- --------------------------------------------------------------------------------
The Fund may purchase foreign securities. Foreign investments could be more
difficult to sell than U.S. investments. They also may subject the Fund to risks
different from investing in domestic securities. Investments in foreign
securities involve risks of currency controls by governments, changes in
currency rates and interest rates, difficulties in receiving or interpreting
financial and economic information, possible imposition of taxes, higher
brokerage and custodian fees, possible exchange controls
22
<PAGE>
or other government restrictions, including possible seizure or nationalization
of foreign deposits or assets. Foreign securities may also be less liquid and
more volatile than U.S. securities. There may also be difficulty in invoking
legal protections across borders. In addition, investment in emerging market
countries presents risks in greater degree than those presented by investment in
foreign issuers in countries with developed securities markets and more advanced
regulatory systems.
Many of the foreign securities in which the Fund invests will be denominated in
foreign currencies. Changes in foreign exchange rates will affect the value of
securities denominated or quoted in foreign currencies. Exchange rate movements
can be large and can endure for extended periods of time, affecting either
favorably or unfavorably the value of the Fund's assets. The Fund may, however,
engage in foreign currency transactions to protect itself against fluctuations
in currency exchange rates in relation to the U.S. dollar. See page 24, Risk
"Management Techniques".
- --------------------------------------------------------------------------------
INDUSTRIAL DEVELOPMENT AND POLLUTION CONTROL BONDS
- --------------------------------------------------------------------------------
The Fund may purchase Industrial Development and Pollution Control Bonds.
Industrial Development and Pollution Control Bonds, although nominally issued by
municipal authorities, are generally not secured by the taxing power of the
municipality but are secured by the revenues of the authority derived from
payments by the industrial user. (For more information, see the SAI.)
- --------------------------------------------------------------------------------
LENDING OF PORTFOLIO SECURITIES
- --------------------------------------------------------------------------------
The Fund may lend its investment securities to brokers, dealers and financial
institutions for the purpose of realizing additional income pursuant to
guidelines adopted by the Board of Trustees. The total market value of
securities loaned will not at any time exceed 33% of the total assets of the
Fund. The risks in lending portfolio securities, as with other extensions of
credit, consist of possible loss of rights in the collateral should the borrower
fail financially. In determining whether to lend securities, the Sub-Adviser
will consider all relevant facts and circumstances, including the
creditworthiness of the borrower. (For more information, see the SAI.)
- --------------------------------------------------------------------------------
LOAN PARTICIPATION INTERESTS
- --------------------------------------------------------------------------------
The Fund may invest in participation interests in loans. Such participation
interests, which may take the form of interests in, or assignments of, loans,
are acquired from banks which have made loans or are members of lending
syndicates. The Fund's investments in loan participation interests will be
subject to its limitation on investments in illiquid securities and its
limitation on investments in securities rated below investment grade.
In a typical corporate loan syndication, a number of institutional lenders lend
a corporate borrower a specified sum pursuant to the terms and conditions of a
loan agreement. One of the co-lenders usually agrees to act as the agent bank
with respect to the loan. The loan agreement among the corporate borrower and
the co-lenders identifies the agent bank as well as sets forth the rights and
duties of the parties. The agreement often (but not always) provides for the
collateralization of the corporate borrower's obligations thereunder and
includes various types of restrictive covenants which must be met by the
borrower.
The principal credit risk associated with acquiring participation interests from
a co-lender or another participant is the credit risk associated with the
underlying corporate borrower. The Fund may incur additional credit risk,
however, when it is in the position of participant rather than a co-lender
because the Fund must assume the risk of insolvency of the co-lender from which
the participation interest was acquired and that of any person interpositioned
between the Fund and the co-lender.
- --------------------------------------------------------------------------------
MORTGAGE-BACKED AND ASSET-BACKED SECURITIES
- --------------------------------------------------------------------------------
Mortgage-backed and asset-backed securities are securities that derive their
value from underlying pools of loans that may include interests in pools of
lower-rated debt securities, consumer loans or mortgages, or complex instruments
such as collateralized mortgage obligations and stripped mortgage-backed
securities. The value of these securities may be significantly affected by
changes in interest rates, the market's perception of issuers and the
creditworthiness of the parties involved. The ability of the Fund to
successfully utilize these instruments may depend in part upon the ability of
the Sub-Adviser to forecast interest rates and other economic factors correctly.
Some securities may have a structure that makes their reaction to interest rate
changes and other factors difficult to predict, making their value highly
volatile. These securities may also be subject to prepayment risk and if the
security has been purchased at a premium the amount of the premium would be lost
in the event of prepayment.
- --------------------------------------------------------------------------------
REPURCHASE AGREEMENTS
- --------------------------------------------------------------------------------
The Fund may enter into domestic repurchase agreements to earn income. A
repurchase agreement is an agreement whereby the Fund purchases a portfolio
eligible security from a bank or broker-dealer that agrees to repurchase the
security at the Fund's cost plus interest within a specified time (normally one
day).
The Fund may enter into reverse repurchase agreements. A reverse repurchase
agreement involves the sale of a security by the Fund and its agreement to
repurchase the instrument at a specified time and price. The Fund will maintain
a segregated account consisting of liquid assets to cover its obligations under
reverse repurchase agreements. The Fund will limit its
23
<PAGE>
investments in reverse repurchase agreements and other borrowing to no more than
one-third of its total assets. The use of reverse repurchase agreements by the
Fund creates leverage which increases the Fund's investment risk. If the income
and gains on securities purchased with the proceeds of reverse repurchase
agreements exceed the cost of the agreements, the Fund's earnings or NAV will
increase faster than otherwise would be the case; conversely, if the income and
gains fail to exceed the costs, earnings or NAV would decline faster than
otherwise would be the case.
The Trustees have reviewed and approved certain sellers who they believe to be
creditworthy and have authorized the Fund to enter into repurchase agreements
with such sellers. If the other party to a repurchase agreement were to become
bankrupt, the Fund could experience delays in recovering its investment or
losses.
- --------------------------------------------------------------------------------
RISK MANAGEMENT TECHNIQUES
- --------------------------------------------------------------------------------
The Fund can use various techniques to increase or decrease its exposure to
changing security prices, interest rates, currency exchange rates, commodity
prices or other factors that affect security values. These techniques may
involve derivative transactions such as buying and selling futures contracts and
options on futures contracts, entering into foreign currency transactions (such
as forward foreign currency exchange contracts and options on foreign
currencies) and purchasing put or call options on securities and securities
indexes.
The Fund can use these practices in an attempt to adjust the risk and return
characteristics of its portfolio of investments. When the Fund uses such
techniques in an attempt to reduce risk it is known as "hedging". If the Fund's
Sub-Adviser judges market conditions incorrectly or employs a strategy that does
not correlate well with the Fund's investments, these techniques could result in
a loss, regardless of whether the intent was to reduce risk or increase return.
These techniques may increase the volatility of the Fund and may involve a small
investment of cash relative to the magnitude of the risk assumed. In addition,
these techniques could result in a loss if the counterparty to the transaction
does not perform as promised.
The Fund may each enter into contracts for the future delivery of debt
securities or an index of debt securities that are sufficiently correlated to
its portfolio. The Fund may also enter into contracts for the future delivery of
securities and stock index futures contracts to protect against changes in stock
market prices.
In addition, the Fund may enter into contracts for the future delivery of
foreign currencies to protect against changes in currency exchange rates for the
same type of hedging purposes, purchase and write put and call options on
foreign currencies for the purpose of protecting against declines in the dollar
value of foreign portfolio securities and against increases in the U.S. dollar
cost of foreign securities to be acquired, and enter into a variety of foreign
currency transactions, including forward foreign currency exchange contracts in
order to protect or hedge against the adverse effect that changes in future
foreign currency exchange rates may have on its investment portfolio or on its
investment activities that are undertaken in foreign currencies.
The Fund may sell (write) covered put and call options and purchase put and call
options on any securities in which it may invest that are traded on U.S. and
foreign securities and options exchanges and in the over-the-counter market,
each in accordance with its respective investment objectives and policies.
The Fund may purchase put and call options on securities indexes to hedge
against risks of market-wide price fluctuations. Options on securities indexes
are similar to options on securities except that settlement is in cash.
- --------------------------------------------------------------------------------
SHORT SALES AGAINST THE BOX
- --------------------------------------------------------------------------------
A short sale is a transaction in which the Fund sells through a broker a
security it does not own in anticipation of a possible decline in market price.
A short sale "against the box" is a short sale in which, at the time of the
short sale, the Fund owns or has the right to obtain securities equivalent in
kind and amount. The Fund will only enter into short sales against the box. The
Fund may enter into a short sale against the box, among other reasons, to hedge
against a possible market decline in the value of the security owned. To effect
a short sale against the box, the Fund borrows from a broker the securities
which are sold in the short sale, and the broker holds the proceeds until the
borrowed securities are replaced. If the value of a security sold short against
the box increases, the Fund would suffer a loss when it purchases or delivers to
the selling broker the security sold short. If a broker, with which the Fund has
open short sales, were to become bankrupt, the Fund could experience losses or
delays in recovering gains on short sales. The Fund will only enter into short
sales against the box with brokers the Sub-Adviser believes are creditworthy.
Short sales against the box will be limited to no more than 25% of the Fund's
assets.
- --------------------------------------------------------------------------------
SWAP AGREEMENTS
- --------------------------------------------------------------------------------
The Fund may enter into interest rate, index and currency exchange rate swap
agreements for purposes of attempting to obtain a particular desired return at a
lower cost to the Fund than if the Fund had invested directly in an instrument
that yielded that desired return.
Whether the Fund's use of swap agreements will be successful in furthering its
investment objective will depend on the Sub-Adviser's ability to predict
correctly whether certain types of investments are likely to produce greater
returns than other investments. Because they are two-party contracts and because
they may have terms of greater than seven days, swap agreements may be
considered to be
24
<PAGE>
illiquid. Moreover, the Fund bears the risk of loss of the amount expected to be
received under a swap agreement in the event of the default or bankruptcy of a
swap agreement counterparty. The Sub-Adviser will cause the Fund to enter into
swap agreements only with counterparties that would be eligible for
consideration as repurchase agreement counterparties under the Fund's repurchase
agreement guidelines. Certain restrictions imposed on the Fund by the Internal
Revenue Code may limit the Fund's ability to use swap agreements. The swaps
market is a relatively new market and is largely unregulated. It is possible
that developments in the swaps market and the laws relating to swaps, including
potential government regulation, could adversely affect the Fund's ability to
terminate existing swap agreements, to realize amounts to be received under such
agreements, or to enter into swap agreements. Furthermore, swap agreements could
have adverse tax consequences. See "Tax Status" in the SAI for information
regarding the tax considerations relating to swap agreements.
- --------------------------------------------------------------------------------
WHEN-ISSUED SECURITIES AND FORWARD COMMITMENTS
- --------------------------------------------------------------------------------
The Fund may from time to time purchase securities on a when-issued basis. Debt
securities are often issued on this basis. The price (or yield) of such
securities is fixed at the time a commitment to purchase is made, but delivery
and payment for the when-issued securities take place at a later date. During
the period between purchase and settlement, no payment is made by the Fund and
no interest accrues to the Fund. The market value of the when-issued securities
on the settlement date may be more or less than the purchase price payable at
settlement date. Similarly, the Fund may commit to purchase a security at a
future date at a price determined at the time of the commitment. The same
procedures for when-issued securities will be followed.
- --------------------------------------------------------------------------------
ZERO COUPON BONDS
- --------------------------------------------------------------------------------
The Fund may purchase zero coupon bonds, which are debt obligations issued
without any requirement for the periodic payment of interest. Zero coupon bonds
are issued at a significant discount from face value. Zero coupon bonds tend to
be more volatile than conventional debt securities.
- --------------------------------------------------------------------------------
RISKS OF INVESTING IN HIGH YIELD SECURITIES ("JUNK BONDS")
- --------------------------------------------------------------------------------
The Fund may invest in debt securities rated lower than Baa by Moody's or BBB by
S&P. Securities rated lower than Baa by Moody's or BBB by S&P, or, if not rated,
determined to be of equivalent quality by the Sub-Adviser, are sometimes
referred to as junk bonds and are considered speculative.
Investment in high yield bonds involves special risks in addition to the risks
associated with investments in higher rated debt securities. High yield bonds
may be regarded as predominantly speculative with respect to the issuer's
continuing ability to meet principal and interest payments. Moreover, such
securities may, under certain circumstances, be less liquid than higher rated
debt securities.
Analysis of the creditworthiness of issuers of high yield securities may be more
complex than for issuers of higher quality debt securities, and the ability of
the Fund to achieve its investment objective may, to the extent of its
investment in high yield bonds, be more dependent upon such creditworthiness
analysis than would be the case if the Fund were investing in higher quality
bonds.
High yield bonds may be more susceptible to real or perceived adverse economic
and competitive industry conditions than higher grade bonds. The prices of high
yield bonds have been found to be less sensitive to interest rate changes than
more highly rated investments, but more sensitive to adverse economic downturns
or individual corporate developments. If the issuer of high yield bonds
defaults, the Fund may incur additional expenses to seek recovery. In the case
of high yield bonds structured as zero coupon or payment-in-kind securities, the
market prices of such securities are affected to a greater extent by interest
rate changes and, therefore, tend to be more volatile than securities which pay
interest periodically and in cash.
The secondary market on which high yield bonds are traded may be less liquid
than the market for higher grade bonds. Less liquidity in the secondary trading
market could adversely affect the price at which the Fund could sell a high
yield bond, and could adversely affect and cause large fluctuations in the daily
NAV of the Fund's shares. Adverse publicity and investor perceptions, whether or
not based on fundamental analysis, may decrease the values and liquidity of high
yield bonds, especially in a thinly traded market.
The use of credit ratings for evaluating high yield bonds also involves certain
risks. For example, credit ratings evaluate the safety of principal and interest
payments, not the market value risk of high yield bonds. Also, credit rating
agencies may fail to change credit ratings in a timely manner to reflect
subsequent events. If a credit rating agency changes the rating of a portfolio
security held by a Fund, the Fund may retain the portfolio security if the
Sub-Adviser deems it in the best interest of the shareholders.
================================================================================
INVESTMENT RESTRICTIONS
================================================================================
The following restrictions may not be changed with respect to the Fund without
the approval of the majority of outstanding voting securities of the Fund (as
defined in the 1940 Act). Investment restrictions that appear below or elsewhere
in this Prospectus that involve a maximum percentage of securities or assets
shall not be considered to be violated unless an excess
25
<PAGE>
over the percentage occurs immediately after, and is caused by, an acquisition
or encumbrance of securities or assets of, or borrowings by or on behalf of, the
Fund.
The Trust may not, on behalf of the Fund:
(1) with respect to 75% of the Fund's total assets, invest more than 5% of the
value of the total assets of the Fund in the securities of any one issuer,
except U.S. government securities, or purchase the securities of any issuer
if such purchase would cause more than 10% of the voting securities of such
issuer to be held by the Fund;
(2) borrow money except from banks on a temporary basis for extraordinary or
emergency purposes, including the meeting of redemption requests, or by
engaging in reverse repurchase agreements or comparable portfolio
transactions provided that the Fund maintains asset coverage of at least
300% for all such borrowings, and no purchases of securities will be made
while such borrowings exceed 5% of the value of the Fund's assets;
(3) purchase securities if such purchase would cause 25% or more in the
aggregate of the market value of the total assets of the Fund to be
invested in the securities of one or more issuers having their principal
business activities in the same industry, provided that there is no
limitation with respect to investments in U.S. government securities (for
the purposes of this restriction, telephone companies are considered to be
a separate industry from gas or electric utilities, and wholly owned
finance companies are considered to be in the industry of their parents if
their activities are primarily related to financing the activities of the
parents) except that up to 40% of the Fund's total assets, taken at market
value, may be invested in each of the electric utility and telephone
industries, but it will not invest 25% or more in either of those
industries unless yields available for four consecutive weeks in the four
highest rating categories on new issue bonds in such industry (issue size
of $50 million or more) have averaged in excess of 105% of yields of new
issue long-term industrial bonds similarly rated (issue size of $50 million
or more) and at such time that the 1940 Act is amended to permit a
registered investment company to elect to be "industry nondiversified"
(i.e., a fund that does not concentrate its investments in a particular
industry would be permitted, but not required, to invest 25% or more of its
assets in a particular industry), the Fund elects to be so classified and
the foregoing limitation shall no longer apply;
(4) purchase or sell real estate (excluding securities secured by real estate
or interests therein or, issued by companies that invest in or deal in real
estate) commodities and commodity contracts. The Trust reserves the freedom
of action to hold and to sell real estate acquired for the Fund as a result
of the ownership of securities. Purchases and sales of foreign currencies
on a spot basis and forward foreign currency exchange contracts, options on
currency, futures contracts on currency, securities or securities indices
and options on such futures contracts are not deemed to be an investment in
a prohibited commodity or commodity contract for the purpose of this
restriction; or
(5) make loans to other persons, except loans of portfolio securities. The
purchase of debt obligations and the entry into repurchase agreements in
accordance with the Fund's investment objectives and policies are not
deemed to be loans for this purpose.
"Value" for the purposes of all investment restrictions shall mean the value
used in determining the Fund's NAV. Additional fundamental and nonfundamental
investment restrictions may be found in the SAI.
================================================================================
MANAGER, SUB-SDVISER AND DISTRIBUTOR
================================================================================
- --------------------------------------------------------------------------------
THE MANAGER
- --------------------------------------------------------------------------------
The Trust, on behalf of the Fund, pays the Manager a monthly fee for services
performed at the annual rate of .75% of the average daily net assets of the
Fund.
The Fund, pursuant to an Accounting Agreement with the Manager, will bear an
allocable portion of the Manager's cost of performing certain bookkeeping and
pricing services. The Fund pays the Manager a monthly fee for services provided
under the Accounting Agreement at the annual rate of 1/20 of 1% for the first
$20 million of average monthly net assets, 1/30 of 1% of the next $80 million of
average monthly net assets and 1/100 of 1% of any amount in excess of $100
million of average monthly net assets. In addition, the Manager provides the
Fund with certain recordkeeping and administrative services pursuant to a
Service Agreement with the Fund.
The Manager is not responsible for records maintained by the Fund's Custodian,
Transfer, Dividend Disbursing and Shareholder Servicing Agent or Sub-Adviser.
- --------------------------------------------------------------------------------
THE SUB-ADVISER
- --------------------------------------------------------------------------------
Pursuant to the terms of the Sub-Advisory Agreement between the Manager and the
Sub-Adviser on behalf of the Fund, the Manager, not the Fund, pays the
Sub-Adviser a monthly fee for services performed at the annual rate of .375% of
the Fund's average daily net assets.
- --------------------------------------------------------------------------------
THE DISTRIBUTOR
- --------------------------------------------------------------------------------
To compensate the Distributor for the services it provides and for the expenses
it bears in distributing shares and servicing shareholders of the Fund, the Fund
has adopted separate distribution plans pursuant to Rule 12b-1 under the 1940
Act for each class of shares (the "Class A Plan," the "Class B Plan" and,
collectively, the "Plans"). Pursuant to the Class A Plan, the Fund pays the
Distributor a monthly fee, which is an expense of
26
<PAGE>
the Class A shares of the Fund charged against its income, at the annual rate of
0.25% of the average daily net assets of the Fund's Class A shares for
distribution or service activities, as designated by the Distributor. Pursuant
to the Class B Plan, the Fund pays the Distributor a monthly distribution fee,
which is an expense of the Class B shares of the Fund, at the annual rate of
0.75% of the average daily net assets of the Fund's Class B shares.
Class B shares of the Fund pay to the Distributor, in addition to the
distribution fee, a service fee at the rate of 0.25% on an annualized basis of
the average daily net asset value of the Class B shares of the Fund as
compensation for personal continuing services rendered to Class B shareholders
of the Fund and the maintenance of shareholder accounts.
The combination of the contingent deferred sales charge and the distribution fee
contributes to the Fund's ability to sell Class B shares without a sales charge
being deducted at the time of purchase. The Distributor is entitled to receive
the proceeds of contingent deferred sales charges which may be imposed at the
time of redemptions or repurchases of shares. The receipt of contingent deferred
sales charges does not reduce the distribution fee. See page 30, "Alternative
Sales Arrangements--Deferred Sales Charge Class B Shares--Contingent Deferred
Sales Charge, Class B".
Under a Plan, a class of shares of the Fund pays distribution and/or service
fees to the Distributor as compensation for distribution and/or service
activities related to that class of shares and its shareholders. Each Plan
provides that the distribution and/or service fees are payable to the
Distributor regardless of the amounts actually expended by the Distributor.
Authorized distribution expenses include the Distributor's interest expense and
profit. The Distributor anticipates that its actual expenditures will
substantially exceed the distribution fee received by it during the early years
of the operation of a Plan. For example, the Distributor will advance to dealers
who sell Class B shares of the Funds an amount equal to 4% of the aggregate net
asset value of the shares sold. In addition, the Distributor will pay dealers an
ongoing annual service fee equal to 0.25% of the aggregate net asset value of
shares held by investors serviced by the dealer. In later years, its
expenditures may be less than the distribution fee, thus enabling the
Distributor to realize a profit in those years. If the Plans for the Fund are
terminated, the Fund will owe no payments to the Distributor other than any
portion of the distribution fee accrued through the effective date of
termination but then unpaid.
Plan revenues may be used to reimburse third parties which provide various
services to shareholders who are participants in various retirement plans. These
services include aggregating and processing purchase and redemption orders for
participant shareholders, processing dividend payments, forwarding shareholder
communications, and recordkeeping.
Persons selling or servicing different classes of shares of the Fund may receive
different compensation with respect to one particular class of shares as opposed
to another.
================================================================================
HOW TO PURCHASE SHARES OF THE FUND
================================================================================
- --------------------------------------------------------------------------------
GENERAL INFORMATION
- --------------------------------------------------------------------------------
The two classes of shares each represent an interest in the same portfolio of
investments of the Fund, have the same rights and are identical in all respects,
except that, to the extent applicable, each class bears its own service and
distribution expenses and may bear incremental transfer agency costs resulting
from such sales arrangement. Each class of the Fund has exclusive voting rights
with respect to provisions of the Rule 12b-1 plan for such class pursuant to
which its distribution and service fees are paid, and each class has similar
exchange privileges. The net income attributable to Class B shares and the
dividends payable on Class B shares will be reduced by the amount of the higher
Rule 12b-1 fee and incremental expenses associated with such class. Likewise,
the NAV of the Class B shares will be generally reduced by such class specific
expenses (to the extent the Fund has undistributed net income) and investment
performance of Class B shares will be less competitive than that of Class A
shares. For additional information on the features of Class A and Class B
shares, see "Alternative Sales Arrangements", page 29.
- --------------------------------------------------------------------------------
BY MAIL
- --------------------------------------------------------------------------------
Initial purchases of shares of the Fund should be made by mailing the completed
application form to the investor's Registered Representative. Shares of the Fund
may be purchased at the NAV per share next determined after receipt and
acceptance of the purchase order by the Fund plus any applicable sales charge.
- --------------------------------------------------------------------------------
BY TELEPHONE
- --------------------------------------------------------------------------------
An investor may make an initial investment by having his or her Registered
Representative telephone the Distributor between 9:00 AM and 4:00 PM, Eastern
time, on any day the New York Stock Exchange is open. The purchase will be
effected at the NAV per share plus any applicable sales charge next determined
following receipt of the telephone order as described above. An application and
payment must be received and accepted by the Distributor within three business
days. All telephone calls are recorded to protect shareholders and the
Shareholder Servicing Agent. For a description of certain limitations on the
liability of the Fund and the Shareholder Servicing Agent for transactions
effected by telephone, see page 14, "Know How to Sell and Exchange Shares".
27
<PAGE>
- --------------------------------------------------------------------------------
BY WIRE
- --------------------------------------------------------------------------------
An investor may open an account and invest by wire by having his or her
Registered Representative telephone the Distributor between 9:00 AM and 4:00 PM,
Eastern time, to obtain an account number and instructions. For both initial and
subsequent investments, federal funds should be wired to:
State Street Bank and Trust Company
225 Franklin Street
Boston, Massachusetts 02110
ABA No.: 011 0000 28
Attn.: Custody and Shareholder Services
For Credit: MainStay Strategic Value Fund--
Class______
Shareholder Account No.____________________________
Shareholder Registration ____________________________
DDA Account Number 99029415
An application must be received by the Distributor within three business days.
The investor's bank may charge the investor a fee for the wire.
To make a purchase effective the same day, the registered representative must
call the Distributor by 12:00 noon, Eastern time, and federal funds must be
received by the Shareholder Servicing Agent before 4:00 PM, Eastern time.
Wiring money to the Fund will reduce the time a shareholder must wait before
redeeming or exchanging shares because, when a shareholder purchases by check,
the Fund will withhold payment for up to 10 days of purchase or until the check
clears, whichever is first.
- --------------------------------------------------------------------------------
ADDITIONAL INVESTMENTS
- --------------------------------------------------------------------------------
Additional investments in the Fund may be made at any time by mailing a check
payable to the Fund directly to The MainStay Funds, P.O. Box 8401, Boston,
Massachusetts 02266-8401. The shareholder's account number and the name of the
Fund and class of shares must be included with each investment. Purchases will
be effected at the NAV per share plus any applicable sales charge as described
above.
- --------------------------------------------------------------------------------
SYSTEMATIC INVESTMENT PLANS
- --------------------------------------------------------------------------------
The Trust's officers may waive the initial and subsequent investment minimums
for certain purchases when they deem it appropriate, including, but not limited
to, purchases by certain qualified retirement plans, New York Life employee and
agent investment plans, investments resulting from distributions by other New
York Life products and NYLIFE Distributors products, and purchases by certain
individual participants.
Investors whose bank is a member of the Automated Clearing House ("ACH") may
purchase shares of the Fund through AutoInvest. AutoInvest facilitates
investments by using electronic debits, authorized by the shareholder, to a
checking or savings account, for share purchases. When the authorization is
accepted (usually within two weeks of receipt) a shareholder may purchase shares
by calling the Shareholder Servicing Agent toll free at 1-800-MAINSTAY (between
8:00 AM and 4:00 PM, Eastern time). The investment will be effected at the NAV
per share, next determined after receipt and acceptance of the order plus any
applicable sales charge, and normally will be credited to the shareholder's Fund
account within two business days thereafter. Shareholders whose bank is an ACH
member also may use AutoInvest to automatically purchase shares of the Fund on a
scheduled basis by electronic debit for an account designated by the shareholder
on an application form. The initial investment must be in accordance with the
investment amounts previously mentioned. Subsequent minimum investments are $50
monthly, $100 quarterly, $250 semiannually, or $500 annually. The investment day
may be any day from the first through the twenty-eighth of the respective month.
Redemption proceeds from Fund shares purchased by AutoInvest may not be paid for
up to 10 days after the purchase date. Fund shares may not be redeemed by
AutoInvest.
- --------------------------------------------------------------------------------
OTHER INFORMATION
- --------------------------------------------------------------------------------
Investors may, subject to the approval of the Trust, the Distributor, the
Manager and the Sub-Adviser purchase shares of the Fund with liquid securities
that are eligible for purchase by the Fund and that have a value that is readily
ascertainable. These transactions will be effected only if the Sub-Adviser
intends to retain the security in the Fund as an investment. The Trust reserves
the right to amend or terminate this practice at any time. An investor must call
MainStay at 1-800-MAINSTAY before sending any securities.
An investor in certain qualified retirement plans may open an account with a
minimum investment of a lesser amount when permitted under such qualified
retirement plan. The Trust and the Distributor reserve the right to redeem
shares of any shareholder who has failed to provide the Trust with a certified
Taxpayer I.D. Number or such other tax-related certifications as the Trust may
require. A notice of redemption, sent by first class mail to the shareholder's
address of record, will fix a date not less than 30 days after the mailing date,
and shares will be redeemed at the NAV determined as of the close of business on
that date unless a certified Taxpayer I.D. Number (or such other information as
the Trust has requested) has been provided.
28
<PAGE>
================================================================================
ALTERNATIVE SALES ARRANGEMENTS
================================================================================
- --------------------------------------------------------------------------------
INITIAL SALES CHARGE ALTERNATIVE: CLASS A SHARES
- --------------------------------------------------------------------------------
The sales charge on Class A shares of the Fund is a variable percentage of the
public offering price depending upon the amount of the sale.
The sales charge applicable to an investment in Class A shares of the Fund will
be determined according to the following table:
<TABLE>
<CAPTION>
Sales Charge as
Sales Charge as a Percentage of
a Percentage of: Offering Price:
---------------------- --------------------------
Net Retained
Amount of Offering Amount Retained by the
Purchase Price Invested by Dealer Distributor
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Less than $50,000 5.50% 5.82% 4.75% 0.75%
$50,000 to $99,999 4.50% 4.71% 4.00% 0.50%
$100,000 to $249,999 3.50% 3.63% 3.00% 0.50%
$250,000 to $499,999 2.50% 2.56% 2.00% 0.50%
$500,000 to $999,999 2.00% 2.04% 1.75% 0.25%
$1,000,000 or more* None None See Below* None
- --------------------------------------------------------------------------------
</TABLE>
* No sales charge applies on investments of $1 million or more, but a
contingent deferred sales charge of 1% is imposed on certain redemptions of
such shares within one year of the date of purchase. See "Reduced Sales
Charges on Class A Shares--Contingent Deferred Sales Charge, Class A."
From October 22, 1997 through December 31, 1997, a 100% Dealer Reallowance will
be offered.
Although an investor will not pay an initial sales charge on investments of
$1,000,000 or more, the Distributor will pay, from its own resources, a
commission to dealers on such investments. The dealer will receive a commission
of 1.00% on the portion of a sale from $1,000,000 to $2,999,999, 0.50% of any
portion from $3,000,000 to $4,999,999 and 0.40% on any portion of $5,000,000 or
more.
The Distributor may allow the full sales charge to be retained by dealers. The
amount retained may be changed from time to time but will remain the same for
all dealers. The Distributor, at its expense, also may from time to time provide
additional promotional incentives to dealers. A selected dealer who receives a
reallowance in excess of 90% of such a sales charge may be deemed to be an
"underwriter" under the 1933 Act.
- --------------------------------------------------------------------------------
PURCHASES AT NAV
- --------------------------------------------------------------------------------
The Fund's Class A shares may be purchased at NAV, without payment of any sales
charge, by its Trustees, New York Life and its subsidiaries and their employees,
officers, directors or agents (and immediate family members). Also, any employee
or registered representative of an authorized broker-dealer may purchase the
Fund's shares at NAV without payment of any sales charge. In addition, the Trust
will treat Class A share purchases of the Fund in an amount less than $1,000,000
by defined contribution plans that are sponsored by employers with 250 or more
employees as if such purchases were equal to an amount more than $1,000,000 but
less than $2,999,999.
In addition, Class A shares of the Fund may be purchased at NAV through
broker-dealers, investment advisers and other financial institutions which have
entered into a supplemental agreement with the Distributor, which includes a
requirement that such shares be sold for the benefit of clients participating in
a "wrap account" or similar program under which clients pay a fee to the
broker-dealer, investment adviser or other financial institution.
- --------------------------------------------------------------------------------
REDUCED SALES CHARGES ON CLASS A SHARES
- --------------------------------------------------------------------------------
The sales charge varies with the size of the purchase and reduced charges apply
to the aggregate of purchases of the Fund made at one time by any "Qualified
Purchaser," which term includes (i) an individual and his/her spouse and their
children under the age of 21; and (ii) any other organized group of persons,
whether incorporated or not, which is itself a shareholder of the Fund,
including group retirement and benefit plans (other than IRAs and 403(b) plans)
whether incorporated or not, provided the organization has been in existence for
at least six months and has some purpose other than the purchase at a discount
of redeemable securities of a registered investment company. The circumstances
under which "Qualified Purchasers" and other investors in the Fund may pay
reduced sales charges are described on page 11, "Consider Reducing Your Sales
Charge."
Letter of Intent
Qualified Purchasers may obtain reduced sales charges by signing an LOI. The LOI
is a nonbinding obligation on the Qualified Purchaser to purchase the full
amount indicated in the LOI. The sales charge is based on the total amount
invested during a 24-month period. A 90-day back-dated period can be used to
include earlier purchases; the 24-month period would then begin on the date of
the first purchase during the 90-day period. For more information, see the SAI
or call your Registered Representative or MainStay at 1-800-MAINSTAY.
Contingent Deferred Sales Charge, Class A
In order to recover commissions paid to dealers on qualified investments of $1
million or more, a contingent deferred sales charge of 1% may be imposed on
redemptions of such investments made within one year of the date of purchase.
Class A shares that are redeemed will not be subject to a contingent deferred
sales charge, however, to the extent that the value of such shares represents:
(1) capital appreciation of Fund assets; (2) reinvestment of dividends or
capital gains distributions; or (3) Class A shares redeemed more than one year
after their purchase. Class A shares of the Fund that are purchased without a
front-end sales charge may be exchanged for Class A shares of another Fund
without the imposition of a contingent deferred sales charge, although, upon
redemption, contingent deferred sales charges may apply to the Class A shares
that were acquired through an exchange.
29
<PAGE>
The contingent deferred sales charge will be applicable to amounts invested
pursuant to a right of accumulation or an LOI to the extent that (a) a front-end
sales charge was not paid at the time of the purchase and (b) any shares so
purchased are redeemed within one year of the date of purchase.
For federal income tax purposes, the amount of the contingent deferred sales
charge generally will reduce the gain or increase the loss, as the case may be,
recognized upon redemption.
- --------------------------------------------------------------------------------
DEFERRED SALES CHARGE CLASS B SHARES
- --------------------------------------------------------------------------------
Proceeds from the contingent deferred sales charge are paid to, and are used in
whole or in part by, the Distributor to defray its expenses related to providing
distribution related services to the Fund in connection with the sale of the
Class B shares, such as the payment of compensation to selected dealers and
agents. The combination of the contingent deferred sales charge and the
distribution fee facilitates the ability of the Fund to sell the Class B shares
without a sales charge being deducted at the time of purchase.
Contingent Deferred Sales Charge, Class B
A contingent deferred sales charge will be imposed on redemptions of Class B
shares of the Fund, in accordance with the table below, at the time of any
redemption by a shareholder which reduces the current value of the shareholder's
Class B account in the Fund to an amount which is lower than the amount of all
payments by the shareholder for the purchase of Class B shares in the Fund
during the preceding six years. However, no such charge will be imposed to the
extent that the net asset value of the Class B shares redeemed does not exceed
(a) the current aggregate net asset value of Class B shares of the Fund
purchased more than six years prior to the redemption, plus (b) the current
aggregate net asset value of Class B shares of the Fund purchased through
reinvestment of dividends or distributions, plus (c) increases in the net asset
value of the investor's Class B shares of the Fund above the total amount of
payments for the purchase of Class B shares of the Fund made during the
preceding six years. The amount of any contingent deferred sales charge will be
paid to and retained by the Distributor.
The amount of the contingent deferred sales charge, if any, will vary depending
on the number of years from the time of payment for the purchase of Class B
shares of the Fund until the time of redemption of such shares. Solely for
purposes of determining the number of years from the time of payment for the
purchase of shares, all payments during a month will be aggregated and deemed to
have been made on the last day of the month.
The following table sets forth the rates of the contingent deferred sales
charge:
<TABLE>
<CAPTION>
Contingent Deferred Sales
Charge as a Percentage
Year Since Purchase of Amount Redeemed
Payment Made Subject to the Charge
- --------------------------------------------------------------------------------
<S> <C>
First ........................................... 5.0%
Second .......................................... 4.0%
Third ........................................... 3.0%
Fourth .......................................... 2.0%
Fifth ........................................... 2.0%
Sixth ........................................... 1.0%
Thereafter ...................................... None
- --------------------------------------------------------------------------------
</TABLE>
In determining the rate of any applicable contingent deferred sales charge, it
will be assumed that a redemption is made of shares held by the shareholder for
the longest period of time. This will result in any such charge being imposed at
the lowest possible rate. For federal income tax purposes, the amount of the
contingent deferred sales charge generally will reduce the gain or increase the
loss, as the case may be, recognized on the redemption or repurchase of shares.
The contingent deferred sales charge will be waived in connection with the
following redemptions: (i) withdrawals from qualified retirement plans and
nonqualified deferred compensation plans resulting from seperation of service,
loans, hardship withdrawals, QDRO's, and excess contributions pursuant to
applicable IRS rules; and Required Minimum Distributions at age 70 1/2 for IRA
and 403(b) participants; (ii) withdrawals related to the termination of a
retirement plan where no successor plan has been established; (iii)
preretirement transfers or rollovers within a retirement plan where the proceeds
of the redemption are invested in a MainStay IRA, the New York Life Separate
Account or any guaranteed investment contract written by New York Life or any of
its affiliates, as well as preretirement transfers within a retirement plan
administered by New York Life Benefit Services, Inc or TRAC-2000; (iv) required
distributions by charitable trusts under Section 664 of the Code; (v)
redemptions following the death of the shareholder or the beneficiary of a
living revocable trust or within one year following the disability of a
shareholder occurring subsequent to the purchase of shares; (vi) continuing,
periodic monthly or quarterly withdrawals, under the Systematic Withdrawal Plan,
up to an annual total of 10% of the value of a shareholder's Class B share
account in the Fund; (vii) redemptions by New York Life or any of its affiliates
or by accounts managed by New York Life or any of its affiliates; (viii)
redemptions effected by registered investment companies by virtue of
transactions with the Fund; (ix) involuntary redemptions of an account with a
net asset value
30
<PAGE>
of $250 or less; and (x) redemptions by shareholders of shares purchased with
the proceeds of a settlement payment made in connection with the liquidation and
dissolution of a limited partnership sponsored by New York Life or one of its
affiliates. The contingent deferred sales charge is waived on such sales or
redemptions to promote goodwill and because the sales effort, if any, involved
in making such sales is negligible.
Shareholders should notify the Fund's Transfer Agent at the time of requesting
such redemptions that they are eligible for a waiver of the contingent deferred
sales charge. Class B shares upon which the contingent deferred sales charge may
be waived may not be resold, except to the Trust. Shareholders who are making
withdrawals from retirement plans and accounts or other tax-sheltered or
tax-deferred accounts should consult their tax advisers regarding the tax
consequences of such withdrawals.
================================================================================
REDEMPTION AND EXCHANGES
================================================================================
Shares may be redeemed directly from the Fund or through your Registered
Representative. Shares redeemed will be valued at the NAV per share next
determined after the Transfer Agent receives the redemption request in "good
order." "Good order" with respect to a redemption request generally means that a
stock power or certificate must be endorsed by the record owner(s) exactly as
the shares are registered and the signature(s) must be guaranteed by an eligible
guarantor institution. In cases where redemption is requested by a corporation,
partnership, trust, fiduciary or any other person other than the record owner,
written evidence of authority acceptable to the Fund's Transfer Agent must be
submitted before the redemption request will be accepted. The signature
guarantee may be waived on a redemption of $100,000 or less which is payable to
the shareholder(s) of record and mailed to the address of record, or under such
other circumstances as the Trust may allow.
Upon the redemption of shares, the Fund will make payment in cash, except as
described below, of the net asset value of the shares next determined after such
redemption request was received, less any applicable contingent deferred sales
charge. There will be no redemption, however, during any period in which the
right of redemption is suspended or date of payment is postponed because the New
York Stock Exchange is closed or trading on such Exchange is restricted or the
SEC deems an emergency to exist.
The value of the shares redeemed from the Fund may be more or less than the
shareholder's cost, depending on portfolio performance during the period the
shareholder owned the shares.
Systematic Withdrawal Plan
Dividends and capital gains distributions on shares held under the Systematic
Withdrawal Plan are reinvested in additional full and fractional shares of the
Fund at NAV. The Fund's Transfer Agent acts as agent for the shareholder in
redeeming sufficient full and fractional shares to provide the amount of the
systematic withdrawal payment and any contingent deferred sales charge, if
applicable.
Exchange Privileges
Exchanges will be based upon each Fund's NAV per share next computed following
receipt of a properly executed exchange request.
Subject to the conditions and limitations described herein, Class A and Class B
shares of the Fund may be exchanged for shares of an identical class of the
following MainStay Funds:
MainStay California Tax Free Fund
MainStay Capital Appreciation Fund
MainStay Convertible Fund
MainStay Government Fund
MainStay High Yield Corporate Bond Fund
MainStay International Bond Fund
MainStay International Equity Fund
MainStay Money Market Fund
MainStay New York Tax Free Fund
MainStay Strategic Income Fund
MainStay Tax Free Bond Fund
MainStay Total Return Fund
MainStay Value Fund
In addition, an exchange privilege between Class A shares of the Fund and
MainStay Equity Index Fund is offered. Any exchanges between the Fund and
MainStay Equity Index Fund will be subject to the conditions applicable to Class
A share exchanges described herein, as well as any applicable minimum investment
requirements. No exchange privilege between Class B shares of the Fund and
MainStay Equity Index Fund is offered.
You must first obtain the prospectus for any MainStay Fund into which you wish
to make an exchange by calling 1-800-MAINSTAY. You should read the Prospectus
carefully before you place an exchange request.
Generally, shareholders may exchange their Class A shares of the Fund for Class
A shares of another MainStay Fund, without the imposition of a sales charge. Any
such exchanges will be based upon each Fund's NAV per share next computed
following receipt of a properly executed exchange request.
Class B shares of the Fund may be exchanged for Class B shares of another
MainStay Fund at the NAV next computed following receipt of a properly executed
exchange request, without the payment of a contingent deferred sales charge; the
sales charge will be assessed, if applicable, when the shareholder redeems his
or her shares without a corresponding purchase of shares of another MainStay
Fund. However, where a shareholder previously exchanged his or her Class B
shares into the MainStay Money Market Fund from another MainStay Fund, the
applicable contingent deferred sales charge will be assessed when
31
<PAGE>
the shares are redeemed from the Money Market Fund even though the Money Market
Fund does not otherwise assess a contingent deferred sales charge on
redemptions. Class B shares of a Fund acquired as a result of subsequent
investments, except reinvested dividends and distributions, will be subject to
the contingent deferred sales charge when ultimately redeemed or repurchased
without purchasing shares of another MainStay Fund.
Exchanges may only be made with respect to Funds registered in the state of
residence of the investor or where an exemption from registration is available.
An exchange may be made by either writing to the Fund's Shareholder Servicing
Agent at the following address: The MainStay Funds, P.O. Box 8401, Boston,
Massachusetts 02266-8401, or by calling the Fund's Shareholder Servicing Agent
at 1-800-MAINSTAY (8:00 AM to 4:00 PM, Eastern time).
In times when the volume of telephone exchanges is heavy, additional phone lines
will automatically be added by the Transfer Agent. However, in times of drastic
economic or market changes, the telephone exchange privilege may be difficult to
implement. When calling the Shareholder Servicing Agent to make a telephone
exchange, shareholders should have available their account number and Social
Security or Taxpayer I.D. Numbers. Under the telephone exchange privilege,
shares may only be transferred among accounts with identical names, addresses
and Social Security or Taxpayer I.D. Numbers. Shares may be exchanged among
accounts with different names, addresses and Social Security or Taxpayer I.D.
Numbers only if the exchange request is in writing and is received in "good
order." If the dealer permits, the dealer representative of record may initiate
telephone exchanges on behalf of a shareholder, unless the shareholder notifies
the Fund in writing not to permit such exchanges. See "Redemptions and
Exchanges", page 31.
It is the policy of The MainStay Funds to discourage frequent trading by
shareholders among the Funds in response to market fluctuations. Accordingly, in
order to maintain a stable asset base in each Fund and to reduce administrative
expenses borne by each Fund, five exchanges are permitted in each 12-month
period without the imposition of any transaction fee; subsequently, exchange
requests may be denied.
For purposes of determining the length of time a shareholder owned Class B
shares prior to redemption or repurchase in order to determine the applicable
contingent deferred sales charge, Class B shares will be deemed to have been
held from the date of purchase of the shares, regardless of exchanges into other
Funds. For federal income tax purposes, an exchange is treated as a sale on
which an investor may realize a gain or loss.
See page 17, "Understand the Tax Consequences", for information concerning the
federal income tax treatment of a disposition of shares. All exchanges are
subject to the minimum investment requirements of the Funds involved. The
exchange privilege may be modified or withdrawn at any time without notice.
Distributions in Kind
The Trust has agreed to redeem shares of the Fund solely in cash up to the
lesser of $250,000 or 1% of the net asset value of the Fund during any 90-day
period for any one shareholder. The Trust reserves the right to pay other
redemptions, either total or partial, by a distribution in kind of securities
(instead of cash) from the Fund's portfolio. The securities distributed in such
a distribution would be valued at the same value as that assigned to them in
calculating the NAV of the shares being redeemed. If a shareholder receives a
distribution in kind, he or she should expect to incur transaction costs when he
or she converts the securities to cash.
================================================================================
TAX-DEFERRED RETIREMENT PLANS
================================================================================
Shares of the Fund may be purchased for retirement plans, providing tax-deferred
investments for individuals and institutions. Shares purchased may be used as
investments for established plans, or the Distributor may provide plan documents
for selected plans. A plan document must be adopted in order for a plan to be in
existence.
Custodial services are provided for IRA/SEP/SARSEP and SIMPLE IRA plans, and for
403(b)(7) Custodial Accounts. Plan administration is also available for select
qualified retirement plans.
Contributions made to such plans to the extent provided in federal income tax
law currently in effect, and earnings thereon, will not be taxable to the plan
participant until distribution. An investor should consult with his or her tax
adviser before establishing any tax-deferred retirement plan.
The Internal Revenue Service ("IRS") has specific distribution requirements that
apply to investors who reach age 70 1/2.
================================================================================
NET ASSET VALUE
================================================================================
For purposes of determining NAV, portfolio securities of the Fund are valued at
their fair market values as determined by the methods described in the SAI with
the exception of money market instruments held by the Fund, which are valued by
the amortized cost method.
================================================================================
PORTFOLIO TRANSACTIONS
================================================================================
The primary consideration in portfolio security transactions is best execution.
Subject to this requirement, securities may be bought from or sold to brokers or
dealers who have furnished statistical, research and other information or
services to the Adviser. Consistent with the foregoing primary consideration,
the Rules of Fair Practice of the National Association of Securities Dealers,
Inc. and such other policies as the Trustees
32
<PAGE>
may determine, the Sub-Adviser may consider sales of shares of the Fund as a
factor in the selection of broker-dealers to execute the Fund's portfolio
transactions. NYLIFE Securities Inc., may act as a broker for the Trust in
accordance with applicable regulations.
Some securities considered for investment by the Fund may also be appropriate
for other clients served by the Fund's Sub-Adviser. If a purchase or sale of
securities consistent with the investment policies of a Fund and one or more of
the clients served by the Fund's Sub-Adviser is considered at or about the same
time, transactions in such securities may be executed together and will, to the
extent practicable, be allocated among the Fund and clients in a manner deemed
equitable to the Fund and the clients by the Fund's Sub-Adviser. Although there
is no specified formula for allocating such transactions, the various allocation
methods used by a Fund's Sub-Adviser, and the results of such allocations, are
subject to periodic review by the Trustees.
================================================================================
TAX INFORMATION
================================================================================
The Fund generally will not be subject to federal income tax on its net taxable
investment income and net realized capital gains to the extent such income and
gains are distributed to its shareholders in accordance with the timing
requirements of the Code.
33
<PAGE>
================================================================================
APPENDIX A
================================================================================
- --------------------------------------------------------------------------------
DESCRIPTION OF SECURITIES RATINGS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MOODY'S INVESTORS SERVICE, INC.
- --------------------------------------------------------------------------------
Corporate and Municipal Bond Ratings
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than the Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations,
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca: Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Moody's applies numerical modifiers, 1, 2, and 3, in each generic rating
classified from Aa through B in its corporate bond rating system. The modifier 1
indicates that the security ranks in the higher end of its generic rating
category; the modifier 2 indicates a midrange ranking; and the modifier 3
indicates that the issue ranks in the lower end of its generic rating category.
Designations Applicable to Municipal Bond Ratings
In its municipal bond rating system, Moody's designates those bonds within the
Aa, A, Baa, Ba and B categories that it believes possess the strongest credit
attributes with the symbols Aa1, A1, Baa1, Ba1 and B1.
Advance refunded issues that are secured by escrowed funds held in cash, held in
trust, reinvested in direct noncallable United States government obligations or
noncallable obligations unconditionally guaranteed by the U.S. government are
identified with a hatchmark (#) symbol, i.e., #Aaa.
Moody's assigns conditional ratings to bonds for which the security depends upon
the completion of some act or the fulfillment of some condition. These are bonds
secured by: (a) earnings of projects under construction; (b) earnings of
projects unseasoned in operating experience; (c) rentals that begin when
facilities are completed; or (d) payments to which some other limiting condition
attaches. The parenthetical rating denotes probable credit stature upon
completion of construction or elimination of basis of condition, e.g.,
Con.(Baa).
Issues that are subject to a periodic reoffer and resale in the secondary market
in a "dutch auction" are assigned a long-term rating based only on Moody's
assessment of the ability and willingness of the issuer to make timely principal
and interest payments. Moody's expresses no opinion as to the ability of the
holder to sell the security in a secondary market "dutch auction." Such issues
are identified by the insertion of the words "dutch auction" into the name of
the issue.
Municipal Short-Term Loan Ratings
Issues or the features associated with MIG, VMIG or SQ ratings are identified by
date of issue, date of maturity or maturities or rating expiration date and
description to distinguish each rating from other ratings. Each rating
designation is unique with no implication as to any other similar issue of the
same obligor. MIG ratings terminate at the retirement of the obligation while
VMIG rating expiration will be a function of each issue's specific structural or
credit features.
MIG 1/VMIG 1: This designation denotes best quality. There
34
<PAGE>
is present strong protection by established cash flows, superior liquidity
support or demonstrated broad-based access to the market for refinancing.
MIG 2/VMIG 2: This designation denotes high quality. Margins of protection are
ample although not so large as in the preceding group.
MIG 3/VMIG 3: This designation denotes favorable quality. All security elements
are accounted for but there is lacking the undeniable strength of the preceding
grades. Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
MIG 4/VMIG 4: This designation denotes adequate quality. Protection commonly
regarded as required of an investment security is present and although not
distinctly or predominantly speculative, there is specific risk.
SQ: This designation denotes speculative quality. Debt instruments in this
category lack margins of protection.
Corporate Short-Term Debt Ratings
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations which have an original maturity not exceeding
one year. Obligations relying upon support mechanisms such as letters-of-credit
and bonds of indemnity are excluded unless explicitly rated.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
leading market positions in well-established industries; high rates of return on
funds employed; conservative capitalization structure with moderate reliance on
debt and ample asset protection; broad margins in earnings coverage of fixed
financial charges and high internal cash generation; and well-established access
to a range of financial markets and assured sources of alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime rating
categories.
- --------------------------------------------------------------------------------
STANDARD & POOR'S
- --------------------------------------------------------------------------------
Corporate and Municipal Debt Ratings
Investment Grade
AAA: Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA: Debt rated AA has a very strong capacity to pay interest and repay principal
and differs from the highest rated issues only in small degree.
A: Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB: Debt rated BBB is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
Speculative Grade
Debt rated BB, B, CCC, CC, and C is regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal. BB
indicates the least degree of speculation and C the highest. While such debt
will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major exposures to adverse conditions.
BB: Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B: Debt rated B has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The B rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BB or BB-
rating.
CCC: Debt rated CCC has a currently identifiable vulnerability to default and is
dependent upon favorable business, financial and economic conditions to meet
timely
35
<PAGE>
payment of interest and repayment of principal. In the event of adverse
business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The CCC rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
B or B- rating.
CC: The rating CC typically is applied to debt subordinated to senior debt which
is assigned an actual or implied CCC rating.
C: The rating C typically is applied to debt subordinated to senior debt which
is assigned an actual or implied CCC- debt rating. The C rating may be used to
cover a situation where a bankruptcy petition has been filed, but debt service
payments are continued.
C1: The rating C1 is reserved for income bonds on which no interest is being
paid.
D: Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating will also be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Provisional ratings: The letter "p" indicates that the rating is provisional. A
provisional rating assumes the successful completion of the project being
financed by the debt being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and timely
completion of the project. This rating, however, while addressing credit quality
subsequent to completion of the project, makes no comment on the likelihood of,
or the risk of default upon failure of, such completion. The investor should
exercise his own judgment with respect to such likelihood and risk.
r: The "r" is attached to highlight derivative, hybrid, and certain other
obligations that S&P believes may experience high volatility or high variability
in expected returns due to noncredit risks. Examples of such obligations are:
securities whose principal or interest return is indexed to equities,
commodities, or currencies; certain swaps and options; and interest-only and
principal-only mortgage securities.
The absence of an "r" symbol should not be taken as an indication that an
obligation will exhibit no volatility or variability in total return.
N.R.: Not rated.
Debt obligations of issuers outside the United States and its territories are
rated on the same basis as domestic corporate and municipal issues. The ratings
measure the creditworthiness of the obligor but do not take into account
currency exchange and related uncertainties.
Note Rating Definitions
SP-1: Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2: Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3: Speculative capacity to pay principal and interest.
Commercial Paper Rating Definitions
A-1: This highest category indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
A-2: Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
A-3: Issues carrying this designation have adequate capacity for timely payment.
They are, however, more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations.
B: Issues rated B are regarded as having only speculative capacity for timely
payment.
C: This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D: Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due, even if
the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period.
A commercial paper rating is not a recommendation to purchase, sell or hold a
security inasmuch as it does not comment as to market price or suitability for a
particular investor. The ratings are based on current information furnished to
S&P by the issuer or obtained by S&P from other sources it considers reliable.
S&P does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended, or withdrawn as a result of changes in, or unavailability of, such
information.
36
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37
<PAGE>
No dealer, salesman or any other person has been authorized to give any
information or to make any representations other than those contained in this
Prospectus and in the related Statement of Additional Information, in connection
with the offer contained in this Prospectus, and, if given or made, such other
information or representations must not be relied upon as having been authorized
by the Trust or the Distributor. This Prospectus and the related Statement of
Additional Information do not constitute an offer by the Trust or by the
Distributor to sell or a solicitation of any offer to buy any of the securities
offered hereby in any jurisdiction to any person to whom it is unlawful to make
such offer in such jurisdiction.
[LOGO] MainStay(R) Funds
NYLIFE Distributors Inc., member NASD, 300 Interpace Parkway,
Building A, Parsippany, NJ 07054, the distributor of The MainStay Funds,
http://www.mainstayfunds.com, is an indirect wholly owned subsidiary
of New York Life Insurance Company.
[LOGO] NEW YORK LIFE
10/97
[GRAPHIC]
38
<PAGE>
THE MAINSTAY FUNDS
STRATEGIC VALUE FUND
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
OCTOBER 22, 1997
- --------------------------------------------------------------------------------
This Statement of Additional Information is not a prospectus and
should be read in conjunction with the Prospectus of the MainStay Strategic
Value Fund dated October 22, 1997, as amended or supplemented from time to time,
a copy of which may be obtained without charge by writing to NYLIFE Distributors
Inc., (the "Distributor") 300 Interpace Parkway, Parsippany, NJ 07054 or by
calling 1-800-MAINSTAY (1-800-624-6782).
The MainStay Strategic Value Fund (the "Fund") is a diversified, open-
end management investment company organized as a separate series of The MainStay
Funds (the "Trust"), a Massachusetts business trust.
No dealer, salesman or any other person has been authorized to give
any information or to make any representations, other than those contained in
this Statement of Additional Information or in the related Prospectus, in
connection with the offers contained herein, and, if given or made, such other
information or representations must not be relied upon as having been authorized
by the Funds or the Distributor. This Statement of Additional Information and
the related Prospectus do not constitute an offer by the Trust or by the
Distributor to sell or a solicitation of any offer to buy any of the securities
offered hereby in any jurisdiction to any person to whom it is unlawful to make
such offer in such jurisdiction.
Shareholder inquiries should be made by writing directly to MainStay
Shareholder Services, Inc., P.O. Box 8401, Boston, Massachusetts 02266-8401, or
by calling 1-800-MAINSTAY. In addition, you can make inquiries through your
registered representative.
<PAGE>
TABLE OF CONTENTS
PAGE IN
STATEMENT OF
ADDITIONAL
INFORMATION
-----------
Repurchase Agreements.................................. 4
Lending of Portfolio Securities........................ 5
Bank Obligations....................................... 6
U.S. Government Securities............................. 6
Debt Securities........................................ 7
Convertible Securities................................. 7
Arbitrage 8
Foreign Securities..................................... 9
Foreign Currency Transactions.......................... 10
Brady Bonds............................................ 13
Municipal Securities................................... 14
Floating and Variable Rate Securities.................. 16
Zero Coupon Bonds...................................... 16
When-Issued Securities................................. 17
Mortgage-Related and Other Asset-Backed Securities..... 17
Short Sales Against the Box............................ 26
Options on Securities.................................. 26
Options on Foreign Currencies.......................... 32
Securities Index Options............................... 35
Futures Transactions................................... 36
Swap Agreements........................................ 47
Loan Participation Interests........................... 49
Risks Associated with Debt Securities.................. 51
Risks of Investing in High Yield Securities ("Junk
Bonds")........................................... 52
ADDITIONAL FUNDAMENTAL INVESTMENT RESTRICTIONS.............. 53
ADDITIONAL NON-FUNDAMENTAL INVESTMENT RESTRICTIONS.......... 54
TRUSTEES AND OFFICERS....................................... 55
THE MANAGER, THE SUB-ADVISER AND THE DISTRIBUTOR............ 63
Management Agreement................................... 63
Sub-Advisory Agreement................................. 64
Distribution Agreement................................. 65
Other Services......................................... 67
Expenses Borne by the Trust............................ 68
PORTFOLIO TRANSACTIONS AND BROKERAGE........................ 69
NET ASSET VALUE............................................. 72
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SHAREHOLDER INVESTMENT ACCOUNT.............................. 75
SHAREHOLDER SERVICING AGENT................................. 75
PURCHASES AND REDEMPTIONS................................... 75
Letter of Intent ("LOI")............................... 75
Suspension of Redemptions.............................. 76
TAX-DEFERRED RETIREMENT PLANS............................... 76
Cash or Deferred Profit Sharing Plans Under Section
401(k) for Corporations and Self-Employed
Individuals 76
Individual Retirement Account ("IRA").................. 77
403(b)(7) Tax Sheltered Account........................ 79
General Information.................................... 79
CALCULATION OF PERFORMANCE QUOTATIONS....................... 80
TAX STATUS.................................................. 84
Taxation of the Fund................................... 84
Character of Distributions to Shareholders -- General.. 85
Discount............................................... 87
Excise Tax............................................. 87
Taxation of Options, Futures and Similar Instruments... 88
Passive Foreign Investment Companies................... 89
Foreign Currency Gains and Losses...................... 91
Commodity Investments.................................. 91
Dispositions of Fund Shares............................ 92
Tax Reporting Requirements............................. 93
Foreign Taxes.......................................... 94
State and Local Taxes - General........................ 95
Explanation of Fund Distributions...................... 95
General Information.................................... 95
ORGANIZATION AND CAPITALIZATION............................. 96
General................................................ 96
Voting Rights.......................................... 96
Shareholder and Trustee Liability...................... 96
OTHER INFORMATION........................................... 98
Independent Accountants................................ 98
Legal Counsel.......................................... 98
Code of Ethics......................................... 98
FINANCIAL STATEMENTS........................................ 98
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The Fund may engage in the following investment practices or invest in the
following instruments to the extent permitted in the Prospectus.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with member banks of the
Federal Reserve System or member firms of the National Association of Securities
Dealers, Inc. that meet the repurchase agreement creditworthiness guidelines
established by the Trustees.
A repurchase agreement, which provides a means for a Fund to earn income on
uninvested cash for periods as short as overnight, is an arrangement under which
the purchaser (i.e., the Fund) purchases a U.S. government or other high quality
short-term debt obligation (the "Obligation") and the seller agrees, at the time
of sale, to repurchase the Obligation at a specified time and price. Repurchase
agreements with foreign banks may be available with respect to government
securities of the particular foreign jurisdiction. The custody of the
Obligation will be maintained by the Fund's Custodian. The value of the
purchased securities, including any accrued interest, will at all times exceed
the value of the repurchase agreement. The repurchase price may be higher than
the purchase price, the difference being income to the Fund, or the purchase and
repurchase prices may be the same, with interest at a stated rate due to the
Fund together with the repurchase price upon repurchase. In either case, the
income to the Fund is unrelated to the interest rate on the Obligation subject
to the repurchase agreement.
The income on repurchase agreements may be subject to federal and state
income taxes when distributed by the Fund as a dividend to shareholders.
For purposes of the 1940 Act, a repurchase agreement is deemed to be a loan
from the Fund to the seller of the Obligation. It is not clear whether a court
would consider the Obligation purchased by the Fund subject to a repurchase
agreement as being owned by the Fund or as being collateral for a loan by the
Fund to the seller. In the event of the commencement of bankruptcy or
insolvency proceedings with respect to the seller of the Obligation before
repurchase of the Obligation under a repurchase agreement, the Fund may
encounter delays and incur costs before being able to sell the security. Delays
may involve loss of interest or decline in price of the Obligation. If the
court characterizes the transaction as a loan and the Fund has not perfected a
security interest in the Obligation, the Fund
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<PAGE>
may be required to return the Obligation to the seller's estate and be treated
as an unsecured creditor of the seller. As an unsecured creditor, the Fund
would be at risk of losing some or all of the principal and income involved in
the transaction. As with any unsecured debt instrument purchased for the Funds,
the Sub-Adviser seeks to minimize the risk of loss from repurchase agreements by
analyzing the creditworthiness of the obligor, in this case the seller of the
Obligation. Apart from the risk of bankruptcy or insolvency proceedings, there
is also the risk that the seller may fail to repurchase the security. However,
if the market value of the Obligation subject to the repurchase agreement
becomes less than the repurchase price (including accrued interest), the Fund
will direct the seller of the Obligation to deliver additional securities so
that the market value of all securities subject to the repurchase agreement
equals or exceeds the repurchase price.
The Fund may enter into reverse repurchase agreements. The Fund will
maintain a segregated account consisting of liquid assets to cover its
obligations under reverse repurchase agreements. The Fund will limit its
investments in reverse repurchase agreements to no more than 5% of its total
assets.
LENDING OF PORTFOLIO SECURITIES
The Fund may seek to increase its income by lending portfolio securities.
Under guidelines adopted by the Fund's Board, such loans may be made to
institutions, such as broker-dealers, and are required to be secured
continuously by collateral in cash or U.S. government securities maintained on a
current basis at an amount at least equal to the market value of the securities
loaned. The Fund would have the right to call a loan and obtain the securities
loaned at any time generally on less than five days' notice. For the duration
of a loan, the Fund would continue to receive the equivalent of the interest or
dividends paid by the issuer on the securities loaned and would also receive
compensation from the investment of the collateral. The Fund would not,
however, have the right to vote any securities having voting rights during the
existence of the loan, but the Fund would call the loan in anticipation of an
important vote to be taken among holders of the securities or of the giving or
withholding of their consent on a material matter affecting the investment. The
Trust, on behalf of the Fund, has entered into an agency agreement with Merrill
Lynch Portfolio Services, Inc. which acts as the Fund's agent in making loans of
portfolio securities and short-term money market investments of the cash
collateral received, under the supervision and control of the Fund's Sub-
Adviser.
B-5
<PAGE>
As with other extensions of credit there are risks of delay in recovery of,
or even loss of rights in, the collateral should the borrower of the securities
fail financially or breach its agreement with the Fund. However, the loans
would be made only to firms deemed by the Sub-Adviser to be creditworthy and
approved by the Board, and when, in the judgment of the Sub-Adviser, the
consideration which can be earned currently from securities loans of this type
justifies the attendant risk. The value of securities loaned will not exceed
33% of the value of the total assets of the Fund. In addition, pursuant to
guidelines adopted by the Board, the Fund is prohibited from lending more than
5% of its assets to any one counterparty.
BANK OBLIGATIONS
Time deposits are nonnegotiable deposits maintained in a banking
institution for a specified period of time at a stated interest rate. Time
deposits which may be held by the Fund will not benefit from insurance from the
Bank Insurance Fund or the Savings Association Insurance Fund administered by
the Federal Deposit Insurance Corporation.
Certificates of deposit are certificates evidencing the obligation of a
bank to repay funds deposited with it for a specified period of time.
Bankers' acceptances are credit instruments evidencing the obligation of a
bank to pay a draft drawn on it by a customer. These instruments reflect the
obligation both of the bank and of the drawer to pay the full amount of the
instrument upon maturity.
Investments in the obligations of banks are deemed to be "cash equivalents"
if, at the date of investment, the banks have capital surplus and individual
profits (as of the date of their most recently published financials) in excess
of $100,000,000, or if, with respect to the obligations of other banks and
savings and loan associations, such obligations are federally insured.
U.S. GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. government or its agencies or
instrumentalities include U.S. Treasury securities, which differ only in their
interest rates, maturities and times of issuance. Treasury bills have initial
maturities of one year or less; Treasury notes have initial maturities of one to
ten years; and Treasury bonds generally have initial maturities of greater than
ten years. Some obligations issued or guaranteed by U.S. government agencies
and instrumentalities, for example, Government National Mortgage Association
("GNMA") pass-
B-6
<PAGE>
through certificates, are supported by the full faith and credit of the U.S.
Treasury; others, such as those of the Federal Home Loan Banks, by the right of
the issuer to borrow from the Treasury; others, such as those issued by the
Federal National Mortgage Association ("FNMA"), by the discretionary authority
of the U.S. government to purchase certain obligations of the agency or
instrumentality; and others, such as those issued by the Student Loan Marketing
Association, only by the credit of the agency or instrumentality. While the
U.S. government provides financial support to such U.S. government-sponsored
agencies or instrumentalities, no assurance can be given that it will always do
so, and it is not so obligated by law. See "Mortgage-Related and Other Asset-
Backed Securities."
DEBT SECURITIES
Debt securities may have fixed, variable or floating (including inverse
floating) rates of interest. To the extent that the Fund invests in debt
securities, it will be subject to certain risks. The value of the debt
securities held by the Fund, and thus the NAV of the shares of the Fund,
generally will fluctuate depending on a number of factors, including, among
others, changes in the perceived creditworthiness of the issuers of those
securities, movements in interest rates, the average maturity of the Fund's
investments, changes in relative values of the currencies in which the Fund's
investments are denominated relative to the U.S. dollar, and the extent to which
the Fund hedges its interest rate, credit and currency exchange rate risks.
Generally, a rise in interest rates will reduce the value of fixed income
securities held by the Fund, and a decline in interest rates will increase the
value of fixed income securities held by the Fund.
CONVERTIBLE SECURITIES
The Fund may invest in securities convertible into common stock or the cash
value of a single equity security or a basket or index of equity securities.
Such investments may be made, for example, if the Sub-Adviser believes that a
company's convertible securities are undervalued in the market. Convertible
securities eligible for inclusion in the Fund's portfolio include convertible
bonds, convertible preferred stocks, warrants or notes or other debt instruments
that may be exchanged for cash payable in an amount that is linked to the value
of a particular security, basket of securities, index or indices of securities
or currencies.
Convertible securities, until converted, have the same general
characteristics as other fixed income securities insofar as they generally
provide a stable stream of income with
B-7
<PAGE>
generally higher yields than those of equity securities of the same or similar
issuers. By permitting the holder to exchange his investment for common stock
or the cash value of a security or a basket or index of securities, convertible
securities may also enable the investor to benefit from increases in the market
price of the underlying securities. Therefore, convertible securities generally
offer lower interest or dividend yields than non-convertible securities of
similar quality.
As with all fixed income securities, the market value of convertible
securities tends to decline as interest rates increase and, conversely, tends to
increase as interest rates decline. The unique feature of the convertible
security is that as the market price of the underlying common stock declines, a
convertible security tends to trade increasingly on a yield basis, and so may
not experience market value declines to the same extent as the underlying common
stock. When the market price of the underlying common stock increases, the
price of a convertible security increasingly reflects the value of the
underlying common stock and may rise accordingly. While no securities
investment is without some risk, investments in convertible securities generally
entail less risk than investments in the common stock of the same issuer.
Holders of fixed income securities (including convertible securities) have
a claim on the assets of the issuer prior to the holders of common stock in case
of liquidation. However, convertible securities are typically subordinated to
similar non-convertible securities of the same issuer.
Accordingly, convertible securities have unique investment characteristics
because (i) they have relatively high yields as compared to common stocks, (ii)
they have defensive characteristics since they provide a fixed return even if
the market price of the underlying common stock declines, and (iii) they provide
the potential for capital appreciation if the market price of the underlying
common stock increases.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the charter provision or indenture pursuant to
which the convertible security is issued. If a convertible security held by the
Fund is called for redemption, the Fund will be required to surrender the
security for redemption, convert it into the underlying common stock or cash or
sell it to a third party.
ARBITRAGE
The Fund may sell in one market a security which it owns and simultaneously
purchase the same security in another market, or
B-8
<PAGE>
it may buy a security in one market and simultaneously sell it in another
market, in order to take advantage of differences between the prices of the
security in the different markets. Although the Fund does not actively engage
in arbitrage, such transactions may be entered into only with respect to debt
securities and will occur only in a dealer's market where the buying and selling
dealers involved confirm their prices to the Fund at the time of the
transaction, thus eliminating any risk to the assets of the Fund.
FOREIGN SECURITIES
The Fund may invest, without limit, subject to the other investment
policies applicable to the Fund, in U.S. dollar-denominated and non-dollar-
denominated foreign debt and equity securities and in certificates of deposit
issued by foreign banks and foreign branches of U.S. banks.
Investors should carefully consider the appropriateness of foreign
investing in light of their financial objectives and goals. While foreign
markets may present unique investment opportunities, foreign investing involves
risks not associated with domestic investing. Securities markets in other
countries are not always as efficient as those in the U.S. and are sometimes
less liquid and more volatile. Other risks involved in investing in the
securities of foreign issuers include differences in accounting, auditing and
financial reporting standards; limited publicly available information; the
difficulty of assessing economic trends in foreign countries; generally higher
commission rates on foreign portfolio transactions; the possibility of
nationalization, expropriation or confiscatory taxation; adverse changes in
investment or exchange control regulations (which may include suspension of the
ability to transfer currency from a country); government interference, including
government ownership of companies in certain sectors, wage and price controls,
or imposition of trade barriers and other protectionist measures; difficulties
in invoking legal process abroad and enforcing contractual obligations;
political, social or economic instability which could affect U.S. investments in
foreign countries; and potential restrictions on the flow of international
capital. Additionally, foreign securities and dividends and interest payable on
those securities may be subject to foreign taxes, including foreign withholding
taxes, and other foreign taxes may apply with respect to securities
transactions. Additional costs associated with an investment in foreign
securities may include higher transaction, custody and foreign currency
conversion costs. In the event of litigation relating to a portfolio
investment, the Fund may encounter substantial difficulties in obtaining and
enforcing judgments against non-U.S. resident individuals and companies.
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<PAGE>
Investment in emerging market countries presents risks in greater degree than,
and in addition to, those presented by investment in foreign issuers in general.
FOREIGN CURRENCY TRANSACTIONS
Many of the foreign securities in which the Fund invests will be
denominated in foreign currencies. Changes in foreign exchange rates will
affect the value of securities denominated or quoted in foreign currencies.
Exchange rate movements can be large and can endure for extended periods of
time, affecting either favorably or unfavorably the value of the Fund's assets.
However, the Fund may, to the extent it invests in foreign securities, enter
into forward foreign currency transactions in order to protect against
uncertainty in the level of future foreign currency exchange rates. The Fund
may enter into contracts to purchase foreign currencies to protect against an
anticipated rise in the U.S. dollar price of securities it intends to purchase
and may enter into contracts to sell foreign currencies to protect against the
decline in value of its foreign currency-denominated portfolio securities due to
a decline in the value of the foreign currencies against the U.S. dollar. In
addition, the Fund may use one currency (or a basket of currencies) to hedge
against adverse changes in the value of another currency (or a basket of
currencies) when exchange rates between the two currencies are correlated.
Foreign currency transactions in which the Fund may engage include forward
foreign currency contracts, currency exchange transactions on a spot (i.e.,
----
cash) basis, put and call options on foreign currencies and foreign exchange
futures contracts. A forward foreign currency exchange contract involves an
obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days (usually less than one year) from the date of the
contract agreed upon by the parties, at a price set at the time of the contract.
These contracts are traded in the interbank market conducted directly between
traders (usually large commercial banks) and their customers. A forward
contract generally has no deposit requirement, and no commissions are charged at
any stage for trades. Although foreign exchange dealers do not charge a fee for
conversion, they do realize a profit based on the difference (the spread)
between the price at which they are buying and selling various currencies.
Normally, consideration of the prospect for currency parities will be
incorporated in a longer term investment decision made with regard to overall
diversification strategies. However, the Sub-Adviser believes that it is
important to have the flexibility to enter into such forward contracts when it
determines that the best interest of the Fund will be served by
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<PAGE>
entering into such a contract. Generally, the Sub-Adviser believes that the
best interest of the Fund will be served if the Fund is permitted to enter into
forward contracts under specified circumstances. First, when the Fund enters
into, or anticipates entering into, a contract for the purchase or sale of a
security denominated in a foreign currency, it may desire to "lock in" the U.S.
dollar price of the security. By entering into a forward contract for the
purchase or sale, for a fixed amount of U.S. dollars, of the amount of foreign
currency involved in the underlying security transaction, the Fund will be able
to insulate itself from a possible loss resulting from a change in the
relationship between the U.S. dollar and the subject foreign currency during the
period between the date on which the security is purchased or sold and the date
on which payment is made or received, although the Fund would also forego any
gain it might have realized had rates moved in the opposite direction. This
technique is sometimes referred to as a "settlement" hedge or "transaction"
hedge.
Second, when the Sub-Adviser believes that the currency of a particular
foreign country may suffer a substantial decline against the U.S. dollar, it may
enter into a forward contract to sell, for a fixed amount of dollars, the amount
of foreign currency approximating the value of some or all of the Fund's
portfolio securities denominated in such foreign currency. Such a hedge
(sometimes referred to as a "position" hedge) will tend to offset both positive
and negative currency fluctuations, but will not offset changes in security
values caused by other factors. The Fund also may hedge the same position by
using another currency (or a basket of currencies) expected to perform in a
manner substantially similar to the hedged currency ("proxy hedge"). The
precise matching of the forward contract amounts and the value of the securities
involved will not generally be possible since the future value of such
securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. With respect to positions that
constitute "transaction" or "position" hedges (including "proxy" hedges), the
Fund will not enter into forward contracts to sell currency or maintain a net
exposure to such contracts if the consummation of such contracts would obligate
the Fund to deliver an amount of foreign currency in excess of the value of the
Fund's portfolio securities or other assets denominated in that currency (or the
related currency, in the case of a "proxy" hedge).
Finally, the Fund may enter into forward contracts to shift its investment
exposure from one currency into another currency that is expected to perform
inversely with respect to the hedged currency relative to the U.S. dollar. This
type of strategy,
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sometimes known as a "cross-currency" hedge, will tend to reduce or eliminate
exposure to the currency that is sold, and increase exposure to the currency
that is purchased, much as if the Fund had sold a security denominated in one
currency and purchased an equivalent security denominated in another. "Cross-
currency" hedges protect against losses resulting from a decline in the hedged
currency, but will cause the Fund to assume the risk of fluctuations in the
value of the currency it purchases.
At the consummation of the forward contract, the Fund may either make
delivery of the foreign currency or terminate its contractual obligation to
deliver the foreign currency by purchasing an offsetting contract obligating it
to purchase at the same maturity date the same amount of such foreign currency.
If the Fund chooses to make delivery of the foreign currency, it may be required
to obtain such currency for delivery through the sale of portfolio securities
denominated in such currency or through conversion of other assets of the Fund
into such currency. If the Fund engages in an offsetting transaction, the Fund
will realize a gain or a loss to the extent that there has been a change in
forward contract prices. Closing purchase transactions with respect to forward
contracts are usually effected with the currency trader who is a party to the
original forward contract.
The Fund's dealing in forward contracts will be limited to the transactions
described above. Of course, the Fund is not required to enter into such
transactions with regard to its foreign currency-denominated securities and will
not do so unless deemed appropriate by the Sub-Adviser. The Fund generally will
not enter into a forward contract with a term of greater than one year.
In cases of transactions which constitute "transaction" hedges, or
"position" hedges (including "proxy" hedges) or "cross-currency" hedges that
involve purchase and sale of two different foreign currencies directly through
the same foreign currency contract, the Fund may deem its forward currency hedge
position to be covered by underlying Fund portfolio securities or may establish
a Segregated Account with its Custodian in an amount equal to the value of the
Fund's total assets committed to the consummation of the subject hedge. The
Segregated Account will consist of liquid assets. In the case of "anticipatory"
hedges and "cross-currency" hedges that involve the purchase and sale of two
different foreign currencies indirectly through separate forward currency
contracts, the Fund will establish a Segregated Account with its Custodian as
described above. In the event the Fund establishes a Segregated Account, the
Fund will mark-to-market the value of the assets in the Segregated Account. If
the value of the liquid assets placed in the Segregated
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Account declines, additional liquid assets will be placed in the account by the
Fund on a daily basis so that the value of the account will equal the amount of
the Fund's commitments with respect to such contracts.
It should be realized that this method of protecting the value of the
Fund's portfolio securities against a decline in the value of a currency does
not eliminate fluctuations in the underlying prices of the securities. It
simply establishes a rate of exchange which can be achieved at some future point
in time. It also reduces any potential gain which may have otherwise occurred
had the currency value increased above the settlement price of the contract.
The Fund cannot assure that the techniques discussed above will be successful.
Successful use of forward contracts depends on the investment manager's skill in
analyzing and predicting relative currency values. Forward contracts alter the
Fund's exposure to currency exchange rate activity and could result in losses to
the Fund if currencies do not perform as the Sub-Adviser anticipates. The Fund
may also incur significant costs when converting assets from one currency to
another. Contracts to sell foreign currency would limit any potential gain
which might be realized by the Fund if the value of the hedged currency
increases.
The Sub-Adviser believes active currency management can be employed as an
overall portfolio risk management tool. For example, in their view, foreign
currency management can provide overall portfolio risk diversification when
combined with a portfolio of foreign securities, and the market risks of
investing in specific foreign markets can at times be reduced by currency
strategies which may not involve the currency in which the foreign security is
denominated.
The Fund's foreign currency transactions may be limited by the requirements
of Subchapter M of the Code for qualification as a regulated investment company.
BRADY BONDS
The Fund may invest a portion of its assets in Brady Bonds, which are
securities created through the exchange of existing commercial bank loans to
sovereign entities for new obligations in connection with debt restructurings.
Brady Bonds may be collateralized or uncollateralized and are issued in various
currencies (primarily the U.S. dollar). Brady bonds are not considered U.S.
government securities.
U.S. dollar-denominated, collateralized Brady Bonds, which may be fixed
rate par bonds or floating rate discount bonds, are generally collateralized in
full as to principal by U.S. Treasury
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<PAGE>
zero coupon bonds having the same maturity as the Brady Bonds. Interest
payments on these Brady Bonds generally are collateralized on a one-year or
longer rolling-forward basis by cash or securities in an amount that, in the
case of fixed rate bonds, is equal to at least one year of interest payments or,
in the case of floating rate bonds, initially is equal to at least one year's
interest payments based on the applicable interest rate at that time and is
adjusted at regular intervals thereafter. Certain Brady Bonds are entitled to
"value recovery payments" in certain circumstances, which in effect constitute
supplemental interest payments but generally are not collateralized. Brady
Bonds are often viewed as having three or four valuation components: (i) the
collateralized repayment of principal at final maturity; (ii) the collateralized
interest payments; (iii) the uncollateralized interest payments; and (iv) any
uncollateralized repayment of principal at maturity (these uncollateralized
amounts constitute the "residual risk").
Brady Bonds involve various risk factors including the history of defaults
with respect to commercial bank loans by public and private entities of
countries issuing Brady Bonds. There can be no assurance that Brady Bonds in
which the Fund may invest will not be subject to restructuring arrangements or
to requests for new credit, which may cause the Fund to suffer a loss of
interest or principal on any of its holdings.
MUNICIPAL SECURITIES
Municipal securities generally are understood to include debt obligations
issued by, or on behalf of, states, territories and possessions of the United
States and their political sub-divisions, agencies and instrumentalities and the
District of Columbia, to obtain funds for various public purposes, including
construction of a wide range of public facilities, refunding of outstanding
obligations, payment of general operating expenses and extensions of loans to
public institutions and facilities. The yields on municipal securities depend
upon a variety of factors, including general economic and monetary conditions,
general money market conditions, general conditions of the municipal securities
market, the financial condition of the issuer, the size of a particular
offering, the maturity of the obligations offered and the rating of the issue or
issues. Municipal securities also may be subject to the provisions of
bankruptcy, insolvency and other laws affecting the rights and remedies of
creditors, such as the Federal Bankruptcy Code, and laws, if any, which may be
enacted by Congress or state legislatures extending the time for payment of
principal or interest, or both, or imposing other constraints upon enforcement
of such obligations or upon the ability of municipalities to levy taxes. There
is also the possibility that, as a result of
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litigation or other conditions, the power or ability of any one or more issuers
to pay, when due, the principal of, and interest on, its or their municipal
securities may be materially and adversely affected.
Municipal Bonds, which meet longer-term capital needs and generally have
maturities of more than one year when issued, have two principal
classifications: general obligation bonds and revenue bonds. Issuers of
general obligation bonds include states, counties, cities, towns and regional
districts. The proceeds of these obligations are used to fund a wide range of
public projects, including construction or improvement of schools, highways and
roads, and water and sewer systems. The basic security behind general
obligation bonds is the issuer's pledge of its full faith, credit and taxing
power for the payment of principal and interest. The taxes that can be levied
for the payment of debt service may be limited or unlimited as to the rate or
amount of special assessments.
A revenue bond is not secured by the full faith, credit and taxing power of
an issuer. Rather, the principal security for a revenue bond is generally the
net revenue derived from a particular facility, group of facilities or, in some
cases, the proceeds of a special excise or other specific revenue source.
Revenue bonds are issued to finance a wide variety of capital projects,
including: electric, gas, water, and sewer systems; highways, bridges, and
tunnels; port and airport facilities; colleges and universities; and hospitals.
Although the principal security behind these bonds may vary, many provide
additional security in the form of a debt service reserve fund which may be used
to make principal and interest payments on the issuer's obligations. Housing
finance authorities have a wide range of security and credit enhancement
guarantees available to them, including partially or fully insured mortgages,
rent subsidized and/or collateralized mortgages, and/or the net revenues from
housing or other public projects. Some authorities are provided further
security in the form of a state's assurance (although without obligation) to
make up deficiencies in the debt service reserve fund.
An entire issue of Municipal Bonds may be purchased by one or a small
number of institutional investors such as the Fund. Thus, the issue may not be
said to be publicly offered. Unlike securities which must be registered under
the Securities Act of 1933 prior to offer and sale, unless an exemption from
such registration is available, Municipal Bonds which are not publicly offered
may nevertheless be readily marketable. A secondary market exists for Municipal
Bonds which were not publicly offered initially.
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<PAGE>
There may be other types of municipal securities that become available
which are similar to the foregoing described municipal securities in which the
Fund may invest.
FLOATING AND VARIABLE RATE SECURITIES
Floating and variable rate securities provide for a periodic adjustment in
the interest rate paid on the obligations. The terms of such obligations must
provide that interest rates are adjusted periodically based upon an interest
rate adjustment index as provided in the respective obligations. The adjustment
intervals may be regular, and range from daily up to annually, or may be based
on an event, such as a change in the prime rate.
The interest rate on a floating rate debt instrument ("floater") is a
variable rate which is tied to another interest rate, such as a money-market
index or Treasury bill rate. The interest rate on a floater resets
periodically, typically every six months. While, because of the interest rate
reset feature, floaters provide the Fund with a certain degree of protection
against rises in interest rates, the Fund will participate in any declines in
interest rates as well.
The interest rate on a leveraged inverse floating rate debt instrument
("inverse floater") resets in the opposite direction from the market rate of
interest to which the inverse floater is indexed. An inverse floater may be
considered to be leveraged to the extent that its interest rate varies by a
magnitude that exceeds the magnitude of the change in the index rate of
interest. The higher degree of leverage inherent in inverse floaters is
associated with greater volatility in their market values. Accordingly, the
duration of an inverse floater may exceed its stated final maturity. Certain
inverse floaters may be deemed to be illiquid securities for purposes of the
Fund's limitations on investments in such securities.
ZERO COUPON BONDS
The Fund may purchase zero coupon bonds, which are debt obligations issued
without any requirement for the periodic payment of interest. Zero coupon bonds
are issued at a significant discount from face value. The discount approximates
the total amount of interest the bonds would accrue and compound over the period
until maturity at a rate of interest reflecting market rate at the time of
issuance. Because interest on zero coupon bonds is not distributed on a current
basis but is, in effect, compounded, zero coupon bonds tend to be subject to
greater market risk than interest paying securities of similar maturities. The
discount represents income, a portion of which the Funds must accrue and
distribute every year even though a
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Fund receives no payment on the investment in that year. Zero coupon bonds tend
to be more volatile than conventional debt securities.
WHEN-ISSUED SECURITIES
The Fund may from time to time purchase securities on a "when-issued"
basis. Debt securities, including municipal bonds, are often issued in this
manner. The price of such securities, which may be expressed in yield terms, is
fixed at the time a commitment to purchase is made, but delivery of and payment
for the when-issued securities take place at a later date. Normally, the
settlement date occurs within one month of the purchase (60 days for municipal
bonds and notes). During the period between purchase and settlement, no payment
is made by the Fund and no interest accrues to the Fund. To the extent that
assets of a Fund are held in cash pending the settlement of a purchase of
securities, the Fund would earn no income; however, it is the Trust's intention
that the Fund will be fully invested to the extent practicable and subject to
the policies stated herein. Although when-issued securities may be sold prior
to the settlement date, the Fund intends to purchase such securities with the
purpose of actually acquiring them unless a sale appears desirable for
investment reasons.
At the time the Trust makes the commitment on behalf of the Fund to
purchase a security on a when-issued basis, it will record the transaction and
reflect the amount due and the value of the security in determining the Fund's
net asset value. The market value of the when-issued security may be more or
less than the purchase price payable at the settlement date. The Trustees do
not believe that the Fund's net asset value or income will be exposed to
additional risk by the purchase of securities on a when-issued basis. The Fund
will establish a segregated account in which it will maintain liquid assets at
least equal in value to commitments for when-issued securities. Such segregated
securities either will mature or, if necessary, be sold on or before the
settlement date.
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES
The Fund may buy mortgage-related securities. Mortgage-related securities
are interests in pools of residential or commercial mortgage loans or leases,
including mortgage loans made by savings and loan institutions, mortgage
bankers, commercial banks and others. Pools of mortgage loans are assembled as
securities for sale to investors by various governmental, government-related and
private organizations (see "Mortgage Pass-Through Securities"). The Fund may
also invest in debt securities which are secured with collateral consisting of
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mortgage-related securities (see "Collateralized Mortgage Obligations"), and in
other types of mortgage-related securities. Like other fixed-income securities,
when interest rates rise, the value of a mortgage-related security generally
will decline; however, when interest rates are declining, the value of a
mortgage-related security with prepayment features may not increase as much as
other fixed-income securities.
MORTGAGE PASS-THROUGH SECURITIES Interests in pools of mortgage-related
--------------------------------
securities differ from other forms of debt securities, which normally provide
for periodic payment of interest in fixed amounts with principal payments at
maturity or specified call dates. Instead, mortgage pass-through securities
provide a monthly payment which consists of both interest and principal
payments. In effect, these payments are a "pass-through" of the monthly
payments made by the individual borrowers on their residential mortgage loans,
net of any fees paid to the issuer or guarantor of such securities. Additional
payments are caused by repayments of principal resulting from the sale of the
underlying residential property, refinancing or foreclosure, net of fees or
costs which may be incurred. Some mortgage-related securities (such as
securities issued by the GNMA) are described as "modified pass-through." These
securities entitle the holder to receive all interest and principal payments
owed on the mortgage pool, net of certain fees, at the scheduled payment dates
regardless of whether or not the mortgagor actually makes the payment. Some
mortgage pass-through certificates may include securities backed by adjustable-
rate mortgages which bear interest at a rate that will be adjusted periodically.
Early repayment of principal on mortgage pass-through securities (arising
from prepayments of principal due to sale of the underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose the Fund to a lower rate of return upon reinvestment of principal. Also,
if a security subject to prepayment has been purchased at a premium, in the
event of prepayment the value of the premium would be lost.
Payment of principal and interest on some mortgage pass-through securities
(but not the market value of the securities themselves) may be guaranteed by the
full faith and credit of the U.S. government (in the case of securities
guaranteed by GNMA); or guaranteed by agencies or instrumentalities of the U.S.
Government (in the case of securities guaranteed by FNMA or FHLMC, which are
supported only by the discretionary authority of the U.S. government to purchase
the agency's obligations).
The principal governmental guarantor of mortgage-related securities is the
GNMA. GNMA is a wholly owned U.S. government
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<PAGE>
corporation within the U.S. Department of Housing and Urban Development ("HUD").
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
government, the timely payment of principal and interest on securities issued by
institutions approved by GNMA (such a savings and loan institutions, commercial
banks and mortgage bankers) and backed by pools of FHA-insured or VA-guaranteed
mortgages.
Government-related guarantors (i.e., not backed by the full faith and
credit of the U.S. government) include the FNMA and the FHLMC. FNMA is a
government-sponsored corporation owned entirely by private stockholders. It is
subject to general regulation by the Secretary of Housing and Urban Development
and acts as a government instrumentality under authority granted by Congress.
FNMA purchases conventional (i.e., not insured or guaranteed by any government
agency) residential mortgages from a list of approved seller/servicers which
include state and federally chartered savings and loan associations, mutual
savings banks, commercial banks and credit unions and mortgage bankers. Pass-
through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA but are not backed by the full faith and credit
of the U.S. government. FNMA is authorized to borrow from the U.S. Treasury to
meet its obligations.
FHLMC was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. It is a government-
sponsored corporation and acts as a government instrumentality under authority
granted by Congress. FHLMC was formerly owned by the twelve Federal Home Loan
Banks and is now owned entirely by private stockholders. FHLMC issues
Participation Certificates ("PCs") which represent interests in conventional
mortgages from FHLMC's national portfolio. FHLMC guarantees the timely payment
of interest and collection of principal, but PCs are not backed by the full
faith and credit of the U.S. government.
If either fixed or variable rate pass-through securities issued by the U.S.
government or its agencies or instrumentalities are developed in the future, the
Fund reserves the right to invest in them.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create pass-
through pools of conventional residential mortgage loans. Such issuers may, in
addition, be the originators and/or servicers of the underlying mortgage loans
as well as the guarantors of the mortgage-related securities. Pools created by
such non-governmental issuers generally offer a higher rate of interest than
government and
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government-related pools because there are no direct or indirect government or
agency guarantees of payments in the former pools. However, timely payment of
interest and principal of these pools may be supported by various forms of
insurance or guarantees, including individual loan, title, pool and hazard
insurance and letters of credit. The insurance and guarantees are issued by
governmental entities, private insurers and the mortgage poolers. Such
insurance and guarantees and the creditworthiness of the issuers thereof will be
considered in determining whether a mortgage-related security meets the Fund's
investment quality standards. There can be no assurance that the private
insurers or guarantors can meet their obligations under the insurance policies
or guarantee arrangements. The Fund may buy mortgage-related securities without
insurance or guarantees if, through an examination of the loan experience and
practices of the originator/servicers and poolers, the Sub-Adviser determines
that the securities meet the Fund's quality standards.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES The mortgage-related
--------------------------------------------
securities in which the Fund may invest may be: (i) privately issued securities
which are collateralized by pools of mortgages in which each mortgage is
guaranteed as to payment of principal and interest by an agency or
instrumentality of the U.S. government; (ii) privately issued securities which
are collateralized by pools of mortgages in which payment of principal and
interest is guaranteed by the issuer and such guarantee is collateralized by
U.S. government securities; and (iii) other privately issued securities in which
the proceeds of the issuance are invested in mortgage-backed securities and
payment of the principal and interest is supported by the credit of an agency or
instrumentality of the U.S. government.
Although the market for non-government mortgage pass-through securities is
becoming increasingly liquid, securities issued by certain private organizations
may not be readily marketable. The Fund will not purchase mortgage-related
securities or any other assets which in the Sub-Adviser's opinion are illiquid
if, as a result, more than 15% of the value of the Fund's total assets will be
illiquid.
COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) A CMO is a hybrid between a
------------------------------------------
mortgage-backed bond and a mortgage pass-through security. Interest and prepaid
principal is paid, in most cases, semiannually. CMOs may be collateralized by
whole mortgage loans, but are more typically collateralized by portfolios of
mortgage pass-through securities guaranteed by GNMA, FHLMC, or FNMA and their
income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will
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depend upon the prepayment experience of the collateral. CMOs are structured
into multiple classes, each bearing a different stated maturity - actual
maturing and average life will depend upon the prepayment experience of the
collateral. CMOs provide for a modified form of call protection through a de
--
facto breakdown of the underlying pool of mortgages according to how quickly the
- -----
loans are repaid. Monthly payment of principal received from the pool of
underlying mortgages, including prepayments, is first returned to investors
holding the shortest maturity class. Investors holding the longer maturity
classes receive principal only after the first class has been retired. An
investor is partially guarded against a sooner than desired return of principal
because of the sequential payments.
In a typical CMO transaction, a corporation ("issuer") issues multiple
series (e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond Offering
are used to purchase mortgages or mortgage pass-through certificates
("Collateral"). The Collateral is pledged to a third-party trustee as security
for the Bonds. Principal and interest payments from the Collateral are used to
pay principal on the Bonds in the order A, B, C, Z. The Series A, B, and C
Bonds all bear current interest. Interest on the Series Z Bond is accrued and
added to principal and a like amount is paid as principal on the Series A, B or
C Bond currently being paid off. When the Series A, B and C Bonds are paid in
full, interest and principal on the Series Z Bond begins to be paid currently.
With some CMOs, the issuer serves as a conduit to allow loan originators
(primarily builders or savings and loan associations) to borrow against their
loan portfolios.
FHLMC COLLATERALIZED MORTGAGE OBLIGATIONS FHLMC CMOs are debt obligations
-----------------------------------------
of FHLMC issued in multiple classes having different maturity dates which are
secured by the pledge of a pool of conventional mortgage loans purchased by
FHLMC. Unlike FHLMC PCs, payments of principal and interest on the CMOs are
made semiannually, as opposed to monthly. The amount of principal payable on
each semiannual payment date is determined in accordance with FHLMC's mandatory
sinking fund schedule, which, in turn, is equal to approximately 100% of FHA
prepayment experience applied to the mortgage collateral pool. All sinking fund
payments in the CMOs are allocated to the retirement of the individual classes
of bonds in the order of their stated maturities. Payment of principal on the
mortgage loans in the collateral pool in excess of the amount of FHLMC's minimum
sinking fund obligation for any payment date are paid to the holders of the CMOs
as additional sinking fund payments. Because of the "pass-through" nature of
all principal payments received on the collateral pool in excess of FHLMC's
minimum sinking fund requirement, the rate at which principal of the CMOs is
actually
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repaid is likely to be such that each class of bonds will be retired in advance
of its scheduled maturity date.
If collection of principal (including prepayments) on the mortgage loans
during any semiannual payment period is not sufficient to meet FHLMC's minimum
sinking fund obligation on the next sinking fund payment date, FHLMC agrees to
make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the CMOs are identical
to those of FHLMC PCs. FHLMC has the right to substitute collateral in the
event of delinquencies and/or defaults.
OTHER MORTGAGE-RELATED SECURITIES Other mortgage-related securities
---------------------------------
include securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage loans
on real property, including CMO residuals or stripped mortgage-backed
securities, and may be structured in classes with rights to receive varying
proportions of principal and interest. Other mortgage-related securities may be
equity or debt securities 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, homebuilders, mortgage banks,
commercial banks, investment banks, partnerships, trusts and special purpose
entities of the foregoing.
CMO RESIDUALS CMO residuals are derivative mortgage securities 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,
homebuilders, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the
CMOs and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets.
In particular, the yield to maturity on CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
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interest-only ("IO") class of stripped mortgage-backed securities. See
"Stripped Mortgage-Backed Securities." In addition, if a series of a CMO
includes a class that bears interest at an adjustable rate, the yield to
maturity on the related CMO residual will also be extremely sensitive to changes
in the level of the index upon which interest rate adjustments are based. As
described below with respect to stripped mortgage-backed securities, in certain
circumstances a portfolio may fail to recoup fully its initial investment in a
CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has only very recently developed and, accordingly, CMO residuals
currently may not have the liquidity of other more established securities
trading in other markets. Transactions in CMO residuals are generally completed
only after careful review of the characteristics of the securities in question.
In addition, CMO residuals may or, pursuant to an exemption therefrom, may not
have been registered under the Securities Act of 1933, as amended. CMO
residuals, whether or not registered under such Act, may be subject to certain
restrictions on transferability, and may be deemed "illiquid" and subject to the
Fund's limitations on investment in illiquid securities.
Under certain circumstances, the Fund's investment in residual interests in
"real estate mortgage investment conduits" ("REMICs") may cause shareholders of
the Fund to be deemed to have taxable income in addition to their Fund dividends
and distributions and such income may not be eligible to be reduced for tax
purposes by certain deductible amounts, including net operating loss deductions.
In addition, in some cases, the Fund may be required to pay taxes on certain
amounts deemed to be earned from a REMIC residual. Prospective investors may
wish to consult their tax advisors regarding REMIC residual investments by the
Fund.
CMOs and REMICs may offer a higher yield than U.S. government securities,
but they may also be subject to greater price fluctuation and credit risk. In
addition, CMOs and REMICs typically will be issued in a variety of classes or
series, which have different maturities and are retired in sequence. Privately
issued CMOs and REMICs are not government securities nor are they supported in
any way by any governmental agency or instrumentality. In the event of a
default by an issuer of a CMO or a REMIC, there is no assurance that the
collateral securing such CMO or REMIC will be sufficient to pay principal and
interest. It is possible that there will be limited opportunities for trading
CMOs and REMICs in the over-the-counter
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market, the depth and liquidity of which will vary from time to time. Under
recent legislation, holders of "residual" interests in REMICs (including the
Fund) could be required to recognize potential phantom income, as could
shareholders (including unrelated business taxable income for tax-exempt
shareholders) of funds that hold such interests. The Fund will consider this
legislation in determining whether to invest in residual interests.
STRIPPED MORTGAGE-BACKED SECURITIES Stripped mortgage-backed securities
-----------------------------------
("SMBS") are derivative multi-class mortgage securities. SMBS 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 entities
of the foregoing.
SMBS 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 SMBS 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 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 a Fund's yield to
maturity from these securities. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, a Fund may fail to fully
recoup its initial investment in these securities even if the security is in one
of the highest rating categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently developed. As a result, established trading markets have not
yet developed and, accordingly, these securities may be deemed "illiquid" and
subject to the Fund's limitations on investment in illiquid securities.
RISKS ASSOCIATED WITH MORTGAGE-BACKED SECURITIES The value of some
------------------------------------------------
mortgage-backed securities in which the Fund may invest may be particularly
sensitive to changes in prevailing interest rates, and, like the other
investments of the Fund, the ability of the Fund to successfully utilize these
instruments may depend in part upon the ability of the Sub-Adviser to forecast
interest
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<PAGE>
rates and other economic factors correctly. If the Sub-Adviser incorrectly
forecasts such factors and has taken a position in mortgage-backed securities
that is or becomes contrary to prevailing market trends, the Fund could be
exposed to the risk of a loss.
Investment in mortgage-backed securities poses several risks, including
prepayment, market, and credit risk. Prepayment risk reflects the chance that
borrowers may prepay their mortgages faster than expected, thereby affecting the
investment's average life and perhaps its yield. Whether or not a mortgage loan
is prepaid is almost entirely controlled by the borrower. Borrowers are most
likely to exercise their prepayment options at a time when it is least
advantageous to investors, generally prepaying mortgages as interest rates fall,
and slowing payments as interest rates rise. Besides the effect of prevailing
interest rates, the rate of prepayment and refinancing of mortgages may also be
affected by home value appreciation, ease of the refinancing process and local
economic conditions.
Market risk reflects the chance that the price of the security may
fluctuate over time. The price of mortgage-backed securities may be
particularly sensitive to prevailing interest rates, the length of time the
security is expected to be outstanding, and the liquidity of the issue. In a
period of unstable interest rates, there may be decreased demand for certain
types of mortgage-backed securities, and if the Fund is invested in such
securities and wishes to sell them may find it difficult to find a buyer, which
may in turn decrease the price at which they may be sold.
Credit risk reflects the chance that the Fund may not receive all or part
of its principal because the issuer or credit enhancer has defaulted on its
obligations. Obligations issued by U.S. government-related entities are
guaranteed as to the payment of principal and interest, but are not backed by
the full faith and credit of the U.S. government. The performance of private
label mortgage-backed securities, issued by private institutions, is based on
the financial health of those institutions.
OTHER ASSET-BACKED SECURITIES Several types of asset-backed securities
-----------------------------
have already been offered to investors, including CARS/SM/ ("Certificates for
Automobile Receivables/SM/"). CARS/SM/ represent undivided fractional interests
in a trust ("trust") whose assets consist of a pool of motor vehicle retail
installment sales contracts and security interests in the vehicles securing the
contracts. Payments of principal and interest on CARS/SM/ are passed-through
monthly to certificate holders, and are guaranteed up to certain amounts and for
a certain time period by a letter of credit issued by a financial
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<PAGE>
institution unaffiliated with the trustee or originator of the trust. An
investor's return on CARS/SM/ may be affected by early prepayment of principal
on the underlying vehicle sales contracts. If the letter of credit is
exhausted, the trust may be prevented from realizing the full amount due on a
sales contract because of state law requirements and restrictions relating to
foreclosure sales of vehicles and the obtaining of deficiency judgments
following such sales or because of depreciation, damage or loss of a vehicle,
the application of federal and state bankruptcy and insolvency laws, or other
factors. As a result, certificate holders may experience delays in payments or
losses if the letter of credit is exhausted.
The Sub-Adviser expects that other asset-backed securities (unrelated to
mortgage loans) will be offered to investors in the future. Consistent with its
investment objectives and policies, the Fund also may invest in other types of
asset-backed securities.
SHORT SALES AGAINST THE BOX
A short sale is a transaction in which the Fund sells through a broker a
security it does not own in anticipation of a possible decline in market price.
A short sale "against the box" is a short sale in which, at the time of the
short sale, the Fund owns or has the right to obtain securities equivalent in
kind and amount. The Fund will only enter into short sales against the box.
The Fund may enter into a short sale against the box, among other reasons, to
hedge against a possible market decline in the value of the security owned by
the Fund. If the value of a security sold short against the box increases, the
Fund would suffer a loss when it purchases or delivers to the selling broker the
security sold short. The proceeds of the short sale are retained by the broker
pursuant to applicable margin rules. In addition, the Fund may segregate
assets, equal in value to 50% of the value of the short sale, in a special
account with the Fund's custodian. The segregated assets are pledged to the
broker pursuant to applicable margin rules. If a broker, with which the Fund
has open short sales, were to become bankrupt, the Fund could experience losses
or delays in recovering gains on short sales. The Fund will only enter into
short sales against the box with brokers the Sub-Adviser believes are
creditworthy. Short sales against the box will be limited to no more than 25%
of the Fund's assets.
OPTIONS ON SECURITIES
WRITING CALL OPTIONS The Fund may sell ("write") covered call options on
--------------------
the portfolio securities of the Fund in an attempt to enhance investment
performance. A call option sold by
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<PAGE>
the Fund is a short-term contract, having a duration of nine months or less,
which gives the purchaser of the option the right to buy, and imposes on the
writer of the option--in return for a premium received--the obligation to sell,
the underlying security at the exercise price upon the exercise of the option at
any time prior to the expiration date, regardless of the market price of the
security during the option period. A call option may be covered by, among other
things, the writer owning the underlying security throughout the option period,
or by holding, on a share-for-share basis, a call on the same security as the
call written, where the exercise price of the call held is equal to or less than
the price of the call written, or greater than the exercise price of a call
written if the difference is maintained by the Fund in liquid assets in a
segregated account with its custodian.
The Fund will write covered call options both to reduce the risks
associated with certain of its investments and to increase total investment
return through the receipt of premiums. In return for the premium income, the
Fund will give up the opportunity to profit from an increase in the market price
of the underlying security above the exercise price so long as its obligations
under the contract continue, except insofar as the premium represents a profit.
Moreover, in writing the call option, the Fund will retain the risk of loss
should the price of the security decline, which loss the premium is intended to
offset in whole or in part. The Fund, in writing call options, must assume that
the call may be exercised at any time prior to the expiration of its obligations
as a writer, and that in such circumstances the net proceeds realized from the
sale of the underlying securities pursuant to the call may be substantially
below the prevailing market price. Covered call options and the securities
underlying such options will be listed on national securities exchanges, except
for certain transactions in options on debt securities and foreign securities.
During the option period, the covered call writer has, in return for the
premium received on the option, given up the opportunity to profit from a price
increase in the underlying securities above the exercise price, but, as long as
its obligation as a writer continues, has retained the risk of loss should the
price of the underlying security decline.
The Fund may protect itself from further losses due to a decline in value
of the underlying security or from the loss of ability to profit from
appreciation by buying an identical option, in which case the purchase cost may
offset the premium. In order to do this, the Fund makes a "closing purchase
transaction"--the purchase of a call option on the same security with the same
exercise price and expiration date as the covered
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<PAGE>
call option which it has previously written on any particular security. The
Fund will realize a gain or loss from a closing purchase transaction if the
amount paid to purchase a call option in a closing transaction is less or more
than the amount received from the sale of the covered call option. Also,
because increases in the market price of a call option will generally reflect
increases in the market price of the underlying security, any loss resulting
from the closing out of a call option is likely to be offset in whole or in part
by unrealized appreciation of the underlying security owned by the Fund. When a
security is to be sold from the Fund's portfolio, the Fund will first effect a
closing purchase transaction so as to close out any existing covered call option
on that security.
A closing purchase transaction may be made only on a national or foreign
securities exchange (an "Exchange") which provides a secondary market for an
option with the same exercise price and expiration date, except as discussed
below. There is no assurance that a liquid secondary market on an Exchange or
otherwise will exist for any particular option, or at any particular time, and
for some options no secondary market on an Exchange or otherwise may exist. If
the Fund is unable to effect a closing purchase transaction involving an
exchange-traded option, the Fund will not sell the underlying security until the
option expires or the Fund delivers the underlying security upon exercise. A
closing purchase transaction for an over-the-counter option may be made only
with the other party to the option. Once an option writer has received an
exercise notice, it cannot effect a closing purchase transaction in order to
terminate its obligation under the option and must deliver or purchase the
underlying securities at the exercise price.
The Fund pays brokerage commissions and dealer spreads in connection with
writing covered call options and effecting closing purchase transactions, as
well as for purchases and sales of underlying securities. The writing of
covered call options could result in significant increases in the Fund's
portfolio turnover rate, especially during periods when market prices of the
underlying securities appreciate. Subject to the limitation that all call and
put option writing transactions be covered, the Fund may, to the extent
determined appropriate by the Sub-Adviser, engage without limitation in the
writing of options on U.S. government securities.
WRITING PUT OPTIONS The Fund may also write covered put options. Put
-------------------
options written by the Fund are agreements by the Fund, for a premium received
by the Fund, to purchase specified securities at a specified price if the option
is exercised during the option period. A put option written by the Fund is
"covered" if the Fund maintains liquid assets with a value equal to the
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<PAGE>
exercise price in a segregated account with its custodian. A put option is also
"covered" if the Fund holds on a share-for-share basis a put on the same
security as the put written, where the exercise price of the put held is equal
to or greater than the exercise price of the put written, or less than the
exercise price of the put written if the difference is maintained by the Fund in
liquid assets in a segregated account with its custodian.
The premium which the Fund receives from writing a put option will reflect,
among other things, the current market price of the underlying security, the
relationship of the exercise price to such market price, the historical price
volatility of the underlying security, the option period, supply and demand and
interest rates.
A covered put writer assumes the risk that the market price for the
underlying security will fall below the exercise price, in which case the writer
could be required to purchase the security at a higher price than the then-
current market price of the security. In both cases, the writer has no control
over the time when it may be required to fulfill its obligation as a writer of
the option.
The Fund may effect a closing purchase transaction to realize a profit on
an outstanding put option or to prevent an outstanding put option from being
exercised. The Fund also may effect a closing purchase transaction, in the case
of a put option, to permit the Fund to maintain its holdings of the deposited
U.S. Treasury obligations, to write another put option to the extent that the
exercise price thereof is secured by the deposited U.S. Treasury obligations, or
to utilize the proceeds from the sale of such obligations to make other
investments.
If the Fund is able to enter into a closing purchase transaction, the Fund
will realize a profit or loss from such transaction if the cost of such
transaction is less or more than the premium received from the writing of the
option respectively. After writing a put option, the Fund may incur a loss
equal to the difference between the exercise price of the option and the sum of
the market value of the underlying security plus the premium received from the
sale of the option.
In addition, the Fund may also write straddles (combinations of covered
puts and calls on the same underlying security). The extent to which the Fund
may write covered put and call options and enter into so-called "straddle"
transactions involving put or call options may be limited by the requirements of
the Internal Revenue Code of 1986, as amended (the "Code") for qualification as
a regulated investment company and the Trust's intention that the Fund qualify
as such. Subject to the limitation that all
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<PAGE>
call and put option writing transactions be covered, the Fund may, to the extent
determined appropriate by the Sub-Adviser, engage without limitation in the
writing of options on U.S. government securities.
PURCHASING OPTIONS The Fund may purchase put or call options which are
------------------
traded on an Exchange or in the over-the-counter market. Options traded in the
over-the-counter market may not be as actively traded as those listed on an
Exchange. Accordingly, it may be more difficult to value such options and to be
assured that they can be closed out at any time. The Fund will engage in such
transactions only with firms the Sub-Adviser deems to be of sufficient
creditworthiness so as to minimize these risks.
The Fund may purchase put options on securities to protect its holdings in
an underlying or related security against a substantial decline in market value.
Securities are considered related if their price movements generally correlate
with one another. The Fund would buy a put option in anticipation of a decline
in the market value of such securities. The purchase of a put option would
entitle the Fund, in exchange for the premium paid, to sell a security at a
specified price upon exercise of the option during the option period. The
purchase of put options on securities held in the portfolio or related to such
securities will enable the Fund to preserve, at least partially, unrealized
gains occurring prior to the purchase of the option on a portfolio security
without actually selling the security. In addition, the Fund will continue to
receive interest or dividend income on the security. The put options purchased
by the Fund may include, but are not limited to, "protective puts" in which the
security to be sold is identical or substantially identical to a security
already held by the Fund or to a security which the Fund has the right to
purchase. The Fund would ordinarily recognize a gain if the value of the
securities decreased during the option period below the exercise price
sufficiently to cover the premium. The Fund would recognize a loss if the value
of the securities remained above the difference between the exercise price and
the premium.
The Fund may also purchase call options on securities the Fund intends to
purchase to protect against substantial increases in prices of such securities
pending their ability to invest in an orderly manner in such securities. The
purchase of a call option would entitle the Fund, in exchange for the premium
paid, to purchase a security at a specified price upon exercise of the option
during the option period. The Fund would ordinarily realize a gain if the value
of the securities increased during the option period above the exercise price
sufficiently to cover the premium. The Fund would have a loss if the value of
the
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<PAGE>
securities remained below the sum of the premium and the exercise price during
the option period. In order to terminate an option position, the Fund may sell
put or call options identical to those previously purchased, which could result
in a net gain or loss depending on whether the amount received on the sale is
more or less than the premium and other transaction costs paid on the put or
call option when it was purchased.
MARRIED PUTS The Fund may each engage in a strategy known as "married
------------
puts." This strategy is most typically used when the Fund owns a particular
common stock or security convertible into the common stock and wishes to effect
a short sale against the box (see "short sales against the box") but for various
---
reasons is unable to do so. The Fund may then enter into a series of stock and
related option transactions to achieve the economic substance of a short sale
against the box. To implement this trading strategy, the Fund will
simultaneously execute with the same broker a series of related transactions.
The Fund will purchase shares of the common stock and an "in the money" over-
the-counter put option to sell the common to the broker and will write an over-
the-counter "out of the money" call option in the same stock with the same
exercise price as the put option. The options are linked and may not be
exercised, transferred or terminated independently of the other.
Holding the put option places the Fund in a position to profit on the
decline in price of the security just as it would by effecting a short sale and
to, thereby, hedge against possible losses in the value of a security or
convertible security held by the Fund. The writer of the put option requires
that the Fund write the call option which would enable the broker to profit in
the event the price of the stock rises above the exercise price of the stock
(see "writing call options" above). In the event the stock price were to
- ----
increase above the strike or exercise price of the option the Fund would suffer
a loss unless it first terminated the call by exercising the put.
SPECIAL RISKS ASSOCIATED WITH OPTIONS ON SECURITIES Exchange markets in
---------------------------------------------------
U.S. government securities options are a relatively new and untested concept,
and it is impossible to predict the amount of trading interest that may exist
in such options. The same types of risk apply to over-the-counter trading in
options. There can be no assurance that viable markets will develop or continue
in the United States or abroad.
The Fund's purpose in selling covered options is to realize greater income
than would be realized on portfolio securities
B-31
<PAGE>
transactions alone. The Fund may forego the benefits of appreciation on
securities sold pursuant to call options, or pay a higher price for securities
acquired pursuant to put options written by the Fund. If a put or call option
purchased by the Fund is not sold when it has remaining value, and if the market
price of the underlying security, in the case of a put, remains equal to or
greater than the exercise price, or, in the case of a call, remains less than or
equal to the exercise price, the Fund will not be able to exercise profitably
the option and will lose its entire investment in the option. Also, the price
of a put or call option purchased to hedge against price movements in a related
security may move more or less than the price of the related security.
The Fund would ordinarily realize a gain if the value of the securities
increased during the option period above the exercise price sufficiently to
cover the premium. The Fund would have a loss if the value of the securities
remained below the sum of the premium paid and the exercise price during the
option period. The ability of the Fund to successfully utilize options may
depend in part upon the ability of the Sub-Adviser to forecast interest rates
and other economic factors correctly.
The hours of trading for options on securities may not conform to the hours
during which the underlying securities are traded. To the extent that the
options markets close before the markets for the underlying securities,
significant price and rate movements can take place in the underlying markets
that cannot be reflected in the options markets.
OPTIONS ON FOREIGN CURRENCIES
The Fund may, to the extent that it invests in foreign securities, purchase
and write options on foreign currencies for hedging purposes in a manner similar
to that of the Fund's transactions in currency futures contracts or forward
contracts. For example, a decline in the dollar value of a foreign currency in
which portfolio securities are denominated will reduce the dollar value of such
securities, even if their value in the foreign currency remains constant. In
order to protect against such declines in the value of portfolio securities, the
Fund may purchase put options on the foreign currency. If the value of the
currency does decline, the Fund will have the right to sell such currency for a
fixed amount of dollars which exceeds the
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<PAGE>
market value of such currency, resulting in a gain that may offset, in whole or
in part, the negative effect of currency depreciation on the value of the Fund's
securities denominated in that currency.
Conversely, if a rise in the dollar value of a currency in which securities
to be acquired are denominated is projected, thereby increasing the cost of such
securities, the Fund may purchase call options on such currency. If the value
of such currency does increase, the purchase of such call options would enable
the Fund to purchase currency for a fixed amount of dollars which is less than
the market value of such currency, resulting in a gain that may offset, at least
partially, the effect of any currency-related increase in the price of
securities the Fund intends to acquire. As in the case of other types of
options transactions, however, the benefit the Fund derives from purchasing
foreign currency options will be reduced by the amount of the premium and
related transaction costs. In addition, if currency exchange rates do not move
in the direction or to the extent anticipated, the Fund could sustain losses on
transactions in foreign currency options which would deprive it of a portion or
all of the benefits of advantageous changes in such rates.
The Fund may also write options on foreign currencies for hedging purposes.
For example, if the Fund anticipates a decline in the dollar value of foreign
currency-denominated securities due to declining exchange rates, it could,
instead of purchasing a put option, write a call option on the relevant
currency. If the expected decline occurs, the option will most likely not be
exercised, and the decrease in value of portfolio securities will be offset by
the amount of the premium received by the Fund.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, the Fund
could write a put option on the relevant currency. If rates move in the manner
projected, the put option will expire unexercised and allow the Fund to offset
such increased cost up to the amount of the premium. As in the case of other
types of options transactions, however, the writing of a foreign currency option
will constitute only a partial hedge up to the amount of the premium, and only
if rates move in the expected direction. If unanticipated exchange rate
fluctuations occur, the option may be exercised and the Fund would be required
to purchase or sell the underlying currency at a loss which may not be fully
offset by the amount of the premium. As a result of
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<PAGE>
writing options on foreign currencies, the Fund also may be required to forgo
all or a portion of the benefits which might otherwise have been obtained from
favorable movements in currency exchange rates.
A call option written on foreign currency by the Fund is "covered" if the
Fund owns the underlying foreign currency subject to the call or securities
denominated in that currency or has an absolute and immediate right to acquire
that foreign currency without additional cash consideration (or for additional
cash consideration held in a segregated account by its custodian) upon
conversion or exchange of other foreign currency held in its portfolio. A call
option is also covered if the Fund holds a call on the same foreign currency for
the same principal amount as the call written where the exercise price of the
call held (a) is equal to or less than the exercise price of the call written or
(b) is greater than the exercise price of the call written if the amount of the
difference is maintained by the Fund in liquid assets in a segregated account
with its custodian.
As with other kinds of options transactions, the writing of an option on
foreign currency will constitute only a partial hedge up to the amount of the
premium received and the Fund could be required to purchase or sell foreign
currencies at disadvantageous exchange rates, thereby incurring losses. The
purchase of an option on foreign currency may constitute an effective hedge
against exchange rate fluctuations, although, in the event of rate movements
adverse to the Fund's position, the Fund may forfeit the entire amount of the
premium plus related transaction costs. Options on foreign currencies to be
written or purchased by the Fund will be traded on U.S. and foreign exchanges or
over-the-counter.
The Fund also may use foreign currency options to protect against potential
losses in positions denominated in one foreign currency against another foreign
currency in which the Fund's assets are or may be denominated. There can be no
assurance that a liquid market will exist when the Fund seeks to close out an
option position. Furthermore, if trading restrictions or suspensions are
imposed on the options markets, the Fund may be unable to close out a position.
Currency options traded on U.S. or other exchanges may be subject to
position limits which may limit the ability of the
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<PAGE>
Fund to reduce foreign currency risk using such options. Over-the-counter
options differ from traded options in that they are two-party contracts with
price and other terms negotiated between buyer and seller and generally do not
have as much market liquidity as exchanged-traded options. Foreign currency
exchange-traded options generally settle in cash, whereas options traded over-
the-counter may settle in cash or result in delivery of the underlying currency
upon exercise of the option.
SECURITIES INDEX OPTIONS
The Fund may purchase call and put options on securities indexes for the
purpose of hedging against the risk of unfavorable price movements which may
adversely affect the value of the Fund's securities.
Unlike a securities option, which gives the holder the right to purchase or
sell specified securities at a specified price, an option on a securities index
gives the holder the right to receive a cash "exercise settlement amount" equal
to (i) the difference between the value of the underlying securities index on
the exercise date and the exercise price of the option, multiplied by (ii) a
fixed "index multiplier." In exchange for undertaking the obligation to make
such a cash payment, the writer of the securities index option receives a
premium.
A securities index fluctuates with changes in the market values of the
securities included in the index. For example, some securities index options
are based on a broad market index such as the S&P 500 Composite Price Index or
the N.Y.S.E. Composite Index, or a narrower market index such as the S&P 100
Index. Indexes may also be based on an industry or market segment such as the
AMEX Oil and Gas Index or the Computer and Business Equipment Index. Options on
stock indexes are currently traded on the following exchanges, among others:
The Chicago Board Options Exchange, New York Stock Exchange, and American Stock
Exchange.
The effectiveness of hedging through the purchase of securities index
options will depend upon the extent to which price movements in the portion of
the securities portfolio being hedged correlate with price movements in the
selected securities index. Perfect correlation is not possible because the
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<PAGE>
securities held or to be acquired by the Fund will not exactly match the
securities represented in the securities indexes on which options are based. In
addition, the purchase of securities index options involves essentially the same
risks as the purchase of options on futures contracts. The principal risk is
that the premium and transaction costs paid by the Fund in purchasing an option
will be lost as a result of unanticipated movements in prices of the securities
comprising the securities index on which the option is based. Gains or losses
on the Fund's transactions in securities index options depend on price movements
in the securities market generally (or, for narrow market indexes, in a
particular industry or segment of the market) rather than the price movements of
individual securities held by the Fund. In this respect, purchasing a
securities index put (or call) option is analogous to the purchase of a put (or
call) on a securities index futures contract.
The Fund may sell securities index options prior to expiration in order to
close out its positions in securities index options which it has purchased. The
Fund may also allow options to expire unexercised.
FUTURES TRANSACTIONS
The Fund may purchase and sell futures contracts on debt securities and on
indexes of debt securities in order to attempt to protect against the effects of
adverse changes in interest rates, to lengthen or shorten the average maturity
or duration of the Fund's portfolio and for other appropriate risk management
purposes. For example, the Fund may purchase futures contracts as a substitute
for the purchase of longer-term debt securities to lengthen the average duration
of the Fund's portfolio of fixed-income securities. Such futures contracts
would obligate the Fund to make or take delivery of certain debt securities or
an amount of cash upon expiration of the futures contract, although most futures
positions typically are closed out through an offsetting transaction prior to
expiration. The Fund may also purchase and sell stock index futures to hedge
the equity portion of the Fund's securities portfolio with regard to market
(systematic) risk (involving the market's assessment of overall economic
prospects), as distinguished from stock-specific risk (involving the market's
evaluation of the merits of the issuer of a particular security). The Fund may
also purchase and sell other futures when deemed appropriate, in order to hedge
the equity or non-equity portions of its portfolio. In addition, the Fund may,
to the extent it invests in foreign securities, enter
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<PAGE>
into contracts for the future delivery of foreign currencies to hedge against
changes in currency exchange rates. The Fund may also purchase and write put
and call options on futures contracts and may engage in related closing
transactions. In the United States, all such futures on debt securities, debt
index futures, stock index futures, foreign currency futures and related options
will be traded on exchanges that are regulated by the Commodity Futures Trading
Commission ("CFTC"). Subject to applicable CFTC rules, the Fund also may enter
into futures contracts traded on the following foreign futures exchanges:
Frankfurt, Tokyo, London and Paris, as long as trading on the aforesaid foreign
futures exchanges does not subject the Fund to risks that are materially greater
than the risks associated with trading on U.S. exchanges.
A futures contract is an agreement to buy or sell a security or currency
(or to deliver a final cash settlement price in the case of a contract relating
to an index or otherwise not calling for physical delivery at the end of trading
in the contracts), for a set price at a future date. When interest rates are
changing and portfolio values are falling, futures contracts can offset a
decline in the value of the Fund's current portfolio securities. When interest
rates are changing and portfolio values are rising, the purchase of futures
contracts can secure better effective rates or purchase prices for the Fund than
might later be available in the market when the Fund makes anticipated
purchases. In the United States, futures contracts are traded on boards of
trade which have been designated "contract markets" by the CFTC. Currently,
there are futures contracts based on a variety of instruments, indexes and
currencies, including long-term U.S. Treasury bonds, Treasury notes, GNMA
certificates, three-month U.S. Treasury bills, three-month domestic bank
certificates of deposit, a municipal bond index and various stock indexes.
When a purchase or sale of a futures contract is made by the Fund, the Fund
is required to deposit with its custodian (or broker, if legally permitted) a
specified amount of liquid assets ("initial margin"). The margin required for a
futures contract is set by the exchange on which the contract is traded and may
be modified during the term of the contract. The initial margin is in the
nature of a performance bond or good faith deposit on the futures contract which
is returned to the Fund upon termination of the contract assuming all
contractual obligations have been satisfied. The Fund expects to earn interest
income on its initial margin deposits. A futures contract held by the Fund is
valued daily at the official settlement price of the exchange on
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<PAGE>
which it is traded. Each day the Fund pays or receives cash, called "variation
margin," equal to the daily change in value of the futures contract. This
process is known as "marking-to-market." Variation margin does not represent a
borrowing or loan by the Fund but is instead a settlement between the Fund and
the broker of the amount one would owe the other if the futures contract
expired. In computing daily net asset value, the Fund will mark-to-market its
open futures positions.
The Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Fund.
Positions taken in the futures markets are not normally held until delivery
or final cash settlement is required, but are instead liquidated through
offsetting transactions which may result in a gain or a loss. While futures
positions taken by the Fund will usually be liquidated in this manner, the Fund
may instead make or take delivery of underlying securities or currencies
whenever it appears economically advantageous to the Fund to do so. A clearing
organization associated with the exchange on which futures are traded assumes
responsibility for closing-out transactions and guarantees that as between the
clearing members of an exchange, the sale and purchase obligations will be
performed with regard to all positions that remain open at the termination of
the contract.
FUTURES ON DEBT SECURITIES A futures contract on a debt security is a
--------------------------
binding contractual commitment which, if held to maturity, will result in an
obligation to make or accept delivery, during a particular future month, of
securities having a standardized face value and rate of return. By purchasing
futures on debt securities--assuming a "long" position--the Fund will legally
obligate itself to accept the future delivery of the underlying security and pay
the agreed-upon price. By selling futures on debt securities--assuming a
"short" position--it will legally obligate itself to make the future delivery of
the security against payment of the agreed-upon price. Open futures positions
on debt securities will be valued at the most recent settlement price, unless
such price does not appear to the Sub-Adviser to reflect the fair value of the
contract, in which case the positions will be valued by or under the direction
of the Trustees.
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Hedging by use of futures on debt securities seeks to establish, more
certainly than would otherwise be possible, the effective rate of return on
portfolio securities. The Fund may, for example, take a "short" position in the
futures market by selling contracts for the future delivery of debt securities
held by the Fund (or securities having characteristics similar to those held by
the Fund) in order to hedge against an anticipated rise in interest rates that
would adversely affect the value of the Fund's portfolio securities. When
hedging of this character is successful, any depreciation in the value of
portfolio securities will be substantially offset by appreciation in the value
of the futures position.
On other occasions, the Fund may take a "long" position by purchasing
futures on debt securities. This would be done, for example, when the Fund
intends to purchase particular securities and it has the necessary cash, but
expects the rate of return available in the securities markets at that time to
be less favorable than rates currently available in the futures markets. If the
anticipated rise in the price of the securities should occur (with its
concomitant reduction in yield), the increased cost to the Fund of purchasing
the securities will be offset, at least to some extent, by the rise in the value
of the futures position taken in anticipation of the subsequent securities
purchase. The Fund may also purchase futures contracts as a substitute for the
purchase of longer-term securities to lengthen the average duration of the
Fund's portfolio.
The Fund could accomplish similar results by selling securities with long
maturities and investing in securities with short maturities when interest rates
are expected to increase or by buying securities with long maturities and
selling securities with short maturities when interest rates are expected to
decline. However, by using futures contracts as a risk management technique,
given the greater liquidity in the futures market than in the cash market, it
may be possible to accomplish the same result more easily and more quickly.
SECURITIES INDEX FUTURES A securities index futures contract does not
------------------------
require the physical delivery of securities, but merely provides for profits and
losses resulting from changes in the market value of the contract to be credited
or debited at the close of each trading day to the respective accounts of the
parties to the contract. On the contract's expiration date a final cash
settlement occurs and the futures positions are simply closed out. Changes in
the market value of a particular stock
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index futures contract reflect changes in the specified index of equity
securities on which the contract is based. A stock index is designed to reflect
overall price trends in the market for equity securities.
Stock index futures may be used to hedge the equity portion of the Fund's
securities portfolio with regard to market (systematic) risk, as distinguished
from stock-specific risk. The Fund may enter into stock index futures to the
extent that it has equity securities in its portfolio. Similarly, the Fund may
enter into futures on debt securities indexes (including the municipal bond
index) to the extent it has debt securities in its portfolio. By establishing
an appropriate "short" position in securities index futures, the Fund may seek
to protect the value of its portfolio against an overall decline in the market
for securities. Alternatively, in anticipation of a generally rising market,
the Fund can seek to avoid losing the benefit of apparently low current prices
by establishing a "long" position in securities index futures and later
liquidating that position as particular securities are in fact acquired. To the
extent that these hedging strategies are successful, the Fund will be affected
to a lesser degree by adverse overall market price movements, unrelated to the
merits of specific portfolio securities, than would otherwise be the case. The
Fund may also purchase futures on debt securities or indexes as a substitute for
the purchase of longer-term debt securities to lengthen the average duration of
the Fund's debt portfolio.
The Fund does not intend to use U.S. stock index futures to hedge positions
in securities of non-U.S. companies.
CURRENCY FUTURES A sale of a currency futures contract creates an
----------------
obligation by the Fund, as seller, to deliver the amount of currency called for
in the contract at a specified future time for a specified price. A purchase of
a currency futures contract creates an obligation by the Fund, as purchaser, to
take delivery of an amount of currency at a specified future time at a specified
price. The Fund may sell a currency futures contract, if the Sub-Adviser
anticipates that exchange rates for a particular currency will fall, as a hedge
against a decline in the value of the Fund's securities denominated in such
currency. If the Sub-Adviser anticipates that exchange rates will rise, the
Fund may purchase a currency futures contract to protect against an increase in
the price of securities denominated in a particular currency the Fund intends to
purchase. Although the terms of currency futures contracts specify actual
delivery or
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receipt, in most instances the contracts are closed out before the settlement
date without the making or taking of delivery of the currency. Closing out of a
currency futures contract is effected by entering into an offsetting purchase or
sale transaction. To offset a currency futures contract sold by the Fund, the
Fund purchases a currency futures contract for the same aggregate amount of
currency and delivery date. If the price in the sale exceeds the price in the
offsetting purchase, the Fund is immediately paid the difference. Similarly, to
close out a currency futures contract purchased by the Fund, the Fund sells a
currency futures contract. If the offsetting sale price exceeds the purchase
price, the Fund realizes a gain, and if the offsetting sale price is less than
the purchase price, the Fund realizes a loss.
A risk in employing currency futures contracts to protect against the price
volatility of portfolio securities denominated in a particular currency is that
changes in currency exchange rates or in the value of the futures position may
correlate imperfectly with changes in the cash prices of the Fund's securities.
The degree of correlation may be distorted by the fact that the currency
futures market may be dominated by short-term traders seeking to profit from
changes in exchange rates. This would reduce the value of such contracts for
hedging purposes over a short-term period. Such distortions are generally minor
and would diminish as the contract approached maturity. Another risk is that
the Sub-Adviser could be incorrect in its expectation as to the direction or
extent of various exchange rate movements or the time span within which the
movements take place.
OPTIONS ON FUTURES For bona fide hedging and other appropriate risk
------------------
management purposes, the Fund also may purchase and write call and put options
on futures contracts which are traded on exchanges that are licensed and
regulated by the CFTC for the purpose of options trading, or, subject to
applicable CFTC rules, on foreign exchanges. It is the current policy of the
Trust that the Fund will purchase or write only options on futures contracts
that are traded on a U.S. or foreign exchange or board of trade. The Fund also
may engage in related closing transactions with respect to options on futures.
A "call" option on a futures contract gives the purchaser the right, in return
for the premium paid, to purchase a futures contract (assume a "long" position)
at a specified exercise price at any time before the option expires. A "put"
option gives the purchaser the right, in return for the premium paid, to sell a
futures contract
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(assume a "short" position), for a specified exercise price at any time before
the option expires.
Upon the exercise of a "call," the writer of the option is obligated to
sell the futures contract (to deliver a "long" position to the option holder) at
the option exercise price, which will presumably be lower than the current
market price of the contract in the futures market. Upon exercise of a "put,"
the writer of the option is obligated to purchase the futures contract (deliver
a "short" position to the option holder) at the option exercise price, which
will presumably be higher than the current market price of the contract in the
futures market. When an entity exercises an option and assumes a "long" futures
position, in the case of a "call," or a "short" futures position, in the case of
a "put," its gain will be credited to its futures margin account, while the loss
suffered by the writer of the option will be debited to its account. However,
as with the trading of futures, most participants in the options markets do not
seek to realize their gains or losses by exercise of their option rights.
Instead, the writer or holder of an option will usually realize a gain or loss
by buying or selling an offsetting option at a market price that will reflect an
increase or a decrease from the premium originally paid.
Options on futures contracts can be used by the Fund to hedge substantially
the same risks and for the same duration and risk management purposes as might
be addressed or served by the direct purchase or sale of the underlying futures
contracts. If the Fund purchases an option on a futures contract, it may obtain
benefits similar to those that would result if it held the futures position
itself.
The purchase of put options on futures contracts is a means of hedging the
Fund's portfolio against the risk of rising interest rates, declining securities
prices or declining exchange rates for a particular currency. The purchase of a
call option on a futures contract represents a means of hedging against a market
advance affecting securities prices or currency exchange rates when the Fund is
not fully invested or of lengthening the average maturity or duration of the
Fund's portfolio. Depending on the pricing of the option compared to either the
futures contract upon which it is based or upon the price of the underlying
securities or currencies, it may or may not be less risky than ownership of the
futures contract or underlying securities or currencies.
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In contrast to a futures transaction, in which only transaction costs are
involved, benefits received in an option transaction will be reduced by the
amount of the premium paid as well as by transaction costs. In the event of an
adverse market movement, however, the Fund will not be subject to a risk of loss
on the option transaction beyond the price of the premium it paid plus its
transaction costs, and may consequently benefit from a favorable movement in the
value of its portfolio securities or the currencies in which such securities are
denominated that would have been more completely offset if the hedge had been
effected through the use of futures.
If the Fund writes options on futures contracts, the Fund will receive a
premium but will assume a risk of adverse movement in the price of the
underlying futures contract comparable to that involved in holding a futures
position. If the option is not exercised, the Fund will realize a gain in the
amount of the premium, which may partially offset unfavorable changes in the
value of securities held by or to be acquired for the Fund. If the option is
exercised, the Fund will incur a loss in the option transaction, which will be
reduced by the amount of the premium it has received, but which may partially
offset favorable changes in the value of its portfolio securities or the
currencies in which such securities are denominated.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the underlying securities or the currencies in
which such securities are denominated. If the futures price at expiration is
below the exercise price, the Fund will retain the full amount of the option
premium, which provides a partial hedge against any decline that may have
occurred in the Fund's holdings of securities or the currencies in which such
securities are denominated.
The writing of a put option on a futures contract is analogous to the
purchase of a futures contract. For example, if the Fund writes a put option on
a futures contract on debt securities related to securities that the Fund
expects to acquire and the market price of such securities increases, the net
cost to the Fund of the debt securities acquired by it will be reduced by the
amount of the option premium received. Of course, if market prices have
declined, the Fund's purchase price upon exercise may be greater than the price
at which the debt securities might be purchased in the securities market.
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While the holder or writer of an option on a futures contract may normally
terminate its position by selling or purchasing an offsetting option of the same
series, the Fund's ability to establish and close out options positions at
fairly established prices will be subject to the maintenance of a liquid market.
The Fund will not purchase or write options on futures contracts unless the
market for such options has sufficient liquidity such that the risks associated
with such options transactions are not at unacceptable levels.
LIMITATIONS ON PURCHASE AND SALE OF FUTURES CONTRACTS AND OPTIONS ON
--------------------------------------------------------------------
FUTURES CONTRACTS In general, the Fund will engage in transactions in futures
- -----------------
contracts and related options only for bona fide hedging and other appropriate
risk management purposes, and not for speculation. With respect to positions in
futures and related options that do not constitute bona fide hedging positions,
the Fund will not enter into a futures contract or futures option contract if,
immediately thereafter, the aggregate initial margin deposits relating to such
positions plus premiums paid by it for open futures option positions, less the
amount by which any such options are "in-the-money," would exceed 5% of the
Fund's total assets. A call option is "in-the-money" if the value of the
futures contract that is the subject of the option exceeds the exercise price.
A put option is "in-the-money" if the exercise price exceeds the value of the
futures contract that is the subject of the option.
When purchasing a futures contract, the Fund will maintain with its
custodian (and mark-to-market on a daily basis) liquid assets that, when added
to the amounts deposited with a futures commission merchant as margin, are equal
to the market value of the futures contract. Alternatively, the Fund may
"cover" its position by purchasing a put option on the same futures contract
with a strike price as high or higher than the price of the contract held by the
Fund.
When selling a futures contract, a Fund will maintain with its custodian
(and mark-to-market on a daily basis) liquid assets that, when added to the
amount deposited with a futures commission merchant as margin, are equal to the
market value of the instruments underlying the contract. Alternatively, the
Fund may "cover" its position by owning the instruments underlying the contract
(or, in the case of an index futures contract, a portfolio with a volatility
substantially similar to that of the index on which the futures contract is
based), or by holding a call option permitting the Fund to purchase the same
futures
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contract at a price no higher than the price of the contract written by the Fund
(or at a higher price if the difference is maintained in liquid assets with the
Fund's custodian).
When selling a call option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) liquid assets that,
when added to the amounts deposited with a futures commission merchant as
margin, equal the total market value of the futures contract underlying the call
option. Alternatively, the Fund may cover its position by entering into a long
position in the same futures contract at a price no higher than the strike price
of the call option, by owning the instruments underlying the futures contract,
or by holding a separate call option permitting the Fund to purchase the same
futures contract at a price not higher than the strike price of the call option
sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) liquid assets that
equal the purchase price of the futures contract, less any margin on deposit.
Alternatively, the Fund may cover the position either by entering into a short
position in the same futures contract, or by owning a separate put option
permitting it to sell the same futures contract so long as the strike price of
the purchased put option is the same or higher than the strike price of the put
option sold by the Fund.
The requirements for qualification as a regulated investment company also
may limit the extent to which the Fund may enter into futures, futures options
or forward contracts. See "Tax Status."
RISKS ASSOCIATED WITH FUTURES AND FUTURES OPTIONS There are several risks
-------------------------------------------------
associated with the use of futures contracts and futures options as hedging
techniques. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. There can be no
guarantee that there will be a correlation between price movements in the
hedging vehicle and in the Fund's securities being hedged. In addition, there
are significant differences between the securities and futures markets that
could result in an imperfect correlation between the markets, causing a given
hedge not to achieve its objectives. The degree of imperfection of correlation
depends on circumstances such as variations in
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<PAGE>
speculative market demand for futures and futures options on securities,
including technical influences in futures trading and futures options, and
differences between the financial instruments being hedged and the instruments
underlying the standard contracts available for trading in such respects as
interest rate levels, maturities, and creditworthiness of issuers. A decision
as to whether, when and how to hedge involves the exercise of skill and
judgment, and even a well-conceived hedge may be unsuccessful to some degree
because of market behavior or unexpected interest rate trends. It is also
possible that, when the Fund has sold stock index futures to hedge its portfolio
against a decline in the market, the market may advance while the value of the
particular securities held in the Fund's portfolio may decline. If this
occurred, the Fund would incur a loss on the futures contracts and also
experience a decline in the value of its portfolio securities.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of the
current trading session. Once the daily limit has been reached in a futures
contract subject to the limit, no more trades may be made on that day at a price
beyond that limit. The daily limit governs only price movements during a
particular trading day and therefore does not limit potential losses because the
limit may work to prevent the liquidation of unfavorable positions. For
example, futures prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some holders of futures contracts to
substantial losses.
In addition to the risks that apply to all options transactions, there are
several special risks relating to options on futures contracts. The ability to
establish and close out positions in such options will be subject to the
development and maintenance of a liquid market in the options. It is not
certain that such a market will develop. Although the Fund generally will
purchase only those options and futures contracts for which there appears to be
an active market, there is no assurance that a liquid market on an exchange will
exist for any particular option or futures contract at any particular time. In
the event no such market exists for particular options, it might not be possible
to effect closing transactions in such options with the result that the Fund
would have to exercise options it has
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purchased in order to realize any profit and would be less able to limit is
exposure to losses on options it has written.
Many of the contracts discussed above are relatively new instruments
without a significant trading history. As a result, there can be no assurance
that an active secondary market will develop or continue to exist. If the price
of a futures contract changes more than the price of the securities or
currencies, the Fund will experience either a loss or a gain on the futures
contracts which will not be completely offset by changes in the price of the
securities or currencies which are the subject of the hedge. In addition, it is
not possible to hedge fully or perfectly against currency fluctuations affecting
the value of securities denominated in foreign currencies because the value of
such securities is likely to fluctuate as a result of independent factors not
related to currency fluctuations.
SWAP AGREEMENTS
The Fund may enter into interest rate, index and currency exchange rate
swap agreements for purposes of attempting to obtain a particular desired return
at a lower cost to the Fund than if the Fund had invested directly in an
instrument that yielded that desired return or for other portfolio management
purposes. Swap agreements are two party contracts entered into primarily by
institutional investors for periods ranging from a few weeks to more than one
year. In a standard "swap" transaction, two parties agree to exchange the
returns (or differentials in rates of return) earned or realized on particular
predetermined investments or instruments. The gross returns to be exchanged or
"swapped" between the parties are calculated with respect to a "notional
amount," i.e., the return on or increase in value of a particular dollar amount
----
invested at a particular interest rate, in a particular foreign currency, or in
a "basket" of securities representing a particular index. The "notional amount"
of the swap agreement is only a fictive basis on which to calculate the
obligations which the parties to a swap agreement have agreed to exchange.
Commonly used swap agreements include interest rate caps, under which, in return
for a premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap"; interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified level, or "floor"; and
interest rate collars, under which a party sells a cap and purchases a floor or
vice versa in an attempt to protect itself against interest rate
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movements exceeding given minimum or maximum levels. The Fund's obligations (or
rights) under a swap agreement will generally be equal only to the net amount to
be paid or received under the agreement based on the relative values of the
positions held by each party to the agreement (the "net amount"). The Fund's
obligations under a swap agreement will be accrued daily (offset against any
amounts owing to the Fund) and any accrued but unpaid net amounts owed to a swap
counterparty will be covered by the maintenance of a segregated account
consisting of liquid assets to avoid any potential leveraging of the Fund's
portfolio. The Fund will not enter into a swap agreement with any single party
if the net amount owed or to be received under existing contracts with that
party would exceed 5% of the Fund's assets.
Whether the Fund's use of swap agreements will be successful in furthering
its investment objective will depend on the Sub-Adviser's ability correctly to
predict whether certain types of investments are likely to produce greater
returns than other investments. Because they are two party contracts and
because they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, the Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap agreement counterparty. The Sub-Adviser will
cause the Fund to enter into swap agreements only with counterparties that would
be eligible for consideration as repurchase agreement counterparties under the
Fund's repurchase agreement guidelines. Certain restrictions imposed on the
Fund by the Code may limit the Fund's ability to use swap agreements. The swaps
market is a relatively new market and is largely unregulated. It is possible
that developments in the swaps market, including potential government
regulation, could adversely affect the Fund's ability to terminate existing swap
agreements or to realize amounts to be received under such agreements.
Certain swap agreements are exempt from most provisions of the Commodity
Exchange Act ("CEA") and, therefore, are not regulated as futures or commodity
option transactions under the CEA, pursuant to regulations approved by the CFTC.
To qualify for this exemption, a swap agreement must be entered into by
"eligible participants," which include the following, provided the participants'
total assets exceed established levels: a bank or trust company, savings
association or credit union, insurance company, investment company subject to
regulation under the Investment Company Act of 1940, commodity pool,
corporation, partnership, proprietorship, organization, trust or other entity,
employee benefit plan, governmental entity, broker-dealer,
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futures commission merchant, natural person, or regulated foreign person. To be
eligible, natural persons and most other entities must have total assets
exceeding $10 million; commodity pools and employee benefit plans must have
assets exceeding $5 million. In addition, an eligible swap transaction must
meet three conditions. First, the swap agreement may not be part of a fungible
class of agreements that are standardized as to their material economic terms.
Second, the creditworthiness of parties with actual or potential obligations
under the swap agreement must be a material consideration in entering into or
determining the terms of the swap agreement, including pricing, cost or credit
enhancement terms. Third, swap agreements may not be entered into and traded on
or through a multilateral transaction execution facility.
This exemption is not exclusive, and participants may continue to rely on
existing exclusions for swaps, such as the Policy Statement issued in July 1989
which recognized a safe harbor for swap transactions from regulation as futures
or commodity option transactions under the CEA or its regulations. The Policy
Statement applies to swap transactions settled in cash that (1) have
individually tailored terms, (2) lack exchange-style offset and the use of a
clearing organization or margin system, (3) are undertaken in conjunction with a
line of business, and (4) are not marketed to the public.
LOAN PARTICIPATION INTERESTS
The Fund's investment in loan participation interests may take the form of
participation interests in, assignments or novations of a corporate loan
("Participation Interests"). The Participation Interests may be acquired from
an agent bank, co-lenders or other holders of Participation Interests
("Participants"). In a novation, the Fund would assume all of the rights of the
lender in a corporate loan, including the right to receive payments of principal
and interest and other amounts directly from the borrower and to enforce its
rights as a lender directly against the borrower. As an alternative, the Fund
may purchase an assignment of all or a portion of a lender's interest in a
corporate loan, in which case, the Fund may be required generally to rely on the
assigning lender to demand payment and enforce its rights against the borrower,
but would otherwise be entitled to all of such lender's rights in the corporate
loan. The Fund also may purchase a Participation Interest in a portion of the
rights of a lender in a corporate loan. In such a case, the Fund will be
entitled to receive payments of principal,
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interest and fees, if any, but generally will not be entitled to enforce its
rights directly against the agent bank or the borrower; rather the Fund must
rely on the lending institution for that purpose. The Fund will not act as an
agent bank, a guarantor or sole negotiator of a structure with respect to a
corporate loan.
In a typical corporate loan involving the sale of Participation Interests,
the agent bank administers the terms of the corporate loan agreement and is
responsible for the collection of principal and interest and fee payments to the
credit of all lenders which are parties to the corporate loan agreement. The
agent bank in such cases will be qualified under the 1940 Act to serve as a
custodian for a registered investment company such as the Trust. The Fund
generally will rely on the agent bank or an intermediate Participant to collect
its portion of the payments on the corporate loan. The agent bank monitors the
value of the collateral and, if the value of the collateral declines, may take
certain action, including accelerating the corporate loan, giving the borrower
an opportunity to provide additional collateral or seeking other protection for
the benefit of the Participants in the corporate loan, depending on the terms of
the corporate loan agreement. Furthermore, unless under the terms of a
participation agreement the Fund has direct recourse against the borrower (which
is unlikely), the Fund will rely on the agent bank to use appropriate creditor
remedies against the borrower. The agent bank also is responsible for
monitoring compliance with covenants contained in the corporate loan agreement
and for notifying holders of corporate loans of any failures of compliance.
Typically, under corporate loan agreements, the agent bank is given broad
discretion in enforcing the corporate loan agreement, and is obligated to use
only the same care it would use in the management of its own property. For
these services, the borrower compensates the agent bank. Such compensation may
include special fees paid on structuring and funding the corporate loan and
other fees paid on a continuing basis.
A financial institution's employment as an agent bank may be terminated in
the event that it fails to observe the requisite standard of care or becomes
insolvent, or has a receiver, conservator, or similar official appointed for it
by the appropriate bank regulatory authority or becomes a debtor in a bankruptcy
proceeding. A successor agent bank generally will be appointed to replace the
terminated bank, and assets held by the agent bank under the corporate loan
agreement should remain available to holders of corporate loans. If, however,
assets
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held by the agent bank for the benefit of the Fund were determined by an
appropriate regulatory authority or court to be subject to the claims of the
agent bank's general or secured creditors, the Fund might incur certain costs
and delays in realizing payment on a corporate loan, or suffer a loss of
principal and/or interest. In situations involving intermediate Participants
similar risks may arise.
When the Fund acts as co-lender in connection with a Participation
Interest or when the Fund acquires a Participation Interest the terms of which
provide that the Fund will be in privity of contract with the corporate
borrower, the Fund will have direct recourse against the borrower in the event
the borrower fails to pay scheduled principal and interest. In all other cases,
the Fund will look to the agent bank to enforce appropriate credit remedies
against the borrower. In acquiring Participation Interests the Fund will
conduct analysis and evaluation of the financial condition of each such co-
lender and participant to ensure that the Participation Interest meets the
Fund's qualitative standards. There is a risk that there may not be a readily
available market for loan Participation Interests and, in some cases, this could
result in the Fund disposing of such securities at a substantial discount from
face value or holding such security until maturity. When the Fund is required
to rely upon a lending institution to pay the Fund principal, interest, and
other amounts received by the lending institution for the loan participation,
the Fund will treat both the borrower and the lending institution as an "issuer"
of the loan participation for purposes of certain investment restrictions
pertaining to the diversification and concentration of the Fund's portfolio.
The Fund considers loan Participation Interests not subject to puts to be
illiquid.
RISKS ASSOCIATED WITH DEBT SECURITIES
To the extent that the Fund invests in debt securities, it will be subject
to certain risks. The value of the debt securities held by the Fund, and thus
the net asset value of the shares of beneficial interest of the Fund, generally
will fluctuate depending on a number of factors, including, among others,
changes in the perceived creditworthiness of the issuers of those securities,
movements in interest rates, the average maturity of the Fund's investments,
changes in the relative values of the currencies in which the Fund's investments
are denominated relative to the U.S. dollar, and the extent to which the Fund
hedges its interest rate, credit and currency exchange
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rate risks. Generally, a rise in interest rates will reduce the value of fixed
income securities held by a Fund, and a decline in interest rates will increase
the value of fixed income securities held by a Fund.
Corporate debt securities may bear fixed, contingent, or variable rates of
interest and may involve equity features, such as conversion or exchange rights
or warrants for the acquisition of stock of the same or a different issuer,
participations based on revenues, sales or profits, or the purchase of common
stock in a unit transaction (where corporate debt securities and common stock
are offered as a unit).
When- and if-available, debt securities may be purchased at a discount from
face value. However, the Fund does not intend to hold such securities to
maturity for the purpose of achieving potential capital gains, unless current
yields on these securities remain attractive. From time to time, the Fund may
purchase securities not paying interest or dividends at the time acquired if, in
the opinion of the Sub-Adviser, such securities have the potential for future
income (or capital appreciation, if any).
Since shares of the Funds represent an investment in securities with
fluctuating market prices, the value of shares of the Fund will vary as the
aggregate value of the Fund's portfolio securities increases or decreases.
Moreover, the value of the lower rated debt securities that the Fund purchases
may fluctuate more than the value of higher rated debt securities. These lower
rated fixed income securities generally tend to reflect short-term corporate and
market developments to a greater extent than higher rated securities which react
primarily to fluctuations in the general level of interest rates. Changes in
the value of securities subsequent to their acquisition will not affect cash
income or yields to maturity to the Fund but will be reflected in the net asset
value of the Fund's shares.
RISKS OF INVESTING IN HIGH YIELD SECURITIES ("JUNK BONDS")
High yield bonds may be more susceptible to real or perceived adverse
economic and competitive industry conditions than higher grade bonds. The
prices of high yield bonds have been found to be less sensitive to interest-rate
changes than
B-52
<PAGE>
more highly rated investments, but more sensitive to adverse economic downturns
or individual corporate developments. A projection of an economic downturn or
of a period of rising interest rates, for example, could cause a decline in high
yield bond prices because the advent of a recession could lessen the ability of
a highly leveraged company to make principal and interest payments on its debt
securities.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of high yield bonds,
especially in a thinly traded market.
Legislation designed to limit the use of high yield bonds in corporate
transactions may have a material adverse effect on a Fund's net asset value and
investment practices. In addition, there may be special tax considerations
associated with investing in high yield bonds structured as zero coupon or
payment-in-kind securities. The Fund records the interest on these securities
annually as income even though it receives no cash interest until the security's
maturity or payment date. Also, distributions of such amounts generally will be
taxable to shareholders even if the Fund does not distribute cash to them.
Therefore, in order to pay taxes on this interest, shareholders may have to
redeem some of their shares to pay the tax or the Fund may have to sell some of
its assets to reduce the Fund's assets and may thereby increase its expense
ratio and decrease its rate of return.
ADDITIONAL FUNDAMENTAL INVESTMENT RESTRICTIONS
In addition to the fundamental investment restrictions contained in the
Prospectus, the Trustees of the Trust also have adopted the following
fundamental investment restrictions, which may not be changed with respect to
the Fund without the approval of the majority of the outstanding voting
securities of the Fund, as defined under the 1940 Act.
The Trust may not, on behalf of the Fund:
1. Act as an underwriter of securities issued by others, except to the
extent that the Fund may be considered an
B-53
<PAGE>
underwriter within the meaning of the 1933 Act, as amended, in the disposition
of portfolio securities.
2. Issue senior securities, except to the extent permitted under the 1940
Act.
ADDITIONAL NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
In addition to the Trust's fundamental investment restrictions, the
Trustees of the Trust have voluntarily adopted certain policies and restrictions
which are observed in the conduct of the affairs of the Fund. These represent
intentions of the Trustees based upon current circumstances. They differ from
fundamental investment policies in that the following additional investment
restrictions may be changed or amended by action of the Trustees without
requiring prior notice to or approval of shareholders.
(a) As an operating policy, the Fund may not sell securities short,
except for covered short sales or unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, and
provided that transactions in options, futures and forward contracts are
deemed not to constitute short sales of securities.
(b) As an operating policy, the Fund may not purchase securities on
margin, except that the Fund may obtain such short-term credits as are
necessary for the clearance of transactions, and provided that margin
payments in connection with futures contracts and options on futures
contracts shall not constitute the purchase of securities on margin.
(c) As an operating policy, the Fund may not invest in securities
which are not readily marketable, or the disposition of which is restricted
under federal securities laws (collectively, "illiquid securities"), other
than Rule 144A securities determined to be liquid pursuant to guidelines
adopted by the Trust's Board of Trustees if, as a result, more than 15% of
the Fund's net assets would be invested in illiquid securities.
B-54
<PAGE>
(d) As an operating policy, the Fund may not purchase the securities
of other investment companies, except to the extent permitted by the 1940
Act or in connection with a merger, consolidation, acquisition or
reorganization.
"Value" for the purposes of all investment restrictions shall mean the
value used in determining a Fund's net asset value.
If a percentage restriction is adhered to at the time of investment, a
later change in percentage resulting from a change in values or assets will not
constitute a violation of such restriction.
TRUSTEES AND OFFICERS
Information pertaining to the Trustees and officers of the Trust is set
forth below. Trustees deemed to be "interested persons" of the Trust for
purposes of the 1940 Act are indicated by an asterisk.
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- ----------------------- ---------------------- -----------------------
<S> <C> <C>
Alice T. Kane* Chairperson and Executive Vice President, New York Life
51 Madison Avenue Trustee Insurance Company, 1992 to present;
New York, NY 10010 General Counsel, 1992 to 1995;
Age: 49 Corporate Secretary, 1989 to 1994;
Senior Vice President and General
Counsel, 1986 to 1992; Director and
Chairperson, MainStay Institutional
Funds Inc., 1994 to present; Director,
New York Life Foundation, 1992 to
1995; Director, New York Life
International Investment Inc., 1988 to
present; Director, NYLIFE Inc., 1990 to
present; Director, Greystone Realty
Corporation, 1994 to present; Director,
Monitor Capital Advisors, Inc., 1994
to
</TABLE>
B-55
<PAGE>
<TABLE>
<S> <C> <C>
present; Director, NYLCare Health
Plans, Inc. (formerly Sanus Corp. Health
Systems), 1984 to present; Director,
MacKay-Shields Financial Corporation,
1994 to present; Director, New York
Life Benefit Services Inc. (pension
consultant and third party
administrator), 1994 to present; Director,
NYLIFE Securities Inc., 1994 to present;
Director, Eagle Strategies Corp.
(registered investment adviser), 1994 to
present; Director, NYLIFE Distributors
Inc., 1994 to present; Director, NYL
Management Limited, 1995 to present;
Director, NYL Trust Company, 1995 to
present; Director, NYLINK Insurance
Agency Incorporated, 1996 to present;
Director, Japan Gamma Asset
Management Limited, 1995 to present;
Director, New York Life Worldwide
Holding, Inc., 1995 to present; Director,
New York Life and Health Insurance
Company, 1996 to present; Director,
MainStay Shareholder Services, Inc.,
1997 to present; Director, NASD
Regulation, Inc., 1996 to present; and
Member, Board of Governors of the
National Association of Securities
Dealers, Inc., 1994 to 1996.
Walter W. Ubl* Trustee Senior Vice President, New York Life
51 Madison Avenue Insurance Company, 1995 to present;
New York, NY 10010 Vice President, 1984 to 1995; Vice
Age: 55 President in charge of Mutual Funds
Department, 1989 to 1997; Director and
Vice President, NYLIFE Distributors
Inc., 1993 to present; and Director and
Senior Vice President NYLIFE
Securities Inc., 1996 to present.
Stephen Roussin* President, Chief Senior Vice President, New York Life
51 Madison Avenue Executive Officer Insurance Company, 1997 to present;
New York, NY 10010 Senior Vice President, Smith Barney,
Age: 34 1994 to 1997; Division Sales Manager,
Prudential Securities, 1989 to 1994;
Retail Securities Broker, PaineWebber
Incorporated, 1988 to 1989.
</TABLE>
B-56
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- ----------------------- ---------------------- -----------------------
<S> <C> <C>
Harry G. Hohn* Trustee Retired Chairman and Chief Executive
51 Madison Avenue Officer, New York Life Insurance
New York, NY 10010 Company; Chairman of the Board and
Age 65 Chief Executive Officer, New York Life
Insurance Company, 1990 to 1997; Vice
Chairman of the Board, New York Life
Insurance Company, 1986 to 1990;
Director, New York Life Insurance
Company, 1985 to 1986; Director,
Million Dollar Roundtable Foundation,
1996 to present; Director, Insurance
Marketplace Standards Association, 1996
to present; Director, Witco Corporation,
1989 to present; Member, International
Advisory Board of Credit Commercial de
France, 1995 to present; and a Life
Fellow of the American Bar Foundation.
Donald K. Ross* Trustee Retired Chairman and Chief Executive
953 Cherokee Lane Officer, New York Life Insurance
Franklin Lakes, NJ 07417 Company; Director, New York Life
Age: 71 Insurance Company, 1978 to 1996;
President, New York Life Insurance
Company, 1986 to 1990; Chairman of the
Board, New York Life Insurance
Company, 1981 to 1990; Chief Executive
Officer, New York Life Insurance
Company, 1981 to 1990; Director,
MacKay-Shields Financial Corporation,
1984 to present; and Trustee,
Consolidated Edison Company of New
York, Inc., 1976 to present.
Edward J. Hogan Trustee Independent management consultant,
Box 2321 1991 to 1995; President, Westinghouse -
Sun Valley, ID 83353 Airship Industries, Inc. and Managing
Age: 64 Director, Airship Industries U.K., Ltd.,
1987 to 1990.
</TABLE>
B-57
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- ----------------------- ---------------------- -----------------------
<S> <C> <C>
Nancy Maginnes Trustee Member, Council of Rockefeller
Kissinger University, New York, NY, 1991 to
Hendersons Road present; Trustee, Council of Rockefeller
Kent, CT 06757 University, 1995 to present; Trustee,
Age: 63 Animal Medical Center, 1993 to present;
and Trustee, The Masters School, 1994
to present.
Terry L. Lierman Trustee President, Capitol Associates, Inc., 1984
426 C Street, N.E. to present; President, Employee Health
Washington, D.C. 20002 Programs, 1990 to present; Vice
Age: 49 Chairman, TheraCom Inc., 1994 to
present; Member, UNICEF National
Board, 1993 to present; Director,
Harvard University, Pollin Institute, 1995
to present; Director, PeacePac, 1994 to
present; and Commissioner, State of
Maryland, Higher Education
Commission, 1995 to present.
John B. McGuckian Trustee Director, Ulster Television plc, 1970 to
Ardverna present; Chairman of the Board, Ulster
Cloughmills, Northern Television plc, 1990 to present;
Ireland Chairman of the Board, Tedcastle
BT4 49NL Holding Ltd. (energy), 1995 to present;
Age: 57 Director, Cooneen Textiles Ltd.
(clothing manufacturer), 1967 to present;
Director, Allied Irish Banks plc, 1977 to
present; Director, First Trust Bank, 1991
to present; Director, Unidare plc
(engineering), 1986 to present; Director,
Irish Continental Group plc (ferry
operations), 1988 to present; Director,
Harbour Group Ltd. (management
company), 1980 to present; Chairman,
Industrial Development Board, 1990 to
present; and Chairman of Senate and
Senior Pro-Chancellor, Queen's
University, 1986 to present.
</TABLE>
B-58
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- ----------------------- ---------------------- -----------------------
<S> <C> <C>
Donald E. Nickelson Trustee Vice Chairman, Harbour Group
1701 Highway A-1-A Industries, Inc., 1991 to present;
Suite 101 Director, PaineWebber Group, 1980 to
Vero Beach, FL 32963 1993; President, PaineWebber Group,
Age: 63 1988 to 1990; Chairman of the Board,
PaineWebber Properties, 1985 to 1989;
Director, Harbour Group, 1986 to
present; Director, CPA 10 Real Estate
Inv. Trust, 1990 to present; Director,
CIP 11 Real Estate Inv. Trust, 1991 to
present; Chairman of the Board and
Director, Rapid Rock Industries, Inc.,
1986 to present; Director and Chairman
of the Board, Del Industries, 1990 to
present; Trustee, Jones Foundation (Los
Angeles), 1978 to present; Director,
Allied Healthcare Products, Inc., 1992 to
present; Director, Sugen, Inc., 1992 to
present; Director and Chairman of the
Board, Greenfield Industries, Inc., 1993
to present; Director, DT Industries, 1992
to present; Chairman of the Board,
Omniquip International, Inc., 1996 to
present; and Advisory Panel, Sedgwick
James of NY, 1996 to present.
Richard S. Trutanic Trustee Managing Director, The Somerset Group
1155 Connecticut Ave. (financial advisory firm), 1990 to present;
N.W., Suite 400 Senior Vice President, Washington
Washington, DC 20036 National Investment Corporation
Age: 44 (financial advisory firm), 1985 to 1990;
Director, Allin Communications
Corporation, 1996 to present; and
Director and Member of Executive
Committee, Southern Net, Inc., 1986 to
1990.
</TABLE>
B-59
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- -------------------------------------------- -----------------------
- ---------------------------------------------------------------------------------------------
OFFICERS (OTHER THAN TRUSTEES)
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Jefferson C. Boyce Senior Vice President Senior Vice President, MainStay
51 Madison Avenue Institutional Funds Inc., 1995 to present;
New York, NY 10010 Senior Vice President, New York Life
Age: 39 Insurance Company, 1994 to present;
Director, NYLIFE Distributors Inc.,
1993 to present; and Chief
Administrative Officer, Pension, Mutual
Funds, Structured Finance, Corporate
Quality, Human Resources and
Employees' Health Departments, New
York Life Insurance Company, 1992 to
1994.
Anthony W. Polis Vice President and Vice President, New York Life Insurance
51 Madison Avenue Chief Financial Company, 1988 to present; Director,
New York, NY 10010 Officer Vice President and Chief Financial
Age: 53 Officer, NYLIFE Securities Inc., 1988 to
present; Vice President and Chief
Financial Officer, NYLIFE Distributors
Inc., 1993 to present; Treasurer,
MainStay Institutional Funds Inc., 1990
to present; Treasurer, MainStay VP
Series Fund, Inc., 1993 to present;
Assistant Treasurer, MainStay VP Series
Fund, Inc., 1992 to 1993; Vice President
and Treasurer, Eclipse Financial Asset
Trust, 1992 to present; Vice President
and Chief Financial Officer, Eagle
Strategies Corp. (registered investment
adviser), 1993 to present.
Richard Zuccaro Tax Vice President Vice President, New York Life Insurance
51 Madison Avenue Company, 1995 to present; Vice
New York, NY 10010 President -- Tax, New York Life
Age: 46 Insurance Company, 1986 to 1995; Tax
Vice President, NYLIFE Securities Inc.,
1987 to present; Tax Vice President,
NAFCO, Inc., 1990 to present; Tax
Vice
</TABLE>
B-60
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- ----------------------- ---------------------- -----------------------
<S> <C> <C>
President, NYLIFE Depositary Inc., 1990
to present; Tax Vice President, NYLIFE
Inc., 1990 to present; Tax Vice President,
NYLIFE Insurance Company of
Arizona, 1990 to present; Tax Vice
President, NYLIFE Realty Inc., 1991 to
present; Tax Vice President, NYLICO
Inc., 1991 to present; Tax Vice President,
New York Life Fund Inc., 1991 to
present; Tax Vice President, New York
Life International Investment, Inc., 1991
to present; Tax Vice President, NYLIFE
Equity Inc., 1991 to present; Tax Vice
President, NYLIFE Funding Inc., 1991
to present; Tax Vice President, NYLCO
Inc., 1991 to present; Tax Vice President,
MainStay VP Series Fund, Inc., 1991 to
present; Tax Vice President, CNP Realty,
1991 to present; Tax Vice President,
New York Life Worldwide Holding Inc.,
1992 to present; Tax Vice President,
NYLIFE Structured Asset Management
Co. Ltd., 1992 to present; Tax Vice
President, MainStay Institutional Funds
Inc., 1992 to present; Tax Vice President,
NYLIFE Distributors Inc., 1993 to
present; Vice President & Assistant
Controller, New York Life Insurance
and Annuity Corp., 1995 to present, and
Assistant Controller, 1991 to present;
Vice President, NYLCARE Health
Plans, Inc., 1995 to present; Vice
President - Tax, New York Life and
Health Insurance Co., 1996 to present;
and Tax Vice President, NYL Trust
Company, 1996 to present.
A. Thomas Smith III Secretary Vice President and Associate General
51 Madison Avenue Counsel, New York Life Insurance
New York, NY 10010 Company, 1997 to present; Associate
Age: 40 General Counsel, New York Life
Insurance Company, 1996 to 1997;
Assistant General Counsel, New York
Life Insurance Company, 1994 to 1996;
Secretary, MainStay Institutional
Funds
</TABLE>
B-61
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- ----------------------- ---------------------- -----------------------
<S> <C> <C>
Inc., MainStay VP Series Fund, Inc.,
New York Life Fund Inc., 1994 to 1997;
Secretary, Eclipse Financial Asset Trust,
1994 to present; Secretary, Eagle
Strategies Corp. (registered investment
adviser), 1996 to 1997; and Assistant
General Counsel, Dreyfus Corporation,
1991 to 1993.
</TABLE>
As indicated in the above table, certain Trustees and officers also hold
positions with MainStay Management, Inc., MacKay-Shields, New York Life
Insurance Company, NYLIFE Securities Inc. and/or NYLIFE Distributors Inc.
The Independent Trustees of the Trust receive from the Trust an annual
retainer of $40,000 and a fee of $1,000 for each Board of Trustees meeting and
for each Board committee meeting attended and are reimbursed for all out-of-
pocket expenses related to attendance at such meetings. Trustees who are
affiliated with New York Life Insurance Company do not receive compensation from
the Trust.
For the fiscal year ended December 31, 1996, the Trustees received the
following compensation from the Trust and from certain other investment
companies (as indicated) that have the same manager or sub-advisers as the Trust
or an investment adviser that is an affiliated person of one of the Trust's
manager:
B-62
<PAGE>
Total Compensation
Aggregate From Registrant
Name of Compensation and Fund Complex
Trustee from the Trust Paid to Trustees
- ------- -------------- ------------------
Edward J. Hogan* $0 $0
Nancy M. Kissinger $46,000 $46,000
Terry L. Lierman $45,000 $45,000
John B. McGuckian** $0 $0
Donald E. Nickelson $45,000 $45,000
Richard S. Trutanic $44,000 $44,000
Ralph A. Pfeiffer*** $33,000 $33,000
* Mr. Hogan was elected to his position as Trustee of the Trust on October
28, 1996, effective January 27, 1997.
** Mr. McGuckian was elected to his position as Trustee of the Trust on July
28, 1997.
*** Mr. Pfeiffer passed away on September 13, 1996.
THE MANAGER, THE SUB-ADVISER AND THE DISTRIBUTOR
MANAGEMENT AGREEMENT
Pursuant to the Management Agreement for the Fund dated October 22, 1997,
MainStay Management, Inc. (the "Manager"), subject to the supervision of the
Trustees of the Trust and in conformity with the stated policies of the Fund,
administers the Fund's business affairs and has investment advisory
responsibilities.
On October 21, 1997, the sole initial shareholder of the Fund approved the
Management Agreement. The Management Agreement will remain in effect for two
years following its effective date,
B-63
<PAGE>
and will continue in effect thereafter only if such continuance is specifically
approved at least annually by the Trustees or by vote of a majority of the
outstanding voting securities of the Fund (as defined in the 1940 Act and in a
rule under the Act) and, in either case, by a majority of the Trustees who are
not "interested persons" of the Trust or the Manager (as the term is defined in
the 1940 Act).
The Manager has authorized any of its directors, officers and employees who
have been elected or appointed as Trustees or officers of the Trust to serve in
the capacities in which they have been elected or appointed.
The Management Agreement provides that the Manager shall not be liable to
the Fund for any error of judgment by the Manager or for any loss sustained by
the Fund except in the case of the Manager's willful misfeasance, bad faith,
gross negligence or reckless disregard of duty. The Management Agreement also
provides that it shall terminate automatically if assigned and that it may be
terminated without penalty by either party upon no more than 60 days' nor less
than 30 days' written notice.
In connection with its administration of the business affairs of the Fund,
and except as indicated in the Prospectus under the heading "Manager, Sub-
Adviser and Distributor," the Manager bears the following expenses:
(a) the salaries and expenses of all personnel of the Trust and the
Manager, except the fees and expenses of Trustees not affiliated with the
Manager or the Sub-Adviser; and
(b) all expenses incurred by the Manager in connection with administering
the ordinary course of the Fund's business, other than those assumed by the
Trust.
SUB-ADVISORY AGREEMENT
Pursuant to a Sub-Advisory Agreement between the Manager and MacKay-Shields
Financial Corporation ("MacKay-Shields" or the "Sub-Adviser"), MacKay-Shields,
subject to the supervision of the
B-64
<PAGE>
Trustees of the Trust and the Manager and in conformity with the stated policies
of the Fund and the Trust, manages the Fund's portfolio, including the purchase,
retention, disposition and loan of securities.
On October 21, 1997, the sole initial shareholder of the Fund approved the
Sub-Advisory Agreement with MacKay-Shields. The Sub-Advisory Agreement will
remain in effect for two years following its effective date, and will continue
in effect thereafter only if such continuance is specifically approved at least
annually by the Trustees or by vote of a majority of the outstanding voting
securities of the Fund (as defined in the 1940 Act and in a rule under the Act)
and, in either case, by a majority of the Trustees who are not "interested
persons" of the Trust, the Manager or MacKay-Shields (as the term is defined in
the 1940 Act).
The Sub-Adviser has authorized any of its directors, officers and employees
who have been elected or appointed as Trustees or officers of the Trust to serve
in the capacities in which they have been elected or appointed. In connection
with the services it renders, the Sub-Adviser bears the salaries and expenses of
all of its personnel.
The Sub-Advisory Agreement provides that MacKay-Shields shall not be liable
for any error of judgment by MacKay-Shields or for any loss suffered by the Fund
except in the case of MacKay-Shields' willful misfeasance, bad faith, gross
negligence or reckless disregard of duty. The Agreement also provides that it
shall terminate automatically if assigned and that it may be terminated without
penalty by either party upon no more than 60 days' nor less than 30 days'
written notice.
DISTRIBUTION AGREEMENT
NYLIFE Distributors serves as the Principal Underwriter and Distributor of
the Fund's shares pursuant to the Distribution Agreement with the Trust dated
January 1, 1994. NYLIFE Securities Inc., an affiliated company, sells shares of
the Fund pursuant to a dealer agreement with the Distributor. The Distributor
and other broker-dealers will pay commissions to salesmen as well as the cost of
printing and mailing prospectuses to potential investors and of any advertising
incurred by them in
B-65
<PAGE>
connection with their distribution of Fund shares. In addition, the Distributor
will pay for a variety of account maintenance and personal services to
shareholders after the sale.
The Distribution Agreement for the Fund was approved by the Trustees,
including a majority of the Trustees who are not "interested persons" (as the
term is defined in the 1940 Act) of the Trust nor have any direct or indirect
financial interest in the operation of the distribution plan or in any related
agreement (the "Independent Trustees") at a meeting held on July 28, 1997.
As disclosed in the Prospectus, the Fund has adopted separate plans of
distribution pursuant to Rule 12b-1 under the 1940 Act for each class of shares
of the Fund (the "Class A Plans", the "Class B Plans" and, collectively, the
"Plans"). Under the Class A Plans, Class A shares of the Fund pay the
Distributor a monthly fee at the annual rate of 0.25% of the average daily net
assets of the Fund's Class A shares for distribution or service activities, as
designated by the Distributor.
The Trustees of the Trust, including a majority of the Trustees who are not
interested persons of the Trust and who have no direct or indirect financial
interest in the operation of such Plan (the "Independent Trustees"), by vote
cast in person at a meeting called for the purpose of voting on such Plan,
initially approved the Class A Plan on July 28, 1997.
As noted above, the Class B shares of the Fund also have adopted a 12b-1
distribution plan. The Trustees of the Trust, including a majority of the
Trustees who are not interested persons of the Trust and who have no direct or
indirect financial interest in the operation of such plan of distribution, by
vote cast in person at meetings called for the purpose of voting on such Plans,
initially approved the Class B Plan of the Fund on July 28, 1997.
Under the Class B plan, the Fund's Class B shares pay a monthly
distribution fee to the Distributor at the annual rate of 0.75% of the average
daily net assets attributable to the Fund's Class B shares. Pursuant to the
Class B Plan, the Class B shares of the Fund also pay a service fee to the
Distributor at the
B-66
<PAGE>
annual rate of 0.25% of the average daily net assets of the Fund's Class B
shares.
Once approved by a vote of a majority of the outstanding voting securities
of a class of shares of the Fund, the Plan shall continue in effect thereafter,
provided such continuance is approved annually by a vote of the Trustees in the
manner described above. No Plan may be amended to increase materially the
amount to be spent for the services described therein without approval of the
shareholders of the affected class of shares of the Fund, and all material
amendments of each Plan must also be approved by the Trustees in the manner
described above. Each Plan may be terminated at any time, without payment of
any penalty, by vote of a majority of the Trustees who are not interested
persons of the Trust and who have no direct or indirect financial interest in
the operations of the Plan, or by a vote of a majority of the outstanding voting
securities of the affected Fund (as defined in the 1940 Act) on not more than 30
days' written notice to any other party to the Plan. So long as any Plan is in
effect, the selection and nomination of Trustees who are not such interested
persons has been committed to those Trustees who are not such interested
persons. The Trustees have determined that, in their judgment, there is a
reasonable likelihood that each Plan will benefit the respective Fund and its
shareholders. Pursuant to both the Class A and Class B Plans, the Distributor
shall provide the Trust for review by the Trustees, and the Trustees shall
review at least quarterly, a written report of the amounts expended under each
Plan and the purpose for which such expenditures were made. In the Trustees'
quarterly review of each Plan, they will consider its continued appropriateness
and the level of compensation provided therein.
Pursuant to a rule of the National Association of Securities Dealers, Inc.,
the amount which the Fund may pay for distribution expenses, excluding service
fees, is limited to 6.25% of the gross sales of the Fund's shares since
inception of the Fund's Plan, plus interest at the prime rate plus 1% per annum
(less any contingent deferred sales charges paid by shareholders to the
Distributor or distribution fee (other than service fees) paid by the Funds to
the Distributor).
OTHER SERVICES
B-67
<PAGE>
Pursuant to an Accounting Agreement with the Trust dated January 1, 1994,
the Manager performs certain bookkeeping and pricing services for the Fund.
In addition, the Fund may reimburse NYLIFE Securities, NYLIFE Distributors
and MainStay Shareholder Services for the cost of certain correspondence to
shareholders and establishing shareholder accounts.
EXPENSES BORNE BY THE TRUST
Except for the expenses to be paid by the Manager as described in the
Prospectus, the Trust, on behalf of the Fund, is responsible under its
Management Agreement for the payment of expenses related to the Fund's
operations, including (i) the fees payable to the Manager, (ii) the fees and
expenses of Trustees who are not affiliated with the Manager or the Sub-Adviser,
(iii) certain fees and expenses of the Custodian and Transfer Agent, including
the cost of pricing the Fund's shares, (iv) the charges and expenses of the
Trust's legal counsel and independent accountants, (v) brokers' commissions and
any issue or transfer taxes chargeable to the Trust, on behalf of the Fund, in
connection with its securities transactions, (vi) the fees of any trade
association of which the Fund or the Trust is a member, (vii) the cost of share
certificates representing shares of the Fund, (viii) reimbursement of a portion
of the organization expenses of the Fund and the fees and expenses involved in
registering and maintaining registration of the Trust and of its shares with the
SEC and the states registering the Trust as a broker or dealer, including the
preparation and printing of the Trust's registration statements and prospectuses
for such purposes, (ix) allocable communications expenses with respect to
investor services and all expenses of shareholders' and Trustees' meetings and
preparing, printing and mailing prospectuses and reports to shareholders, (x)
litigation and indemnification expenses and other extraordinary expenses not
incurred in the ordinary course of the Fund's business, (xi) any expenses
assumed by the Fund pursuant to its plan of distribution, and (xii) all taxes
and business fees payable by the Fund to federal, state or other governmental
agencies. Fees and expenses of legal counsel, registering shares, holding
meetings and communicating with shareholders include an allocable portion of the
cost of maintaining an internal legal and compliance department.
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<PAGE>
The Fund has entered into a committed line of credit with The Bank of New
York as agent, and various other lenders from whom the Fund may borrow up to 5%
of its net assets in order to honor redemptions. The credit facility is
expected to be utilized in periods when the Fund experiences unusually large
redemption requests.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Purchases and sales of securities on a securities exchange are effected by
brokers, and the Fund pays a brokerage commission for this service. In
transactions on stock exchanges in the United States, these commissions are
negotiated, whereas on many foreign stock exchanges these commissions are fixed.
In the over-the-counter markets, securities (i.e., Municipal Bonds and other
debt securities) are generally traded on a "net" basis with dealers acting as
principal for their own accounts without a stated commission, although the price
of the security usually includes a profit to the dealer. Transactions in
certain over-the-counter securities also may be effected on an agency basis,
when the total price paid (including commission) is equal to or better than the
best total prices available from other sources. In underwritten offerings,
securities are purchased at a fixed price which includes an amount of
compensation to the underwriter, generally referred to as the underwriter's
concession or discount. On occasion, certain money market instruments may be
purchased directly from an issuer, in which case no commissions or discounts are
paid.
Newly issued securities normally are purchased directly from the issuer or
from an underwriter acting as principal. Other purchases and sales usually are
placed with those dealers from which it appears that the best price or execution
will be obtained; those dealers may be acting as either agents or principals.
The purchase price paid by the Fund to underwriters of newly issued securities
usually includes a concession paid by the issuer to the underwriter, and
purchases of after-market securities from dealers normally are executed at a
price between the bid and asked prices.
The primary consideration in placing portfolio security transactions with
broker-dealers for execution is to obtain and maintain the availability of
execution at the most favorable prices and in the most effective manner
possible. The Adviser
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<PAGE>
attempts to achieve this result by selecting broker-dealers to execute
portfolio transactions on behalf of the Fund and its other clients on the basis
of the broker-dealers' professional capability, the value and quality of their
brokerage services and the level of their brokerage commissions. Consistent
with the foregoing primary considerations, the Rules of Fair Practice of the
NASD 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 broker-
dealers to execute the Fund's portfolio transactions.
NYLIFE Securities (the "Affiliated Broker") may act as broker for the
Trust. In order for the Affiliated Broker to effect any portfolio transactions
for the Trust, the commissions, fees or other remuneration received by the
Affiliated Broker must be reasonable and fair compared to the commissions, fees
or other remuneration paid to other brokers in connection with comparable
transactions involving similar securities being purchased or sold on an exchange
during a comparable period of time. This standard would allow the Affiliated
Broker to receive no more than the remuneration which would be expected to be
received by an unaffiliated broker in a commensurate arms-length transaction.
The Trust will not deal with the Affiliated Broker in any portfolio transaction
in which the Affiliated Broker acts as principal.
Under the Sub-Advisory Agreement and as permitted by Section 28(e) of the
Securities Exchange Act of 1934 (the "1934 Act"), the Sub-Adviser may cause the
Fund to pay a broker-dealer (except the Affiliated Broker) which provides
brokerage and research services to the Sub-Adviser an amount of commission for
effecting a securities transaction for the Fund in excess of the amount other
broker-dealers would have charged for the transaction if the Sub-Adviser
determines in good faith that the greater commission is reasonable in relation
to the value of the brokerage and research services provided by the executing
broker-dealer viewed in terms of either a particular transaction or the Sub-
Adviser's overall responsibilities to the Fund or to its other clients. The
term "brokerage and research services" includes advice as to the value of
securities, the advisability of investing in, purchasing, or selling securities,
and the availability of securities or of purchasers or sellers of securities;
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy and the performance of accounts;
and effecting securities transactions and performing functions incidental
thereto such as clearance and settlement.
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<PAGE>
Although commissions paid on every transaction will, in the judgment of the
Sub-Adviser, be reasonable in relation to the value of the brokerage services
provided, commissions exceeding those which another broker might charge may be
paid to broker-dealers (except the Affiliated Broker) who were selected to
execute transactions on behalf of the Fund and the Sub-Adviser's other clients
in part for providing advice as to the availability of securities or of
purchasers or sellers of securities and services in effecting securities
transactions and performing functions incidental thereto such as clearance and
settlement.
Broker-dealers may be willing to furnish statistical, research and other
factual information or services ("Research") to the Sub-Adviser for no
consideration other than brokerage or underwriting commissions. Securities may
be bought or sold through such broker-dealers, but at present, unless otherwise
directed by the Fund, a commission higher than one charged elsewhere will not be
paid to such a firm solely because it provided Research to the Sub-Adviser.
Research provided by brokers is used for the benefit of all of the Sub-Adviser's
clients and not solely or necessarily for the benefit of the Fund. The Sub-
Adviser's investment management personnel attempt to evaluate the quality of
Research provided by brokers. Results of this effort are sometimes used by the
Sub-Adviser as a consideration in the selection of brokers to execute portfolio
transactions.
In certain instances there may be securities which are suitable for the
Fund's portfolio as well as for that of another MainStay fund or one or more of
the other clients of the Sub-Adviser. Investment decisions for the Fund and for
the Sub-Adviser's other clients are made with a view to achieving their
respective investment objectives. It may develop that a particular security is
bought or sold for only one client even though it might be held by, or bought or
sold for, other clients. Likewise, a particular security may be bought for one
or more clients when one or more other clients are selling that same security.
Some simultaneous transactions are inevitable when several clients receive
investment advice from the same investment adviser, particularly when the same
security is suitable for the investment objectives of more than one client.
When two or more clients are simultaneously engaged in the purchase or sale of
the same security, the securities are allocated among clients in a manner
believed to be equitable to each. It is recognized that in some cases this
system could have a detrimental effect on the price or volume of the security in
a
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<PAGE>
particular transaction as far as the Fund is concerned. The Trust believes that
over time its ability to participate in volume transactions will produce better
executions for the Fund.
The investment advisory fee that the Trust pays on behalf of the Fund to
the Sub-Adviser will not be reduced as a consequence of the Sub-Adviser's
receipt of brokerage and research services. To the extent the Fund's portfolio
transactions are used to obtain such services, the brokerage commissions paid by
the Fund will exceed those that might otherwise be paid, by an amount which
cannot be presently determined. Such services would be useful and of value to
the Sub-Adviser in serving both the Fund and other clients and, conversely, such
services obtained by the placement of brokerage business of other clients would
be useful to the Sub-Adviser in carrying out their obligations to the Fund.
Investors may, subject to the approval of the Trust, NYLIFE Distributors
and the Sub-Adviser, purchase shares of the Fund with liquid securities that are
eligible for purchase by the Fund and that have a value that is readily
ascertainable. These transactions will be effected only if the Adviser intends
to retain the security in the Fund as an investment. The Trust reserves the
right to amend or terminate this practice at any time.
NET ASSET VALUE
The net asset value per share of the Fund is determined by the Trust daily
as of the close of regular trading on the New York Stock Exchange (currently
4:00 p.m., Eastern time) on each day when the New York Stock Exchange is open
for trading.
Portfolio securities of the Fund are valued (a) by appraising common and
preferred stocks which are traded on the New York Stock Exchange at the last
sale price on that Exchange on the day as of which assets are valued or, if no
sale occurs, at the mean between the closing bid price and asked price, (b) by
appraising other common and preferred stocks as nearly as possible in the manner
described in clause (a) if traded on any other exchange, including the National
Association of Securities Dealers National Market System and foreign securities
exchanges, (c) by appraising over-the-counter common and preferred stocks quoted
on the National Association of Securities Dealers NASDAQ
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<PAGE>
system (but not listed on the National Market System) at the closing bid price
supplied through such system, (d) by appraising over-the-counter common and
preferred stocks not quoted on the NASDAQ system and securities listed or traded
on certain foreign exchanges whose operations are similar to the U.S over-the-
counter market at prices supplied by a pricing agent selected by the Sub-Adviser
if those prices are deemed by the Sub-Adviser to be representative of market
values at the first close of business of the New York Stock Exchange, (e) by
appraising debt securities at prices supplied by a pricing agent selected by the
Sub-Adviser, which prices reflect broker-dealer-supplied valuations and
electronic data processing techniques if those prices are deemed by the Sub-
Adviser to be representative of market values at the first close of business of
the New York Stock Exchange, (f) by appraising exchange-traded options and
futures contracts at the last posted settlement price on the market where any
such option or futures contract is principally traded and (g) by appraising all
other securities and other assets, including over-the-counter common and
preferred stocks not quoted on the NASDAQ system, securities listed or traded on
certain foreign exchanges whose operations are similar to the U.S. over-the-
counter market and debt securities for which prices are supplied by a pricing
agent but are not deemed by the Sub-Adviser to be representative of market
values, but excluding money market instruments with a remaining maturity of 60
days or less and including restricted securities and securities for which no
market quotation is available, at fair value in accordance with procedures
approved by and determined in good faith by the Trustees, although the actual
calculation may be done by others. Money market instruments held by the Fund
with a remaining maturity of 60 days or less will be valued by the amortized
cost method unless such method does not represent fair value. Forward foreign
currency exchange contracts held by the Fund are valued at their respective fair
market values determined on the basis of the mean between the last current bid
and asked prices based on dealer or exchange quotations.
Portfolio securities traded on more than one U.S. national securities
exchange or foreign securities exchange are valued at the last sale price on the
business day as of which such value is being determined at the close of the
exchange representing the principal market for such securities. The value of
all assets and liabilities expressed in foreign currencies will be converted
into U.S. dollar values at the mean between the buying and selling rates of such
currencies against U.S. dollars last quoted by any major bank or broker-dealer.
If such quotations are not available, the rate of exchange will be determined in
accordance with policies established by the Trustees. The Fund recognizes
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dividend income and other distributions on the ex-dividend date, except that
certain dividends from foreign securities are recog nized as soon as the Fund is
informed after the ex-dividend date.
Trading in securities on European and Far Eastern securities exchanges and
over-the-counter markets is normally completed well before the close of business
on each business day in New York (i.e., a day on which the New York Stock
---
Exchange is open for trading). In addition, European or Far Eastern securities
trading generally in a particular country or countries may not take place on all
business days in New York. Furthermore, trading takes place in Japanese markets
on certain Saturdays and in various foreign markets on days which are not
business days in New York and on which the Fund's net asset value is not
calculated. Such calculation of net asset value does not take place
contemporaneously with the determination of the prices of the majority of the
portfolio securities used in such calculation.
Events affecting the values of portfolio securities that oc cur between the
time their prices are determined and the close of the New York Stock Exchange
will not be reflected in the Fund's calculation of net asset values unless the
Adviser deems that the particular event would materially affect net asset value,
in which case an adjustment will be made.
The proceeds received by the Fund for each issue or sale of its shares, and
all net investment income, realized and unrealized gain and proceeds thereof,
subject only to the rights of creditors, will be specifically allocated to the
Fund and constitute the underlying assets of the Fund. The underlying assets of
the Fund will be segregated on the books of account, and will be charged with
the liabilities in respect to the Fund and with a share of the general
liabilities of the Trust. Expenses with respect to the Fund and another
MainStay Fund will be allocated in proportion to the net asset values of the
respective Fund except where allocations of direct expenses can otherwise be
fairly made.
To the extent that any newly organized class of shares of the Fund
receives, on or before December 31, any seed capital, the net asset value of
such class will be calculated as of December 31.
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<PAGE>
SHAREHOLDER INVESTMENT ACCOUNT
A Shareholder Investment Account is established for each investor in
the Fund, under which a record of the shares of the Fund held is maintained by
the Transfer Agent. If a share certificate is desired, it must be requested in
writing for each transaction. There is no charge to the investor for issuance
of a certificate. Whenever a transaction takes place in the Fund, the
shareholder will be mailed a confirmation showing the transaction. Shareholders
will be sent a quarterly statement showing the status of the Account. In
addition, shareholders will be sent a monthly statement for each month in which
a transaction occurs.
SHAREHOLDER SERVICING AGENT
The Glass-Steagall Act prohibits national banks from engaging in the
business of underwriting, selling or distributing securities. There is
currently no precedent prohibiting banks from performing shareholder servicing
and recordkeeping functions. Changes in federal or state statutes and
regulations pertaining to the permissible activities of banks and their
affiliates or subsidiaries, as well as further judicial or administrative
decisions or interpretations of those provisions, could prevent a bank from
continuing to perform all or a part of such services. If a bank were prohibited
from so acting, the Trustees would consider what actions, if any, would be
necessary to continue to provide efficient and effective shareholder services.
It is not expected that shareholders would suffer any adverse financial
consequences as a result of any of these occurrences.
PURCHASES AND REDEMPTIONS
LETTER OF INTENT ("LOI")
The LOI is a non-binding obligation on the Qualified Purchaser to
purchase the full amount indicated; however, on the initial purchase, if
required (or, on subsequent purchases if necessary), 5% of the dollar amount
specified in the LOI will be held in escrow by the Transfer Agent in shares
registered in the shareholder's name in order to assure payment of the proper
sales
B-75
<PAGE>
charge. If total purchases pursuant to the LOI (less any dispositions and
exclusive of any distribution on such shares automatically reinvested) are less
than the amount specified, the investor will be requested to remit to the
Distributor an amount equal to the difference between the sales charge paid and
the sales charge applicable to the aggregate purchases actually made. If not
remitted within 20 days after written request, an appropriate number of escrowed
shares will be redeemed in order to realize the difference.
SUSPENSION OF REDEMPTIONS
The Trust may suspend the right of redemption of shares of the Fund
and may postpone payment for any period: (i) during which the New York Stock
Exchange is closed other than customary weekend and holiday closings or during
which trading on the New York Stock Exchange is restricted; (ii) when the SEC
determines that a state of emergency exists which may make payment or transfer
not reasonably practicable; (iii) as the SEC may by order permit for the
protection of the security holders of the Trust; or (iv) at any other time when
the Trust may, under applicable laws and regulations, suspend payment on the
redemption or repurchase of its shares.
TAX-DEFERRED RETIREMENT PLANS
CASH OR DEFERRED PROFIT SHARING PLANS UNDER SECTION 401(K) FOR CORPORATIONS AND
SELF-EMPLOYED INDIVIDUALS
Shares of the Fund may also be purchased as an investment under a
specimen cash or deferred profit sharing plan intended to qualify under Section
401(k) of the Code (a "401(k) Plan") adopted by a corporation, a self-employed
individual (including sole proprietors and partnerships), or other organization.
The Fund may be used as funding vehicles for qualified retirement plans
including 401(k) plans, which may be administered by third-party administrator
organizations. NYLIFE Distributors does not sponsor or administer such
qualified plans at this time.
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<PAGE>
INDIVIDUAL RETIREMENT ACCOUNT ("IRA")
Shares of the Fund may also be purchased as an underlying investment
for an IRA made available by NYLIFE Distributors. For tax years beginning in
1997 only a traditional IRA is available. For tax years beginning after 1997,
two additional types of IRAs will be available - the "Roth" IRA and the
"Education" IRA.
TRADITIONAL IRA An individual may contribute as much as $2,000 of
---------------
his or her earned income to a traditional IRA. A married individual filing a
joint return may also contribute to a traditional IRA for a nonworking spouse.
The maximum deduction allowed for a contribution to a spousal IRA is the lesser
of (1) $2,000 or (ii) the sum of (a) the compensation includible in the working
spouse's gross income plus (b) any compensation includible in the gross income
of the nonworking spouse, reduced by the amount of the deduction taken by the
working spouse. The maximum deduction for an IRA contribution by a married
couple is $4,000.
An individual who has not attained age 70-1/2 may make a IRA
contribution to a traditional IRA which is deductible for federal income tax
purposes. For tax years beginning before 1998, a contribution is deductible
only if (i) neither the individual nor his or her spouse (unless filing separate
returns and living apart at all times during the taxable year) is an active
participant in an employer's retirement plan, or (ii) the individual (and his or
her spouse, if applicable) has an adjusted gross income below a certain level
($40,000 for married individuals filing a joint return, with a phase-out of the
deduction for adjusted gross income between $40,000 and $50,000; $25,000 for a
single individual, with a phase-out for adjusted gross income between $25,000
and $35,000). These phase-out limits will gradually increase starting with tax
years beginning in 1998, eventually reaching $50,000 - $60,000 for single filers
in 2005 and thereafter ($80,000 - $100,000 if married filing jointly in 2007 and
thereafter). In addition, for tax years beginning after 1997, a married
individual may make a deductible IRA contribution even though the individuals'
spouse is an active participant in a qualified employer's retirement plan,
subject to a phase-out for adjusted gross income between $150,000 -$160,000.
However, an individual not permitted to make a deductible contribution to an IRA
may nonetheless make nondeductible contributions up to the maximum contribution
limit for that year. The deductibility of IRA contributions under state law
varies from state to state.
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<PAGE>
Distributions from IRAs (to the extent they are not treated as a tax-
free return of nondeductible contributions) are taxable under federal income tax
laws as ordinary income. There are special rules for determining how
withdrawals are to be taxed if an IRA contains both deductible and nondeductible
amounts. In general, all traditional IRAs are aggregated and treated as one
IRA, all withdrawals are treated as one withdrawal, and then a proportionate
amount of the withdrawal will be deemed to be made from nondeductible
contributions; amounts treated as a return of nondeductible contributions will
not be taxable. Certain early withdrawals are subject to an additional excise
tax. For distributions made after 1997, the excise tax does not apply to
withdrawals up to a total of $10,000 for first-time homebuyer expenses or to
withdrawals used to pay "qualified higher education expenses" of the taxpayer or
his or her spouse, child or grandchild. There are also special rules governing
when traditional IRA distributions must begin and the minimum amount of such
distributions; failure to comply with these rules can result in the imposition
of an excise tax.
ROTH IRAS Roth IRAs are a form of individual retirement account
---------
applicable for tax years beginning after 1997. Contributions to a Roth IRA are
not deductible but may be made even after the individual attains the age of 70 -
1/2. In certain cases, distributions from a Roth IRA may be tax free. The Roth
IRA, like the traditional IRA, is subject to a $2,000 ($4,000 for a married
couple) contribution limit (taking into account both Roth IRA and traditional
IRA contributions). The maximum contribution that can be made is phased-out for
taxpayers with adjusted gross income between $95,000 and $110,000 ($150,000 -
$160,000 if married filing jointly). If the Roth IRA has been in effect for
five years, and distributions are (1) made on or after the individual attains
the age of 59-1/2; (2) made after the individual's death; (3) attributable to
disability; or (4) used for "qualified first-time home buyer expenses", they are
not taxable. If these requirements are not met, distributions are treated first
as a return of contributions and then as taxable earnings. Taxable
distributions may be subject to the same excise tax described above with respect
to traditional IRAs. All Roth IRAs, like traditional IRAs, are treated as one
IRA. The minimum distribution requirements before death that apply to
traditional IRAs do not apply to Roth IRAs.
EDUCATION IRAS After 1997, a taxpayer may make non-deductible
--------------
contributions of up to $500 per year per beneficiary to an Education IRA.
Contributions cannot be made after the beneficiary becomes 18 years old. The
maximum contribution is
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<PAGE>
phased out for taxpayer with adjusted gross income between $95,000 and $110,000
($150,000 - $160,000 if married filing jointly). Earnings are tax-deferred
until a distribution is made. If a distribution does not exceed the
beneficiary's "qualified higher education expenses" for the year, no part of the
distribution is taxable. If a distribution is taxable, an excise tax will
generally apply as well. Any balance remaining in an Education IRA when the
beneficiary becomes 30 years old must be distributed and any earnings will be
taxable and subject to an excise tax upon distribution.
All income and capital gains deriving from IRA investments in the Fund
are reinvested and compound tax-deferred until distributed from the IRA. The
combination of annual contributions to a traditional IRA which may be deductible
and tax-deferred compounding can lead to substantial retirement savings.
Similarly, the combination of tax free distributions from a Roth IRA or
Education IRA combined with the tax-deferred compounding can lead to substantial
retirement and/or education savings.
403(B)(7) TAX SHELTERED ACCOUNT
Shares of the Fund may also be purchased as the underlying investment
for tax sheltered custodial accounts made available by NYLIFE Distributors. In
general, employees of tax-exempt organizations described in Section 501(c)(3) of
the Code (such as hospitals, churches, religious, scientific, or literary
organizations and educational institutions) or a public school system are
eligible to participate in a 403(b) plan.
GENERAL INFORMATION
Shares of the Fund may also be a permitted investment under profit
sharing, pension, and other retirement plans, IRAs, and tax-deferred annuities
other than those offered by the Fund depending on the provisions of the relevant
plan. Third-party administrative services, available for some corporate plans,
may limit or delay the processing of transactions.
The custodial agreements and forms provided by the Fund's Custodian
and Transfer Agent designate State Street Bank and
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<PAGE>
Trust Company as custodian for IRAs and 403(b) plans (unless another trustee or
custodian is designated by the individual or group establishing the plan) and
contain specific information about the plans. Each plan provides that dividends
and distributions will be reinvested automatically. For further details with
respect to any plan, including fees charged by State Street Bank and Trust
Company, tax consequences and redemption information, see the specific documents
for that plan.
The federal tax laws applicable to retirement plans, IRAs and 403(b)
plans are extremely complex and change from time to time. Therefore, an
investor should consult with his or her own professional tax adviser before
establishing any of the tax-deferred retirement plans described above.
CALCULATION OF PERFORMANCE QUOTATIONS
From time to time the Fund may publish its yield and/or average annual
total return in advertisements and communications to shareholders. Total return
and yield are computed separately for Class A and Class B shares. The average
annual total return of the Fund is determined for a particular period by
calculating the actual dollar amount of the investment return on a $1,000
investment in the Fund made at the maximum public offering price at the
beginning of the period, and then calculating the annual compounded rate of
return which would produce that amount. Total return for a period of one year
is equal to the actual return of the Fund during that period. This calculation
assumes a complete redemption of the investment and the deduction of the maximum
contingent deferred sales charge at the end of the period in the case of Class B
shares. In the case of Class A shares, the calculation assumes the maximum
sales charge is deducted from the initial $1,000 purchase order. It also
assumes that all dividends and distributions are reinvested at net asset value
on the reinvestment dates during the period.
In considering any average annual total return quotation, investors
should remember that the maximum initial sales charge reflected in each
quotation for Class A shares is a one-time fee which will have its greatest
impact during the early stages of an investor's investment in the Fund. The
actual performance of your investment will be affected less by this charge the
longer you retain your investment in the Fund.
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<PAGE>
Quotations of the Fund's average annual total
return will be calculated according to the following SEC formula:
P(1+T)/to the nth power/= ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of the 1, 5 or 10-year periods at the end of the 1, 5, or
10-year periods (or fractional portion thereof)
The Fund may quote total rates of return in addition to its average annual
total return. Such quotations are computed in the same manner as the average
annual compounded rate, except that such quotations will be based on the Fund's
actual return for a specified period as opposed to its average return over 1, 5,
and 10-year periods. In considering any total rate of return quotation,
investors should remember that the maximum initial sales charge reflected in
each quotation for Class A shares is a one-time fee which will have its greatest
impact during the early stages of an investor's investment in the Fund. The
actual performance of your investment will be affected less by this charge the
longer you retain your investment in the Fund.
The performance data that may be quoted represents historical performance
and the investment return and principal value of an investment will fluctuate so
that an investor's shares, when redeemed, may be worth more or less than their
original cost.
The yield of the Fund is computed by dividing its net investment income
(determined in accordance with the following SEC formula) earned during a
recent 30-day period by the product of the average daily number of shares
outstanding and entitled to
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<PAGE>
receive dividends during the period and the maximum offering price per share on
the last day of the period. The results are compounded on a bond equivalent
(semiannual) basis and then they are annualized. Yield will be calculated using
the following SEC formula:
Yield = 2[(a-b +1)/to the 6th power/ -1]
---
cd
where:
a = interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period that
were entitled to receive dividends
d = the maximum offering price per share on the last day of the period
This yield figure does not reflect the deduction of any contingent deferred
sales charges which are imposed upon certain redemptions at the rates set forth
under "Redemptions and Repurchases" in the Prospectus.
The Fund may also include its current dividend rate in its prospectus, in
supplemental sales literature, or in communications to shareholders. The
current dividend rate of the Fund for a particular period is calculated by
annualizing total distributions per share from net investment income (including
equalization credits, excluding realized short-term capital gains and premiums
from writing options) during this period and dividing this amount by the maximum
offering price per share on the last day of the period. The current dividend
rate does not reflect all components of the Fund's performance including (i)
realized and unrealized capital gains and losses, which are reflected in
calculations of the Fund's total return, or (ii) the amortized discount and
premium on debt obligations in income using the current market value of the
obligations, as is currently required for yield calculations. In addition, the
current dividend rate does not take into account the imposition
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<PAGE>
of any contingent deferred sales charge on the redemption of Fund shares. Any
performance figure which does not take into account the contingent deferred
sales charge would be reduced to the extent such charge is imposed upon a
redemption.
Investors should note that the investment results of the Fund will
fluctuate over time, and any presentation of the Fund's yield, current dividend
rate or total return of any prior period should not be considered as a
representation of what an investment may earn or what an investor's yield,
current dividend rate or total return may be in any future period.
In addition, advertising for the Fund may indicate that investors may
consider diversifying their investment portfolios in order to seek protection of
the value of their assets against inflation. From time to time, advertising
materials for the Fund may refer to or discuss current or past business,
political, economic or financial conditions, including events as they relate to
those conditions, such as any U.S. monetary or fiscal policies and the current
rate of inflation. In addition, from time to time, advertising materials for
the Fund may include information concerning retirement and investing for
retirement and may refer to the approximate number of then-current Fund
shareholders, shareholder accounts and Fund assets.
From time to time, advertising and sales literature for the Fund may
discuss the investment philosophy, personnel and assets under management of the
Manager and Sub-Adviser, and other pertinent facts relating to the management of
the Fund by the sub-adviser.
From time to time the Fund may publish an indication of its past
performance as measured by independent sources such as Lipper Analytical
Services, Incorporated, Weisenberger Investment Companies Service, Donoghue's
----------
Money Fund Report, Spot Market Prices, Barron's, BusinessWeek, Kiplinger's
- ----------------- -------- ------------ -----------
Personal Finance, Financial World, Forbes, Money, Morningstar, Personal
- ---------------- --------------- ------ ----- ----------- --------
Investor, Sylvia Porter's Personal Finance, and The Wall Street Journal.
-------------------------------- -----------------------
In addition, performance information for the Fund may be compared, in
advertisements, sales literature, and reports to shareholders, to: (i)
unmanaged indexes, such as the Standard & Poor's 500 Composite Stock Price
Index, the Salomon Brothers
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Broad Investment Grade Bond Index, the Morgan Stanley Capital International
indexes; the Dow Jones Industrial Average, Donoghue Money Market Institutional
Averages, the Merrill Lynch 1 to 3 Year Treasury Index, the Salomon Brothers
World Government Benchmark Bond Index, the Salomon Brothers non-U.S. Dollar
World Government Bond Index, the Lehman Brothers Municipal Bond Index and the
Lehman Brothers Government Corporate Index; (ii) other groups of mutual funds
tracked by Morningstar Inc. or Lipper Analytical Services, widely used
independent research firms which rank mutual funds by overall performance,
investment objectives and assets, or tracked by other services, companies,
publications or persons who rank mutual funds on overall performance or other
criteria; and (iii) the Consumer Price Index (measure for inflation) and other
measures of the performance of the economy to assess the real rate of return
from an investment in the Fund. Unmanaged indexes may assume the reinvestment
of dividends but generally do not reflect deductions for administrative and
management costs and expenses.
From time to time, advertisements for the Fund may include general
information about the services and products offered by The MainStay Funds,
MainStay Institutional Funds Inc. and New York Life Insurance Company and its
subsidiaries. For example, such advertisements may include statistical
information about those entities including, but not limited to, the number of
current shareholder accounts, the amount of assets under management, sales
information, the distribution channels through which the entities' products are
available, marketing efforts and statements about this information by the
entities' officers, directors and employees.
TAX STATUS
TAXATION OF THE FUND
The Fund intends to be treated as a regulated investment company ("RIC")
under Subchapter M of the Code. Such qualification does not involve supervision
of management or investment practices or policies by any governmental agency or
bureau.
As a regulated investment company required under Subchapter M of the Code
to distribute at least 90% of its taxable net
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investment income and net short-term capital gain in excess of net long-term
capital losses (and at least 90% of net tax-exempt interest income), the Fund
generally will not be subject to federal income or excise tax on any of its net
investment income or net realized capital gains which are timely distributed to
shareholders. Provided that the Fund qualifies as a regulated investment
company, it generally will not be subject to any excise or income taxes in
Massachusetts. The Fund's investments, if any, in REMIC residual interests (as
explained previously in this SAI) or in Passive Foreign Investment Companies, as
explained below, may cause the Fund to become liable for certain taxes.
Investors that are tax-exempt organizations should carefully consider whether
distributions of the Fund's earnings will be subject to tax in their hands.
CHARACTER OF DISTRIBUTIONS TO SHAREHOLDERS -- GENERAL
Assuming the Fund qualifies as a RIC, distributions of taxable net
investment income and net short-term capital gains in excess of net long-term
capital losses will be treated as ordinary income in the hands of shareholders.
If a Fund's investment income is derived exclusively from interest rather than
dividends, no portion of such distributions will be eligible for the dividends-
received deduction available to corporations. If a portion of a Fund's net
investment income is derived from dividends from domestic corporations, then a
portion of such distributions may be eligible for the corporate dividends-
received deduction. The dividends-received deduction is reduced to the extent
shares of a Fund are treated as debt-financed under the Code and is eliminated
unless such shares are deemed to have been held for at least 45 days. For
dividends received after August 5, 1997, this 45-day period must occur during
the 90-day period beginning 45 days before the date on which the shares become
x-dividend. In addition, the entire dividend (including the deducted portion)
is includable in the corporate shareholder's alternative minimum taxable income.
Finally, if such dividends are large enough to constitute "extraordinary
dividends" under Section 1059 of the Code, the shareholder's basis in its shares
could be reduced by all or a portion of the amount of the dividends that
qualifies for the dividends-received deduction.
Distributions of the excess of net long-term capital gain over net short-
term capital loss are taxable to shareholders as long-term capital gain, if such
distributions are designated as capital gain dividends, regardless of the length
of time the
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shares of the Fund have been held by such shareholders. Such distributions are
not eligible for the corporate dividends-received deduction. Any loss realized
upon the redemption of shares within six months from the date of their purchase
will be treated as a long-term capital loss to the extent of any capital gain
dividends received with respect to such shares during that six-month period. A
loss realized upon a redemption of shares of the Fund within 30 days before or
after a purchase of shares of the Fund (whether by reinvestment of distributions
or otherwise) may be disallowed in whole or in part.
If any net long-term capital gains in excess of net short-term capital
losses are retained by the Fund for reinvestment, requiring federal income taxes
to be paid thereon by the Fund, the Fund intends to elect to treat such capital
gains as having been distributed to shareholders. As a result, such amounts
will be taxable as long-term capital gains in the hands of the shareholders.
Shareholders will be able to claim their proportionate share of the federal
income taxes paid by the Fund on such gains as a credit against their own
federal income tax liabilities and will be entitled to increase the adjusted tax
basis of Fund shares by the difference between their pro-rata share of such
gains and their tax credit.
Distributions by the Fund result in a reduction in the net asset value of
the Fund's shares. Should a distribution reduce the net asset value below a
shareholder's cost basis, such distribution nevertheless would be taxable to the
shareholder (except to the extent the distribution is an exempt interest
dividend as described below) as ordinary income or capital gain as described
above, even though, from an investment standpoint, it may constitute a partial
return of investment. In particular, investors should be careful to consider
the tax implications of buying shares just prior to a distribution. The price
of shares purchased at that time includes the amount of the forthcoming
distribution. Those investors purchasing shares just prior to a distribution
will then receive a partial return of their investment upon such distribution,
which may nevertheless be taxable to them.
Distributions of taxable net investment income and net realized capital
gains will be taxable as described above, whether received in shares or in cash.
Any distributions that are not from the Fund's net investment income or net
capital gain may be characterized as a return of capital to shareholders or,
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in some cases, as capital gain. Shareholders electing to receive distributions
in the form of additional shares will have a cost basis for federal income tax
purposes in each share so received equal to the net asset value of such share on
the reinvestment date.
DISCOUNT
Certain of the bonds purchased by the Fund, such as zero coupon bonds, may
be treated as bonds that were originally issued at a discount. Original issue
discount represents interest for federal income tax purposes and can generally
be defined as the difference between the price at which a security was issued
and its stated redemption price at maturity. Original issue discount is treated
for federal income tax purposes as income earned by the Fund over the term of
the bond, although no cash is actually received by the Fund until the maturity
of the bond, and therefore is subject to the distribution requirements of the
Code. The annual amount of income earned on such a bond by the Fund generally
is determined on the basis of a constant yield to maturity which takes into
account the semiannual compounding of accrued interest.
In addition, some of the bonds may be purchased by the Fund at a discount
which exceeds the original issue discount on such bonds, if any. This
additional discount represents market discount for federal income tax purposes.
The gain realized on the disposition of any bond having market discount,
generally will be treated as taxable ordinary income to the extent it does not
exceed the accrued market discount on such bond (unless the Fund elects to
include market discount in income in tax years to which it is attributable).
Realized accrued market discount on obligations that pay tax-exempt interest is
nonetheless taxable. Generally, market discount accrues on a daily basis for
each day the bond is held by the Fund at a constant rate over the time remaining
to the bond's maturity. In the case of any debt security having a fixed
maturity date of not more than one year from date of issue, the gain realized on
disposition will be treated as short-term capital gain.
EXCISE TAX
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The Fund is potentially subject to a 4% nondeductible excise tax on amounts
required to be but not distributed under a prescribed formula. The formula
generally requires payment to shareholders during a calendar year of
distributions representing at least 98% of the Fund's ordinary income for the
calendar year and at least 98% of the excess of its capital gains over capital
losses realized during the one-year period ending October 31 during such year.
The Fund will adjust its distribution policies to minimize any adverse impact
from this tax or eliminate its application.
TAXATION OF OPTIONS, FUTURES AND SIMILAR INSTRUMENTS
Many of the options, futures contracts and forward contracts entered into
by the Fund will be classified as "Section 1256 contracts." Generally, gains or
losses on Section 1256 contracts are considered 60% long-term and 40% short-term
capital gains or losses ("60/40"). Also, certain Section 1256 contracts held by
a Fund are "marked-to-market" at the times required pursuant to the Code with
the result that unrealized gains or losses are treated as though they were
realized and the resulting gain or loss generally is treated as 60/40 gain or
loss, except for foreign currency gain or loss on such contracts, which
generally is ordinary in character.
Gains from hedging transactions generally are taxable so distributions of
such gains generally will be taxable to shareholders. Generally, the hedging
transactions and certain other transactions in options, futures and forward
contracts undertaken by the Fund may result in "straddles" for federal income
tax purposes. The straddle rules may affect the character of gains (or losses)
realized by the Fund. In addition, losses realized by the Fund on positions
that are part of a straddle may be deferred under the straddle rules rather than
being taken into account in the taxable year in which such losses are realized.
Furthermore, the use of options, futures contracts, notional principal contracts
and short sales - including short sales against the box - to defer recognition
of gain with respect to an "appreciated position" in certain financial
instruments may be deemed a constructive sale of the appreciated position,
requiring the immediate recognition of gain as if the appreciated position were
sold. Because only a few regulations implementing the straddle rules have been
promulgated, and regulations relating to constructive sales of appreciated
positions have yet to be promulgated, the tax consequences of transactions in
options, futures and forward contracts to the Fund are not entirely clear.
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The hedging transactions in which the Fund engages may increase the amount of
short-term capital gain realized by the Fund which is taxed as ordinary income
when distributed to shareholders.
The Fund may make one or more of the elections available under the Code
which are applicable to straddles. If the Fund makes any of the elections, the
amount, character and timing of the recognition of gains or losses from the
affected straddle positions will be determined under rules that vary according
to the election(s) made. The rules applicable under certain of the elections
operate to accelerate the recognition of gains or losses from the affected
straddle positions.
Because application of the straddle rules may affect the character of gains
or losses, defer losses and/or accelerate the recognition of gains or losses
from the affected straddle positions, the amount which must be distributed to
shareholders and which will be taxed to shareholders as ordinary income or long-
term capital gain, may be increased or decreased substantially as compared to a
fund that did not engage in such hedging transactions.
The diversification requirements applicable to the Fund's status as a
regulated investment company may limit the extent to which the Fund will be able
to engage in transactions in options, futures contracts or forward contracts.
Rules governing the tax aspects of swap agreements are in a developing
stage and are not entirely clear in certain respects. Accordingly, while the
Fund intends to account for such transactions in a manner it deems to be
appropriate, the IRS might not accept such treatment. If it did not, the status
of the Fund as a regulated investment company might be affected. The Fund
intends to monitor developments in this area. Certain requirements that must be
met under the Code in order for the Fund to qualify as a regulated investment
company may limit the extent to which the Fund will be able to engage in swap
agreements.
PASSIVE FOREIGN INVESTMENT COMPANIES
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The Fund may invest in shares of foreign corporations which may be
classified under the Code as passive foreign investment companies ("PFICs"). In
general, a foreign corporation is classified as a PFIC if at least one-half of
its assets constitute investment-type assets or 75% or more of its gross income
is investment-type income. If the Fund receives a so-called "excess
distribution" with respect to PFIC stock, the Fund itself may be subject to a
tax on a portion of the excess distribution, whether or not the corresponding
income is distributed by the Fund to Shareholders. In general, under the PFIC
rules, an excess distribution is treated as having been realized ratably over
the period during which the Fund held the PFIC shares. The Fund itself will be
subject to tax on the portion, if any, of an excess distribution that is so
allocated to prior Fund taxable years and an interest factor will be added to
the tax, as if the tax had been payable in such prior taxable years. Certain
distributions from a PFIC as well as gain from the sale of PFIC shares are
treated as excess distributions. Excess distributions are characterized as
ordinary income even though, absent application of the PFIC rules, certain
excess distributions might have been classified as capital gain.
The Fund may be eligible to elect alternative tax treatment with respect to
PFIC shares. Under an election that currently is available in some
circumstances, the Fund generally would be required to include in its gross
income its share of the earnings of a PFIC on a current basis, regardless of
whether distributions are received from the PFIC in a given year. If this
election were made, the special rules, discussed above, relating to the taxation
of excess distributions, would not apply. In addition, another election may be
available that would involve marking-to-market the Fund's PFIC shares at the end
of each taxable year (and on certain other dates prescribed in the Code), with
the result that unrealized gains are treated as though they were realized. If
this election were made, tax at the fund level under the PFIC rules would
generally be eliminated, but the Fund could, in limited circumstances, incur
nondeductible interest charges. Other elections may become available that would
affect the tax treatment of PFIC shares held by the Fund. The Fund's intention
to qualify annually as a regulated investment company may limit its elections
with respect to PFIC shares.
Because the application of the PFIC rules may affect, among other things,
the character of gains, the amount of gain or loss and the timing of the
recognition of income with respect to PFIC shares, as well as subject the Fund
itself to tax on certain income from PFIC shares, the amount that must be
distributed to
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shareholders, and which will be taxed to shareholders as ordinary income or
long-term capital gain, may be increased or decreased substantially as compared
to the Fund that did not invest in PFIC shares.
FOREIGN CURRENCY GAINS AND LOSSES
Under the Code, gains or losses attributable to fluctuations in exchange
rates which occur between the time the Fund accrues income or other receivables
or accrues expenses or other liabilities denominated in a foreign currency and
the time the Fund actually collects such receivables or pays such liabilities
generally are treated as ordinary income or ordinary loss. Similarly, on the
disposition of debt securities denominated in a foreign currency and on the
disposition of certain options, futures, forward and other contracts, gain or
loss attributable to fluctuations in the value of foreign currency between the
date of acquisition of the security or contract and the date of disposition also
are treated as ordinary gain or loss. These gains or losses, referred to under
the Code as "Section 988" gains or losses, may increase or decrease the amount
of the Fund's net investment income to be distributed to its shareholders. If
Section 988 losses exceed other investment company taxable income (which
includes, among other items, dividends, interest and the excess, if any, of net
short-term capital gains over net long-term capital losses) during the taxable
year, the Fund would not be able to make any ordinary dividend distributions,
and distributions made before the losses were realized would be recharacterized
as a return of capital to shareholders or, in some cases, as capital gain,
rather than as an ordinary dividend.
COMMODITY INVESTMENTS
A regulated investment company is required under the Code to derive at
least 90% of its gross income from certain qualifying sources and to have, at
the close of each quarter of the taxable year, at least 50% of the market value
of its assets represented by cash, U.S. government securities, the securities of
other regulated investment companies and other securities, with such other
securities of any one issuer limited for the purposes of this calculation to an
amount not greater than 5% of the value of the Fund's total assets and 10% of
the outstanding voting securities of such issuer. In addition, not more than
25% of the
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value of the Fund's total assets may be invested in the securities of any one
issuer (other than U.S. government securities or the securities of other
regulated investment companies). Qualifying income includes, inter alia,
----------
interest, dividends, and gain from the sale of stock or securities, but it does
not include gain from the sale of commodities such as gold and other precious
metals.
DISPOSITIONS OF FUND SHARES
Upon redemption, sale or exchange of shares of the Fund, a shareholder will
realize a taxable gain or loss, depending on whether the gross proceeds are more
or less than the shareholder's tax basis for the shares. Such gain or loss
generally will be a capital gain or loss if the shares of the Fund were capital
assets in the hands of the shareholder, and generally will be long- or short-
term, depending on the length of time the shares of the Fund were held. A loss
realized by a shareholder on the redemption, sale or exchange of shares of the
Fund with respect to which capital gain dividends have been paid will, to the
extent of such capital gain dividends, be treated as long-term capital loss if
such shares have been held by the shareholder for six months or less at the time
of their disposition. Furthermore, a loss realized by a shareholder on the
redemption, sale or exchange of shares of the Fund with respect to which exempt-
interest dividends have been paid will, to the extent of such exempt-interest
dividends, be disallowed if such shares have been held by the shareholder for
six months or less at the time of their disposition. A loss realized on a
redemption, sale or exchange also will be disallowed to the extent the shares
disposed of are replaced (whether through reinvestment of distributions, or
otherwise) within a period of 61 days beginning 30 days before and ending 30
days after the shares are disposed of. In such a case, the basis of the shares
acquired will be adjusted to reflect the disallowed loss.
Shareholders should be aware that redeeming shares of the Fund after tax-
exempt interest has been accrued by the Fund but before that income has been
declared as a dividend may be disadvantageous. This is because the gain, if
any, on the redemption will be taxable, even though such gains may be
attributable in part to the accrued tax-exempt interest which, if distributed to
the shareholder as a dividend rather than as redemption proceeds, might have
qualified as an exempt-interest dividend.
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Under certain circumstances, the sales charge incurred in acquiring shares
of the Fund may not be taken into account in determining the gain or loss on the
disposition of those shares. This rule applies where shares of the Fund are
exchanged within 90 days after the date they were purchased and new shares are
acquired without a sales charge or at a reduced sales charge. In that case, the
gain or loss recognized on the exchange will be determined by excluding from the
tax basis of the shares exchanged all or a portion of the sales charge incurred
in acquiring those shares. This exclusion applies to the extent that the
otherwise applicable sales charge with respect to the newly acquired shares is
reduced as a result of having incurred a sales charge initially. The portion of
the sales charge affected by this rule will be treated as a sales charge paid
for the new shares.
TAX REPORTING REQUIREMENTS
All distributions, whether received in shares or cash, must be reported by
each shareholder on his or her federal income tax return. Shareholders are also
required to report tax-exempt interest. Dividends declared and payable to
shareholders of record on a specified date in October, November or December, if
any, will be deemed to have been received by shareholders on December 31 if paid
during January of the following year. Redemptions of shares, including
exchanges for shares of another Fund, may result in tax consequences (gain or
loss) to the shareholder and generally are also subject to these reporting
requirements. Each shareholder should consult his or her own tax adviser to
determine the tax status of Fund distributions in his or her own state and
locality.
Under the federal income tax law, the Fund will be required to report to
the IRS all distributions of income (other than exempt-interest dividends) and
capital gains as well as gross proceeds from the redemption or exchange of Fund
shares, except in the case of certain exempt shareholders. Under the backup
withholding provisions of Section 3406 of the Code, all such taxable
distributions and proceeds from the redemption or exchange of a Fund's shares
may be subject to withholding of federal income tax at the rate of 31% in the
case of nonexempt shareholders who fail to furnish the Fund with their taxpayer
identification number and with required certifications regarding their status
under the federal income tax law or if the IRS or a broker notifies the Fund
that the number furnished by the shareholder is incorrect. In addition, both
the Fund and the
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shareholder are potentially subject to a $50 penalty imposed by the IRS if a
correct, certified taxpayer identification number is not furnished and used on
required information returns. If the withholding provisions are applicable, any
such distributions and proceeds, whether taken in cash or reinvested in shares,
will be reduced by the amounts required to be withheld. Backup withholding is
not an additional tax and any amounts withheld are creditable against the
shareholder's U.S. Federal tax liability. Investors may wish to consult their
tax advisers about the applicability of the backup withholding provisions.
FOREIGN TAXES
Investment income and gains received by the Fund from sources outside the
United States may be subject to foreign taxes which were withheld at the
source. If the percentage of the Fund's total assets invested in foreign stocks
and securities at the close of a taxable year is less than [or equal to] 50%,
any foreign tax credits or deductions associated with such foreign taxes will
not be available for use by its shareholders. The effective rate of foreign
taxes to which the Fund will be subject depends on the specific countries in
which the Fund's assets will be invested and the extent of the assets invested
in each such country and, therefore, cannot be determined in advance.
If the percentage of the Fund's total assets invested in foreign stock and
securities is greater than 50% at the close of a taxable year, the Fund may
qualify for and make the election permitted under Section 853 of the Code so
that shareholders will be able to claim a credit or deduction on their federal
income tax returns for, and will be required to treat as part of the amounts
distributed to them, their pro rata portion of qualified taxes paid by the Fund
to foreign countries (which taxes relate primarily to investment income). The
U.S. shareholders of the Fund may claim a foreign tax credit or deduction by
reason of the Fund's election under Section 853 of the Code, provided that more
than 50% of the value of the total assets of the Fund at the close of the
taxable year consists of securities of foreign corporations. The foreign tax
credit and deduction available to shareholders is subject to certain limitations
imposed by the Code. Also, under Section 63 of the Code, no deduction for
foreign taxes may be claimed by shareholders who do not itemize deductions on
their federal income tax returns, although any such shareholder may claim a
credit for foreign taxes and in any event will be treated as having taxable
income in respect to the shareholder's pro rata share of foreign taxes paid by
the Fund.
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It should also be noted that a tax-exempt shareholder, like other shareholders,
will be required to treat as part of the amounts distributed its pro rata
portion of the income taxes paid by the Fund to foreign countries. However,
that income will generally be exempt from taxation by virtue of such
shareholder's tax-exempt status, and such a shareholder will not be entitled to
either a tax credit or a deduction with respect to such income. The foreign tax
credit generally may offset only up to 90% of the alternative minimum tax in any
given year. Foreign taxes generally are not deductible in computing alternative
minimum taxable income.
STATE AND LOCAL TAXES - GENERAL
The state and local tax treatment of distributions received from the Fund
and any special tax considerations associated with foreign investments of the
Fund should be examined by shareholders with regard to their own tax situations.
EXPLANATION OF FUND DISTRIBUTIONS
Each distribution is accompanied by a brief explanation of the form and
character of the distribution. In January of each year, the Fund will issue to
each shareholder a statement of the federal income tax status of all
distributions.
GENERAL INFORMATION
The foregoing discussion generally relates to U.S. federal income tax law
as applicable to U.S. persons (i.e., U.S. citizens and residents and U.S.
domestic corporations, partnerships, trusts and estates). Each shareholder who
is not a U.S. person should consult his or her tax adviser regarding the U.S.
and non-U.S. tax consequences of ownership of shares of the Fund, including the
possibility that such a shareholder may be subject to a U.S. withholding tax at
a rate of 30% (or at a lower rate under an applicable U.S. income tax treaty) on
amounts constituting ordinary income to him or her.
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This discussion of the federal income tax treatment of each Fund and its
shareholders is based on the federal income tax law in effect as of the date of
this SAI.
ORGANIZATION AND CAPITALIZATION
GENERAL
The Fund is a separate series of an open-end investment company, The
MainStay Funds (the "Trust"), established under the laws of The Commonwealth of
Massachusetts by a Declaration of Trust dated January 9, 1986, as amended. The
Fund commenced operations in October, 1997. The organizational expenses of the
Fund will be amortized and deferred over a period not to exceed 60 months. The
Declaration of Trust and By-Laws authorize the Trustees to establish additional
series or "Funds" as well as additional classes of shares.
VOTING RIGHTS
Shares entitle their holders to one vote per share; however, separate votes
will be taken by the Fund or class on matters affecting the Fund or a particular
class of shares issued by the Fund. Shares have noncumulative voting rights,
which means that holders of more than 50% of the shares voting for the election
of Trustees can elect all Trustees and, in such event, the holders of the
remaining shares voting for the election of Trustees will not be able to elect
any person or persons as Trustees. Shares have no preemptive or subscription
rights and are transferable.
SHAREHOLDER AND TRUSTEE LIABILITY
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of such a trust may,
under certain circumstances, be held personally liable as partners for the
obligations of the trust. The Declaration of Trust contains an express
disclaimer of shareholder liability for acts or obligations of the Trust.
Notice of such disclaimer will normally be given in each agreement, obligation
or instrument entered into or executed by
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the Trust or the Trustees. The Declaration of Trust provides for
indemnification by the relevant Fund for any loss suffered by a shareholder as a
result of an obligation of the Fund. The Declaration of Trust also provides
that the Trust shall, upon request, assume the defense of any claim made against
any shareholder for any act or obligation of the Trust and satisfy any judgment
thereon. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which a Fund would be
unable to meet its obligations. The Trustees believe that, in view of the
above, the risk of personal liability of shareholders is remote.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he or she
would otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office.
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OTHER INFORMATION
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, 1177 Avenue of the Americas, New York, New York,
10036, has been selected as independent public accountants of the Trust.
LEGAL COUNSEL
Dechert Price & Rhoads, 1500 K Street, N.W., Washington, D.C. 20005, passes
upon certain legal matters in connection with the shares offered by the Trust,
and also acts as counsel to the Trust.
CODE OF ETHICS
The Trust has adopted a Code of Ethics governing personal trading
activities of all Trustees, officers of the Trust and persons who, in connection
with their regular functions, play a role in the recommendation of any purchase
or sale of a security by the Trust or obtain information pertaining to such
purchase or sale or who have the power to influence the management or policies
of the Trust or an Investment Adviser unless such power is the result of their
position with the Trust or Investment Adviser. Such persons are generally
required to preclear all security transactions with the Trust's Compliance
Officer or his designee and to report all transactions on a regular basis. The
Trust has developed procedures for administration of the Code.
FINANCIAL STATEMENTS
Unaudited financial statements relating to the Fund will be prepared semi-
annually and distributed to shareholders. Audited financial statements will be
prepared annually and distributed to shareholders.
81868.19a
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